How Insurance Premiums Are Rated
Expected claims, plus expenses, a margin and profit. Then a method to fit it to the risk.
A premium is not a number an insurer picks to sound reasonable. It starts from the expected cost of claims for a risk of that kind, and then adds the insurer's expenses, a margin for bad years, and a profit. How the expected cost is estimated, for a whole class or for one particular insured, is what rating methods are about.
This is chapter 3 of IC-01. You do not need actuarial maths for it. You need the building blocks of a premium and the names of the rating methods, with a clear picture of when each is used.
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The Rating Methods
- Judgement rating
- The underwriter sets the rate from experience and judgement, because there is too little data to do it statistically. Used for unusual or one-off risks: a film shoot, a satellite launch, a rare art collection.
- Class (manual) rating
- Similar risks are grouped into classes and every member of a class pays the same published rate, for example a rate per ₹1,000 of sum insured by type of occupancy or construction. Simple and cheap to apply to large numbers of small risks.
- Merit rating
- Starts from the class rate and adjusts it up or down for the individual risk. Three forms follow.
- Schedule rating
- Debits and credits for features of the risk itself: a sprinkler system or fire-resistant construction earns a discount, stored chemicals a loading.
- Experience rating
- Uses the insured's own past claims to adjust the next period's premium. The no-claim bonus on a car policy is the everyday Indian example.
- Retrospective rating
- The final premium for a period is fixed after it ends, based on the losses actually incurred in that period, usually within an agreed minimum and maximum. Used for large commercial accounts.
Who Sets the Rate in India Today
In the past many general insurance rates were set by a central tariff that every insurer had to follow. Most of those tariffs have since been withdrawn, and insurers now price most general insurance themselves, subject to IRDAI's product and pricing rules. Motor third-party premiums are still fixed centrally rather than by each insurer.
How IC-01 Tests This
Expect a method matched to a description: "rating based on the insured's past claims" is experience rating; "premium finalised after the policy period on actual losses" is retrospective rating; "a uniform rate for all risks in a category" is class rating. Questions on the premium itself ask what the pure premium represents (expected losses, without expenses or profit).
The trap is between schedule and experience rating. Both adjust a class rate for one insured, but schedule rating looks at physical features now, and experience rating looks at claims in the past.
FAQs
What are the methods of premium rating in insurance?expand_more
Judgement rating, class (manual) rating, and merit rating. Merit rating has three forms: schedule rating, experience rating and retrospective rating.
What is pure premium?expand_more
The part of the premium that covers expected claims only, worked out as expected frequency of loss times average severity. Expenses, contingencies and profit are added on top to give the office premium.
What is experience rating with example?expand_more
Adjusting an insured's premium based on their own past claims. A car owner who claims nothing for a year gets a no-claim bonus on the own-damage premium at renewal.
What is the difference between schedule rating and experience rating?expand_more
Schedule rating adjusts the rate for physical features of the risk, such as construction or fire protection. Experience rating adjusts it for the insured's actual claims history.
Next steps
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