What Is Experience Rating?

Experience rating is a type of assessment that is sometimes used to determine the cost of various goods and services, based on the historical data collected on the buyer or applicant. This type of rating process is often used by insurance companies to evaluate relevant data collected about individuals or companies seeking some type of insurance policy, making it possible to determine the total cost and the breakdown of monthly premiums that the insurance provider is willing to extend to the applicant. The process of an experience rating may help to lower costs for the applicant or may lead to higher costs as the provider seeks to minimize the perceived risk of doing business with the customer.

The most common application of an experience rating occurs when insurance companies are evaluating the applications of prospective clients. As part of the process, the provider will look into the background of the applicant and identify any information that could have some impact on the relationship, particularly the potential of leading to claims on the coverage at a later date. For example, many health insurance companies will focus on any major health issues that the applicant has experienced in the past, as well as any ongoing conditions that were diagnosed prior to the insurance application. Based on the detail gathered and evaluated, the rating may indicate that the applicant presents a reasonable risk and is able to secure the insurance at equitable rates. In other instances, the experience rating may indicate that the risk to the provider is too great and the application will be rejected.

Not all situations in which an experience rating is used has to do with identifying factors that could disqualify the applicant or at least place that candidate into a higher risk group. In some cases, providers will look for evidence of historical data that indicates the applicant represents an excellent risk. For example, an applicant for auto insurance who has not been involved in an accident or even had traffic citations in the last several years would likely be a desirable client for a car insurance provider. Based on the exact rating that results from the evaluation, the applicant may qualify for discounts off standard pricing that translate into very low premiums for a considerable amount of coverage.

The mechanics of how an experience rating is calculated will vary somewhat, based on any governmental laws and regulations that may apply to the extension of insurance coverage, and the criteria that the provider has identified as essential to evaluating applications. By using a rating system to qualify applications, and even to evaluate the status of current customers, the insurance provider makes it possible to avoid underwriting policies that ultimately cost a great deal of money and will likely result in the necessity of raising premiums for other customers in order to offset that cost. From this perspective, the use of an experience rating not only benefits the provider, but every current customer of that provider.