DEFINITION of 'Experience Rating Insurance'

The amount of loss that an insured party experiences compared to the amount of loss that similar insureds experience. Experience rating is most commonly associated with workers’ compensation insurance. It is used to calculate the experience modification factor.

BREAKING DOWN 'Experience Rating Insurance'

Insurance companies closely monitor the claims and losses that come from the policies that they underwrite. This evaluation includes determining whether certain classes of policyholders are more prone to claims, and are thus more risky to insure.

This also allows the insurance company to determine the likelihood that a particular policyholder will result in claims being filed. In this sense, the past loss experience of a policyholder is used to determine future changes to the premium charged for the policy. In general, it is easier for an insurance company to determine the risk associated with an entire class of policyholders, but harder to determine how risky an individual policyholder is.

Experience ratings are used to determine whether a policyholder is resulting in more claims than similar policyholders. For example, an insurance company will look at whether a medium-sized manufacturing company has produced more workers’ compensation claims than other similar-sized companies. If the claims coming from the insured’s policy are at a higher rate than expected, the insurance company will increase the policy premiums in order to cover the increased expectation of having to pay out losses.

Insurers develop an experience modification factor based off of the likelihood of a policyholder filing claims. By charging a higher premium for more risky policyholders, the insurance company is creating an incentive for the policyholder to improve its risk management techniques. For example, a business that is considered a high risk for a workers’ compensation claim will have to pay more than a low risk policyholder. In order to reduce its premium, the high-risk policyholder could improve its safety procedures and workplace conditions.

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