RATING AND RESERVING
RATING
There are two broad steps in premiums rating:
Step 1
Determination of an adequate overall premium. This is intended to coverthe expected cost of all
claims, expenses and the required profit margin for allrisks written;
The starting point is the estimated ultimate cost of claims in the most recent past accident years.
An accident year’s ultimate claim cost represents the sum of:
• paid losses;
• reported outstanding losses; and
• the estimated IBNR costs
IBNR, in this context, means allowance for deterioration in reported claims, together with costs
in respect of claims that have occurred but have not been reported as yet.
Usually a company would examine these costs for the past two to three accident years. Since
premium rates however will apply in respect of a future time period, these amounts will need to
be adjusted for actual and expected future claim inflation over the period from the past dates of
payment, until the expected date that the claims will be paid, under the newly rated policies.
Further adjustments may also be required if there have been changes in policy conditions
between the past coverages and the new policies
Finally since there will be a period between the receipt of the premium and the payment of
claims it is appropriate to allow for expected investment earnings.
Allowance should be made in these estimates for all direct and indirect administrative costs of
claim settlement.
Step 2
Determination of a basis for differential rating. The aim here is toappropriately price different
risk groups contained within the particular risk portfolio (eg motor portfolio).
If we consider a particular case of motor insurance:
The major risk factors associated with this class of general insurance might include:
• The distance driven over the duration of the insurance policy ( a good measure ofthe
chances of a moving traffic accident )
• Traffic density
• The quality of a driver and the driver’s reaction time.
• The driver’s average speed
• The driver’s natural degree of caution (risk aversion)
• Time that the vehicle is parked in area where thieves operate.
• Value of goods kept in the car (e.g. car radio)
• Car alarm
• Sensitivity of the car’s electronic system to the water damage.
Some of these factors cannot be measured, such as risk aversion while others such as such as
traffic density can be measured in theory, but would be impractical to do so. Since many of the
, risk factors above are difficult to measure directly, it is necessary to summarize these risk factors
into a set of Rating Factors that are measurable and can be used practically.
Rating factors fall under three categories:
• Factors associated with the policyholder.
• Factors associated with the vehicle.
• Factors relating to the coverage.
Each of these factors has a number of levels, for example;
• Age of driver may be broken into 10 or more levels such as ages up to 20, 20–25, 25–30,
31–35, etc.;
• No claim discount may have 6 levels, 0%, 20%, 25%, 35%, 45% and 50%, and so on.
With relation to factors relating to coverage is the claim experience of an individual. This brings
about the aspect of experience rating. Experience rating systems are systems by which the
premium for an individual risk takes into account the claims experience of that individual
risk.e.g. No Claim Discount schemes,
Merits of using Experience Rating
a) Small claims may be discouraged (benefits Insurer).
b) Gives the policyholder an incentive to be cautious and take precautions toavoid claims
(benefits Insurer and Insured).
c) Rewards good claims experience and penalizes bad claims experience(benefits Insurer
and Insured).
d) Premium charged should be more representative of the risk of the policyholderhaving a
claim (more so by amount rather than by number) (benefits Insurerand Insured).
e) May encourage customer loyalty.
f) Can increase insurance companies’ control of underwriting for large risks(benefits
Insurer).
Demerits of using Experience Rating
a) Operates against the insurance principle of spreading costs (drawbackInsured).
b) Can make policyholders feel aggrieved if after many years claim free drivingthey have a
claim and are penalized for it, e.g. in NCD systems (drawbackInsurer and Insured).
c) Can make policyholders feel aggrieved if they lose discount through a claimthat was not
their fault.
d) Penalty for having a claim may be a large increase in premium, e.g. loss ofNCD
(drawback Insured).
e) Limited ability to distinguish between high and low risks if on average oneclaim is made
by a policyholder once every five years (drawback Insurer).
f) Does not achieve objective of rewarding better risks as the reward is given fornot making
a claim and not for being accident free (drawback Insured forNCD systems)
In addition to rating of insurance products is the incorporation of excess or deductible within the
policy cover to improve the claims experience.
The excess is the sum specified in the policy, that the insured must bear before any liability falls
upon the insurer.
If Sum insured = S. Excess = E. Loss = L and
• If L >S + E, insured pays L – S and insurer pays S.
• If L >E but L <Sinsured pays E and insurer pays L – E.
The deductible is the amount deductible from claim amount, payable by policyholder.
If Sum insured = S. Deductible = D. Loss = L.
