What Is an Experience Rating?
Let me explain what an experience rating is—it's basically the amount of loss that you, as an insured party, experience compared to what similar insured parties go through. You'll see this most often in workers’ compensation insurance, where it's used to figure out the experience modification factor.
Key Takeaways
- Insurance experience ratings are the losses you've had relative to similar insured parties.
- These ratings help determine how likely you are to file a claim as an insured.
- Insurers will charge you higher premiums if you're risky, which pushes you to improve your risk management practices.
- Experience modifiers adjust your annual premiums based on your previous loss experience.
Understanding Experience Ratings
Insurance companies keep a close eye on the claims and losses from the policies they underwrite. This means figuring out if certain groups of policyholders are more likely to make claims, making them riskier to insure.
The experience rating lets an insurance company gauge the chances that you, as a specific policyholder, will file a claim. They use your past loss experience to decide on future premium changes. Generally, it's simpler for them to assess risk for a whole class of policyholders than for you individually.
Take, for example, a large construction services company—if it has more workers’ compensation claims than similar-sized companies, the insurer might raise your premiums to cover the expected higher payouts.
By setting higher premiums for riskier policyholders like you, the company encourages better risk management. If your business is high-risk for workers’ compensation claims, you'll pay more than a low-risk one, but you can lower those premiums by improving safety procedures and workplace conditions. Typically, experience rating looks at the three years before your most recent expired policy period.
How an Experience Rating Is Used
An experience modifier is the adjustment to your annual premium based on your previous loss experience. For a workers' compensation policy, they usually use three years of loss data to calculate this modifier, and it's done every year. The modifier can be less than, greater than, or equal to one.
If your modifier is one, your loss experience is average for your industry group—meaning your history isn't better or worse than similar businesses, so your premium likely stays the same. A modifier greater than one means your losses are worse than average, which will increase your premium for the next period. On the other hand, a modifier less than one shows better-than-average loss history, leading to a premium reduction.
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