Individual Risk Rating

Individual risk rating plans modify class (manual) rates to reflect the unique characteristics and loss experience of a specific risk.

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1. Experience Rating

Experience rating uses the insured’s own historical loss experience during a recent period (typically 3 years) to adjust the premium for the upcoming policy period.

Purpose

• To increase pricing equity by reflecting the insured’s actual risk quality.
• To incentivize loss control and safety measures.

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Method A: ISO CGL Experience Modification (Commercial General Liability)

The ISO CGL plan calculates an experience modification factor based on basic limits and maximum single loss (MSL) constraints.

1. Expected Development

• Basic Limits Expected Loss (BLEL): $\text{BLEL} = \text{Expected Loss Ratio (ELR)} \times \text{Basic Limits Earned Premium (BLEP)}$
• Detrended BLEL: Also referred to as the Current Subject Loss Cost (CSLC). If the trend rate is $0\%$, $\text{CSLC} = \text{BLEL}$.
• Expected Unreported/Developed Losses: Calculated using the Bornhuetter-Ferguson (B-F) method: $\text{Expected Unreported Losses} = \text{CSLC} \times \% \text{ Unreported}$
• MSL-Limited Expected Development: If unreported losses are estimated, scale them by the Expected Excess Ratio (EER) to reflect capping by the MSL: $\text{Expected Dev} = \text{CSLC} \times \% \text{ Unreported} \times \text{EER}$ (Only apply the EER when estimating unreported losses; if actual unreported losses are already given, do not apply EER.)

2. Actual Capped Losses

• Cap each individual historical loss at the basic limit.
• Cap the sum of losses and ALAE for each accident at the Maximum Single Loss (MSL) threshold: $\text{Actual Losses} = \text{Capped Basic Limits Loss \& ALAE (subject to MSL)}$

3. Experience Modification Factor (Mod)

Calculate the Actual Loss Ratio (AER): $\text{AER} = \dfrac{\text{Actual Losses} + \text{Expected Development}}{\text{CSLC}}$ $\text{Mod} = \dfrac{\text{AER} - \text{EER}}{\text{EER}}$ $\text{Final Premium} = \text{Manual Premium} \times (1 + \text{Mod})$

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Method B: NCCI Experience Modification (Workers’ Compensation)

The NCCI experience rating plan applies to Workers’ Compensation losses (excluding ALAE) and splits losses into Primary and Excess layers.

Primary vs. Excess Split

For each claim $i$:

• Primary Loss ($A_{p, i}$): The portion of the loss up to a specified threshold (e.g., $15,000).
• Excess Loss ($A_{e, i}$): The portion of the loss above the threshold: $A_{e, i} = \text{Loss}_i - A_{p, i}$
• Aggregates: $A_p = \sum A_{p, i}$, $A_e = \sum A_{e, i}$, and Total Actual Losses $\hat{A} = A_p + A_e$.

NCCI Mod Formula

$\text{Mod} = \dfrac{A_p + W \cdot A_e + (1 - W) E_e + B}{E + B} = \dfrac{A_p + W \cdot A_e + B}{E + B}$ Where:

• $E$: Total expected losses ($\sum E_i$).
• $E_p$: Expected primary losses ($\sum D_i \cdot E_i$, where $D_i$ is the NCCI D-ratio).
• $E_e$: Expected excess losses ($E - E_p$).
• $W$: Weight factor for excess losses ($0 \leq W \leq 1$).
• $B$: Ballast value (acts to stabilize the mod for smaller risks).
• Primary Credibility: $Z_p = \dfrac{E}{E+B}$
• Excess Credibility: $Z_e = W \cdot Z_p$

Expected Loss Component

• Expected Losses ($E_i$): $E_i = \dfrac{\text{Payroll}_i}{100} \times \text{Expected Loss Rate (ELR)}_i$
• Expected Primary Losses ($E_{p, i}$): $E_{p, i} = E_i \times D\text{-ratio}_i$

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2. Schedule Rating

Schedule rating subjectively adjusts manual premium based on physical or operational risk characteristics that are not captured by class rates or experience rating.