RATING
There are two broad steps in premiums rating:
Step 1
Determination of an adequate overall premium. This is intended to coverthe expected cost of all
claims, expenses and the required profit margin for allrisks written;
The starting point is the estimated ultimate cost of claims in the most recent past accident years.
An accident year’s ultimate claim cost represents the sum of:
• paid losses;
• reported outstanding losses; and
• the estimated IBNR costs
IBNR, in this context, means allowance for deterioration in reported claims, together with costs
in respect of claims that have occurred but have not been reported as yet.
Usually a company would examine these costs for the past two to three accident years. Since
premium rates however will apply in respect of a future time period, these amounts will need to
be adjusted for actual and expected future claim inflation over the period from the past dates of
payment, until the expected date that the claims will be paid, under the newly rated policies.
Further adjustments may also be required if there have been changes in policy conditions
between the past coverages and the new policies
Finally since there will be a period between the receipt of the premium and the payment of
claims it is appropriate to allow for expected investment earnings.
Allowance should be made in these estimates for all direct and indirect administrative costs of
claim settlement.
Step 2
Determination of a basis for differential rating. The aim here is toappropriately price different
risk groups contained within the particular risk portfolio (eg motor portfolio).
If we consider a particular case of motor insurance:
The major risk factors associated with this class of general insurance might include:
• The distance driven over the duration of the insurance policy ( a good measure ofthe
chances of a moving traffic accident )
• Traffic density
• The quality of a driver and the driver’s reaction time.
• The driver’s average speed
• The driver’s natural degree of caution (risk aversion)
• Time that the vehicle is parked in area where thieves operate.
• Value of goods kept in the car (e.g. car radio)
• Car alarm
• Sensitivity of the car’s electronic system to the water damage.
Some of these factors cannot be measured, such as risk aversion while others such as such as
traffic density can be measured in theory, but would be impractical to do so. Since many of the
, risk factors above are difficult to measure directly, it is necessary to summarize these risk factors
into a set of Rating Factors that are measurable and can be used practically.
Rating factors fall under three categories:
• Factors associated with the policyholder.
• Factors associated with the vehicle.
• Factors relating to the coverage.
Each of these factors has a number of levels, for example;
• Age of driver may be broken into 10 or more levels such as ages up to 20, 20–25, 25–30,
31–35, etc.;
• No claim discount may have 6 levels, 0%, 20%, 25%, 35%, 45% and 50%, and so on.
With relation to factors relating to coverage is the claim experience of an individual. This brings
about the aspect of experience rating. Experience rating systems are systems by which the
premium for an individual risk takes into account the claims experience of that individual
risk.e.g. No Claim Discount schemes,
Merits of using Experience Rating
a) Small claims may be discouraged (benefits Insurer).
b) Gives the policyholder an incentive to be cautious and take precautions toavoid claims
(benefits Insurer and Insured).
c) Rewards good claims experience and penalizes bad claims experience(benefits Insurer
and Insured).
d) Premium charged should be more representative of the risk of the policyholderhaving a
claim (more so by amount rather than by number) (benefits Insurerand Insured).
e) May encourage customer loyalty.
f) Can increase insurance companies’ control of underwriting for large risks(benefits
Insurer).
Demerits of using Experience Rating
a) Operates against the insurance principle of spreading costs (drawbackInsured).
b) Can make policyholders feel aggrieved if after many years claim free drivingthey have a
claim and are penalized for it, e.g. in NCD systems (drawbackInsurer and Insured).
c) Can make policyholders feel aggrieved if they lose discount through a claimthat was not
their fault.
d) Penalty for having a claim may be a large increase in premium, e.g. loss ofNCD
(drawback Insured).
e) Limited ability to distinguish between high and low risks if on average oneclaim is made
by a policyholder once every five years (drawback Insurer).
f) Does not achieve objective of rewarding better risks as the reward is given fornot making
a claim and not for being accident free (drawback Insured forNCD systems)
In addition to rating of insurance products is the incorporation of excess or deductible within the
policy cover to improve the claims experience.
The excess is the sum specified in the policy, that the insured must bear before any liability falls
upon the insurer.
If Sum insured = S. Excess = E. Loss = L and
• If L >S + E, insured pays L – S and insurer pays S.
• If L >E but L <Sinsured pays E and insurer pays L – E.
The deductible is the amount deductible from claim amount, payable by policyholder.
If Sum insured = S. Deductible = D. Loss = L.
