Bivariate phase-type distributions for experience rating in disability insurance

Abstract: In this paper, we consider the problem of experience rating within the classic Markov chain life insurance framework. We begin by investigating various multivariate mixed Poisson models with mixing distributions encompassing independent Gamma, hierarchical Gamma, and multivariate phase-type. In particular, we demonstrate how maximum likelihood estimation for these proposed models can be performed using expectation-maximization algorithms, which might be of independent interest. Subsequently, we establish a link between mixed Poisson distributions and the problem of pricing group disability insurance contracts that exhibit heterogeneity. We focus on shrinkage estimation of disability and recovery rates, taking into account sampling effects such as right-censoring. Finally, we showcase the practicality of these shrinkage estimators through a numerical study based on simulated yet realistic insurance data. Our findings highlight that by allowing for dependency between latent group effects, estimates of recovery and disability rates mutually improve, leading to enhanced predictive performance.