• Maximum Bounds: Standard plans restrict the maximum credit (discount) or debit (surcharge) permitted for individual categories.
• Double-Counting Warning: Never apply a schedule rating adjustment for characteristics that are already fully reflected in the experience rating period.
  • Example: A employee safety training program implemented 10 years ago is already fully reflected in the historical loss experience. No schedule credit should be applied.
  • Example: A new security system installed this year is not yet reflected in the historical experience period. A schedule credit is appropriate.

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3. ISO Composite Rating Plan for Loss-Rated Risks

Composite rating simplifies billing by rating multiple coverages using a single, easily measurable exposure base (e.g., sales or payroll) instead of rating each coverage separately.

Loss-Rated Composite Rate Calculation

For individual risks, we do not assume uniform writings; instead, policies are written at specific dates (e.g., January 1).

1. Trend Ultimate Losses: Project ultimate losses and ALAE for each coverage to the prospective average accident date.
2. Trend Exposures: Project historical exposures to the prospective period.
3. Calculate Adjusted Premium: $\text{Adjusted Premium} = \dfrac{\text{Trended Ultimate Losses \& ALAE}}{\text{Expected Loss Ratio (ELR)}}$
4. Determine Composite Rate: $\text{Composite Rate} = \dfrac{\sum \text{Adjusted Premium}}{\sum \text{Trended Exposures}}$

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4. Large Deductible Policies

Under a large deductible policy, the insured reimburses the insurer for losses below a high threshold (e.g., $100k or $250k per claim).

Key Considerations

• Claims Handling: Clarify who administers claims. Insured handling (via a Third Party Administrator - TPA) may reduce loss control incentives. Insurer handling increases ULAE.
• Credit Risk: Since the insurer pays claims first and bills the insured for the deductible portion, the insurer faces credit risk if the insured becomes insolvent.
• Risk Margin: Expected losses above high deductibles are highly volatile and difficult to estimate, requiring a higher profit provision.

Large Deductible Premium Formula

$\text{Premium} = \dfrac{\text{Expected Losses Above Deductible} + \text{Expected ALAE} + \text{Deductible Processing Cost} + \text{Credit Risk Charge} + \text{FE}}{1 - V - Q_t}$

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5. Retrospective Rating

Retrospective rating adjusts the policy premium after the policy period ends, based on the actual losses incurred during that policy term.

Prospective vs. Retrospective Rating

Feature	Retrospective Rating	Prospective Rating (Experience & Schedule)
Responsiveness	High: Losses immediately impact the current term’s premium.	Low: Losses impact premiums only upon policy renewal.
Stability	Low: Premium fluctuates as losses develop.	High: Premium is fixed for the policy term.
Incentive	High: Immediate financial reward for loss control.	Low: Reward is delayed until renewal.
Cash Flow	Deferred: Payments/refunds occur over years as losses develop.	Upfront: Full premium paid at inception.

NCCI Retrospective Premium Formula

$R = (b + C \cdot A) \cdot T$ Subject to: $H \leq R \leq G$

Where:

• $R$: Retrospective Premium.
• $H$: Minimum Retrospective Premium.
• $G$: Maximum Retrospective Premium.
• $b$: Basic premium ratio (covers administration expenses, profit, and net insurance charge for min/max caps).
• $A$: Actual reported losses (with or without ALAE).
• $C$: Loss Conversion Factor (LCF) (loads losses for ULAE or total LAE).
• $T$: Tax Multiplier (accounts for state premium taxes).

Basic Premium Ratio ($b$) Formula

If the plan is balanced (retrospective premium equals expected prospective premium): $b = e - (C - 1) E[A] + C \cdot I$ Where:

• $e$: Underwriting expense ratio.
• $I$: Net insurance charge: $I = (\text{Insurance Charge} - \text{Insurance Savings}) \times E[A]$
  • Insurance Charge: Expected losses exceeding the maximum premium limit ($G$).
  • Insurance Savings: Expected losses below the minimum premium limit ($H$).
• Note: Refer to Workers Compensation for details on calculating standard premiums.