Process risk and parameter risk
What do process and parameter risks mean in this sentence:
"The claim count uncertainty is parameter risk, whereas the severity uncertainty is process risk."
What do process and parameter risks mean in this sentence:
"The claim count uncertainty is parameter risk, whereas the severity uncertainty is process risk."
Comments
When we have a split loss plan the primary loss portion represents claim frequency while the excess portion represents claim severity. Since the excess portion is generally driven by relatively few but large claims, it is essentially somewhat random which means you can think of it as capturing process risk. Remember, process risk is the uncertainty due to random events occurring.
Whereas parameter risk is the uncertainty that arises from potentially using incorrect parameter values in your model. In this case, workers' compensation distributions are driven by lots of small claims so the claim count uncertainty is parameter risk and this comes from possibly choosing a poor split point for distinguishing between primary and excess losses.
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