Modelling extreme claims via composite models and threshold selection methods

Abstract The existence of large and extreme claims of a non-life insurance portfolio influences the ability of (re)insurers to estimate the reserve. The excess over-threshold method provides a way to capture and model the typical behaviour of insurance claim data. This paper discusses several composite models with commonly used bulk distributions, combined with a 2-parameter Pareto distribution above the threshold. We have explored how several threshold selection methods perform when estimating the reserve as well as the effect of the choice of bulk distribution, with varying sample size and tail properties. To investigate this, a simulation study has been performed. Our study shows that when data are sufficient, the empirical rule has the overall best performance in term of the quality of the reserve estimate. The second best are either the square root rule or the exponentiality test. The latter works better when the right tail of the data is extreme. As the sample size becomes small, the best performance is obtained with simultaneous estimation. Further, the influence of the choice of bulk distribution seems to be rather large, especially when the distribution is heavy-tailed. Moreover, it shows that the empirical estimate of p ≤ b , the probability that a claim is below the threshold, is more robust than the theoretical one.