What Is an Experience Rating (Insurance)?

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

Key Takeaways

  • Insurance experience ratings are losses an insured party has relative to similar insureds. 
  • Experience ratings help determine the likelihood an insured will file a claim. 
  • Insurers charge higher premiums to risky policyholders, which also incentivizes the policyholder to improve risk management practices. 
  • Experience modifiers are adjustments of annual premiums based on previous loss experience.

How an Experience Rating (Insurance) Works

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.

The experience rating helps an insurance company determine the likelihood that a particular policyholder will file a claim. 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.

For example, an insurance company will look at whether a large-sized construction services company has produced more workers’ compensation claims than similar-sized companies. If the claims occur more often than expected, the insurance company may increase premiums in order to cover the increased expectation of payouts.

By charging higher premiums for more risky policyholders, an insurance company incentivizes a policyholder to improve its risk management practices. For example, a business that is considered high risk for a workers’ compensation claim will have to pay more than a low-risk policyholder. But the high-risk policyholder can improve its safety procedures and workplace conditions to lower its premium. Experience rating is typically based on the three years prior to your most recent expired policy period.

Requirements for Experience Ratings

An experience modifier is the adjustment of annual premium based on previous loss experience. For instance, generally three years of loss experience are used to determine the experience modifier for a workers' compensation policy. An experience modifier is calculated every year. A modifier may be less than, greater than, or equal to "1." A modifier of 1 means that your loss experience is average for your industry group. 

That is, your loss history is no better or worse than other businesses similar to yours. In such a case, your premium will likely remain unchanged. If your modifier is greater than 1, your loss experience is worse than average for your industry group. A modifier that is greater than 1 represents a debit as it will increase your premium. Likewise, a modifier of less than 1 signifies a loss history that is better than average. A modifier of less than 1 will achieve a premium reduction.