Experience Rating
What Does Experience Rating Mean?
In insurance, experience rating is a method that adjusts premium rates based on an insured party’s historical losses compared to others with similar characteristics. This approach is commonly applied to workers’ compensation and liability policies, allowing insurance companies to set premiums that more accurately reflect the policyholder’s actual risk level. The underlying assumption is that past loss patterns will likely continue in the future.
Insuranceopedia Explains Experience Rating
Insurance companies regularly monitor claims filed and paid out under their policies to identify which categories of policyholders are more or less likely to file claims, thereby indicating their level of risk. They then apply experience rating to adjust future premiums, better aligning them with each policyholder’s specific risk level.
In essence, experience rating allows insurers to assess whether a particular policyholder files more claims than others with similar profiles. For example, an insurer might compare a construction company to others of similar size to see if it generates more claims than average. If the construction company has a higher claim rate, its premiums may increase to cover the anticipated rise in payouts.
Insurers also use this data to develop an experience modification factor, which adjusts the premium based on the policyholder’s risk level. By raising premiums for higher-risk policyholders, insurers create an incentive to improve risk management practices. In this example, the construction company might implement better safety procedures and enhance workplace conditions to reduce the likelihood of workers’ compensation claims.
