Lakhasly

When allowed by law, insurers generally use elaborate risk classification systems.Classification involves grouping together consumers with similar characteristics and charging them a premium or rate that differs from consumers with different characteristics.This section describes some of the common classification methods used by insurers.Subsequent chapters provide more detail on the classification methods used in specific lines of business.

When allowed by law, insurers generally use elaborate risk classification systems. This section describes some of the common classification methods used by insurers. Subsequent chapters provide more detail on the classification methods used in specific lines of business.
Classification involves grouping together consumers with similar characteristics and charging them a premium or rate that differs from consumers with different characteristics.
The termn rate often is used synonymously with "premium" in the insurance business. In other cases,
it refers to the price per unit of coverage (e.g., $1,000 of life insurance), with the total premium equal to the rate per unit of coverage times the amount of coverage pur-chased. These risk classes and the rates charged to each risk class are based on analysis performed by actuaries who examine historical data and estimate expected claim costs. They also are affected by competition and, in many states, regulation Each insurer then employs selection standards to determine whether an applicant in a given class will be offered coverage at the insurer's class rate.
As was introduced in Chapter 5, the overall process of assessing the expected claim costs for buyers, determining the applicable rate, and deciding whether to offer coverage is known as underwriting. Class rates and associated underwriting standards generally differ across insurers. Insurers with more stringent standards generally offer lower premiums in any given class. For many types of business insurance, the underwriter also has substantial flexibility to modify the class rate to reflect the underwriter's evaluation of additional characteristics of the business applicant, such as the condition of business premises or property, the existence of safety programs, and so on. This procedure is commonly known as schedule rating.

• Class rates and underwriting standards are based on a variety of characteristics of the buyer. For many types of insurance, class rates are modified to reflect the prior loss experience of the applicant. These modifications are known as experience rating, or merit rat-ing. A special form of experience rating is known as a bonus-malus or no-claims discount system (see Box 81). Medium-to-large businesses also may have their premiums for a given coverage period modified based on loss experience during the same period. This is known as retrospective experience rating
  For example, workers' compensation insurance rates are routinely based on the buyer's prior loss experience, except for very small businesses where the prior loss experience has little ability to predict future claim costs (see below). Rates for larger firms also often reflect their claims experience during the coverage period. Personal auto insurance rates generally will be increased for drivers involved in an accident, at least when the driver is at fault. The simple reason is that the driver's past auto accident experience helps to predict future claim costs. People that cause accidents in a given year on average have more accidents during the next three to five years than people who do not.
  However, a fundamental feature of insurance pricing for individuals and small- and medium-sized businesses is that factors besides prior loss experience of the buyer (or other direct evidence of risky activity, such as traffic citations for automobile insurance or safety regulation violations for a business) have a major effect on prices. The reason for this is that the use of nonexperience factors leads to substantially improved estimates of future loss ex-perience. As noted above for the case of workers' compensation insurance for very small businesses, experience rating sometimes is not used at all because a buyer's prior loss experience does not reliably predict future claim costs. In the language of actuaries, the loss experience has insufficient credibility for use in rating.