Credibility theory

Credibility theory is a statistical method used in insurance and risk management to improve the accuracy of predictions by combining historical data with broader industry or population data. It adjusts the weight given to an individual’s past experience based on its reliability; more recent and consistent data have a greater influence, while less certain data has less impact. This approach helps insurers set more precise rates and reserves, balancing specific experience with overall trends to better reflect future outcomes. Essentially, it ensures predictions are neither overly dependent on limited data nor ignoring valuable historical information.