Policy Year Experience

What Is Policy Year Experience?

Policy year experience refers to the combination of all premiums and losses associated with a particular insurance policy, or set of policies, over a specified year. It is a widely used performance metric in the insurance industry.

Importantly, the policy year experience only measures the performance of underwritten or renewed policies during the specified year. By contrast, the calendar year experience measures the performance of all policies held by an insurer, regardless of when those policies were initiated.

Understanding Policy Year Experience

In the insurance industry, there is often a gap between the time when losses are incurred by an insurer and the time when those claims are actually paid. For example, an insurer might receive a claim in November 2019, but they might only pay that claim in May 2020.

For this reason, insurers must estimate the performance of their policy-writing activities on an ongoing basis, in order to determine whether the premiums they charge are sufficient to cover their expected future losses. Performance measurements—such as policy year experience and calendar year experience—are some of the tools that insurers use to monitor their own profitability.

Oftentimes, a customer who purchases insurance may take several months or even years before making a claim on their insurance policy. In the meantime, they will pay monthly premiums on their insurance contract, creating revenue for the insurer. This means that there is a crucial timing difference between the date an insurer receives money and the moment they must use that money to honor customers’ claims. 

Because of this, in addition to recording the claims they pay to customers each year, insurers also record the losses they expect to incur on a contract in the future—even before those payments are made. This accounting entry, known as the insurer’s loss reserve, helps prevent the insurer from underestimating its potential future liabilities and thereby overestimating its short-term profitability. The policy year experience measures the premiums paid on those policies against its realized and expected future losses. Provided the insurer’s loss reserve estimates are accurate, the policy year experience should prove to be a relatively accurate gauge of the profitability of their underwriting.

Example of Policy Year Experience

Emma is an insurance manager tasked with reviewing the performance of a set of policies. Because she is responsible for a specific book of business, one of her preferred performance metrics is the policy year experience. Unlike the calendar year experience, which relates to all the premiums and losses associated with a specific calendar year, the policy year experience includes only those policies which were initiated or renewed during the year in question.

In conducting this review, Emma begins by considering all of the premiums earned on policies underwritten or renewed during the current year. This part of the analysis is relatively straightforward since the premiums in question have already been paid by the customers. Next, she determines all of the losses that have already been paid on those contracts during the current year.

The last part, however, is the most complex, because it requires Emma to review the loss reserves for her portfolio of policies. These loss reserves are essentially predictions of losses that have not yet occurred. If those projections are overly optimistic, they could lead her to overestimate her policy year experience. Likewise, if the projections are too pessimistic, her policy year experience may be understated.