Explaining functional principal component analysis to actuarial science with an example on vehicle insurance

Given the high competitiveness in the vehicle insurance market, the need arises for an adequate pricing policy. To this end, insurance companies must select risks in a way that allows the expected claims ratio to come as close as possible to the real claims ratio. The use of new analytical tools which provide more information is of great interest. In this paper it is shown how functional principal component analysis can be useful in actuarial science. An empirical study is carried out with data from a Spanish insurance company to estimate the risk of occurrence of a claim in terms of the driver’s age, whilst taking into account other relevant variables.