Experiencerating is a method of calculating the rate of premiums a policyholder is supposed to pay based on past loss experiences. Thismethod of determining premiums is based on the assumption that thelikelihood of a loss in the future can be predicted by the incidencesof loss in the past. It assumes that if an individual or an entityhas suffered losses in the past, there is a likelihood of sufferingsimilar losses in the future. There are many reasons why experiencerating is a more fair method of determining premium rates. Forexample, in workers compensation policy, a business entity is chargedpremiums that reflect the level of risks the employees are exposed toin the workplaces. Therefore, a low risk workstation will pay fairpremiums compared to a high risk workplace. As a result, employersare likely to benefit from improved occupational safety since it hasa direct impact on the experience modifier. In the long run,organizations will implement occupational safety programs, thusreducing claims. This is beneficial to the employers, employers andthe insurance industry. Additionally, experience rating is fairbecause it ensures that insurance companies are able to collectpremiums at a rate that can cover the risks they intend to cover.This ensures that the insurers do not collect low or high premiumsrelative to the risk covered. However, experience rating is notapplicable in all instances when premiums are being calculated. Forexample, in some states, there is a minimum time period of operationsrequired or the minimum amount of premiums which limits theapplicability of the experience modifiers. The main drawbacks toexperience rating includes the unavailability of policy informationrelating to each of the claim included in the rating, possiblechanges in the business operations and the fact that only largelosses are considered (Mata & Verheyen, 2005).
Mata,A. & Verheyen, M. (2005). An Improved method for experiencerating reinsurance treaties using exposure rating techniques.Casualtyactuarial society forum,Spring 2005.