Exponential Utility Theory Ratemaking: An Alternative Ratemaking Approach

The alternative ratemaking methodology proposed here is based on the use of an exponential utility function to describe an insurer's attitude toward risk. Justification for a utility theory approach is provided by considering the relationship between risk, uncertainty, and ratemaking. The specific choice of the exponential utility function results from the fact that this utility function satisfies certain axioms about ratemaking. Several of the properties of an exponential utility theory ratemaking system are Leonard R. Freifelder is assistant professor of operations research, Temple University. He holds a Ph.D. in operations research from the University of Pennsylvania. Professor Freifelder is an Associate Fellow, Society of Actuaries. This paper is based on his book A Decision Theoretic Approach to Insurance Ratemaking published by Richard D. Irwin, Inc., 1976, for the S. S. Huebner Foundation for Insurance Education. Dr. Freifelder received the 1978 C. A. Kulp Award from the American Risk and Insurance Association for the outstanding original contribution made to the literature of insurance by this book. This paper was presented at the annual meeting of the American Statistical Association in San Diego, California, August 1978.