What Is a Composite Rate?
A composite rate is an insurance premium based on the average risk profile of a group rather than the risk profile of an individual policyholder. A composite rate implies that all members of a particular group pay the same insurance premium for coverage against a specific peril.
Composite rates apply to group benefits, such as insurance, that an employer or other organization offers to its workers or members. For group life insurance, for example, a composite rate is used with coverage guaranteed to all group members. Unlike with individual policies, such group insurance doesn’t require a medical exam.
- A composite rate is used in insurance underwriting for group coverage policies.
- As opposed to an individual rate that generates risk premia that correspond to an individual's demographic and behavioral factors, composite rates use a population or sample average instead.
- The composite rate is often applied to all individuals covered in a group, regardless of individual differences.
Understanding Composite Rates
When an insurance company underwrites a new policy, it agrees to indemnify the policyholder against a particular peril in exchange for a premium payment. Determining the amount of premium to charge the policyholder is a critical step in the underwriting process. Underestimating the severity or the frequency of possible claims can lead the insurer to undercharge the policyholder for coverage. Undercharging may cause the insurer to use capital reserves, which will make the policy unprofitable.
Insurance companies use several different methods when determining the amount of premium to charge for any particular insurance policy. The process used depends on whether the assignment of a rate is for a single risk, such as health insurance for an individual, or for a group, such as health insurance for a business with multiple employees.
Determining Individual and Composite Rates
For the determination of a rate for an individual, the company will examine the individual’s risk profile. In the case of health insurance, this profile includes the potential policyholder’s age, smoking status, and where the individual lives. The insurer will use actuarial tables to determine the likelihood of the policyholder making a claim and sets the premium accordingly.
An insurance company will approach the setting of a composite rate differently than they do for individual policies. Rather than look at a single risk profile, the insurer looks at the risk profile for the entire group. The number of group members helps to determine the average composite rate. The underwriter will combine the risk profiles of all individuals and arrive at the average risk profile. They use this average profile to set the premium. Each member of the group will pay the same premium.
Composite rates benefit older, less healthy individuals because everyone is paying the same price. Younger, healthier individuals may be able to locate less expensive individual policies. While the policies may be less expensive, the employer-sponsored plan offers insurance tax benefits and time savings from not researching countless options.
While composite rates allow all employees to pay the same premium for health insurance on an individual basis, the price will differ for employees with different family situations. The employee may apply as a single member, a member plus spouse, or a member plus family. Each level of coverage has a corresponding premium. Since the policy is a composite rate, an employee with one child will pay the same family rate as an employee with four children.