September 2006 Q A5

[snerap@gmail.com]

On what basis is the movement happening in this markov chain?

 

[Mark Mitchell]

Movement between states in this model is dependent on whether the policyholder does or does not make a claim during the year.

 

[snerap@gmail.com]

Yeah but why is there a movement between states (1,0) & (0,1) ? These states represent claims in last to last year and claims in last year respectively.

 

[Mark Mitchell]

So:

(1,0) = no claims in most recent year, claims in the year before that
(0,1) = claims in the most recent year, no claims in the year before that

Then, for example, we move from (1,0) to (0,1) if we make a claim next year. Then there will be claims in the most recent year, and in the year before that (which was the most recent year in the last time period) there were no claims.

 

[snerap@gmail.com]

Ohh wow... Didn't think of it this way. It helped! Thank you so much!!