Experience Ratings in Insurance

What Is an Experience Rating?

An experience rating is the amount of loss that an insured party experiences compared to similar parties. It is commonly used for workers’ compensation insurance to calculate the experience modification factor.

Key Takeaways

• Insurance experience ratings are losses relative to similar parties.
• Experience ratings help determine the likelihood of filing a claim.
• Insurers charge higher premiums to risky policyholders, incentivizing better risk management practices.
• Experience modifiers adjust annual premiums based on previous loss experience.

Understanding Experience Ratings

Insurance companies monitor claims and losses from the policies they underwrite. This includes identifying classes of policyholders prone to claims and considered risky to insure.

The experience rating helps insurers predict the likelihood of a policyholder filing a claim. Past loss experience determines future premium changes. Assessing the risk of a whole class of policyholders is easier compared to determining the risk of an individual policyholder.

For example, an insurance company assesses if a large construction services company has more workers’ compensation claims than similar-sized companies. If claims exceed expectations, the insurer may increase premiums to cover the higher payout expectancy.

By charging higher premiums to risky policyholders, insurers motivate them to improve risk management practices. A high-risk business for workers’ compensation can reduce premiums by enhancing safety procedures and workplace conditions. Experience rating is typically based on the three years preceding the most recent policy period.

How an Experience Rating Is Used

An experience modifier adjusts annual premiums based on previous loss experience, usually using three years of loss experience for workers’ compensation policies. The modifier is recalculated annually and can be less than, greater than, or equal to one.

A modifier of one means average loss experience for the industry group. Premiums remain unchanged in this case. A modifier exceeding one indicates worse-than-average loss experience and increases the premium. Conversely, a modifier below one signifies better-than-average loss history, resulting in a premium reduction.