Example – predicting medical expenses using linear regression

In order for a health insurance company to make money, it needs to collect more in yearly premiums than it spends on medical care to its beneficiaries. Consequently, insurers invest a great deal of time and money to develop models that accurately forecast medical expenses for the insured population.

Medical expenses are difficult to estimate because the costliest conditions are rare and seemingly random. Still, some conditions are more prevalent for certain segments of the population. For instance, lung cancer is more likely among smokers than non-smokers, and heart disease may be more likely among the obese.

The goal of this analysis is to use patient data to forecast the average medical care expenses for such population segments. These estimates could be used to create actuarial tables that set the price of yearly premiums higher or lower according to the expected treatment...