Subj G - Sept 1994 - Paper 1 - Q8. The solution to this question says the following: "The presence of large claims causes distortion. Hense we include each large claim up to a maximum cut-off point - apply grossing up factor". Explain why we can do this when we would want to charge a premium to reflect some large claims? Why do we cut it off because then we're charging premiums that are too low? I do understand why you would exlude a CAT completely and then load for it at the end of the analysis. Is it the same thing with an individual large claim, except we do allow for some of it within one year, but re-spread the excess over all years (whereas with a CAT we re-spread it all over all years?) This comes up again and again in pricing questions and would like to clarify. Thanks
The grossing up factor is the 'extra' allowance for the possibility of large claims. Because large claims and cats are volatile in terms of frequency, it's best to truncate them all at a certain level (attritional claims should be reasonably stable and therefore easier to project), then add a bit more for the annual probability of large claims/cats.
