What it means
Insurers begin by setting a standard premium based on the average risk of a type of business. Experience rating then adjusts that premium up or down according to how the individual customer has actually performed.
The reasoning is that past claims are a good guide to future claims, and that customers should be rewarded for good safety and management. The adjustment is usually expressed as a factor, sometimes called an experience modification or mod.
A factor of 1.00 means the customer is average, while a factor of 0.80 means a 20% discount and 1.25 means a 25% surcharge. The calculation uses claims from a set number of past years, often the most recent three, and normally excludes the latest year.
For larger employers, experience rating creates a direct financial reason to invest in prevention. A reduction in injuries, better return-to-work programmes and tighter hiring or training can all lower the factor and therefore the premium.
That makes safety a finance topic as well as an operations one. Small businesses are often rated more gently, because a handful of claims can be a matter of luck rather than behaviour.
Insurers and regulators use credibility weighting, which gives more weight to a customer's own record as its size grows and more weight to the industry average when the customer is small. This is why the simple formula below is only an illustration of the principle.
Experience rating also changes how a finance team should read an insurance renewal. Instead of treating the premium as a fixed overhead, the team can ask what the claims history is, which claims are still open and whether any of them can be closed or challenged before the next calculation.
Claims that stay open tend to be valued cautiously, so closing them sooner can help the factor. The nuance is that experience rating can be slow to reward improvement, because bad years stay in the calculation for a time.
It also does not apply everywhere: individual car and home insurance use different rating tools, and some markets restrict experience rating for health cover.
In practice
Real-world examples.
Example
A logistics company introduces driver training and reduces accidents over three years. At renewal the insurer lowers its factor from 1.10 to 0.90, which cuts a $200,000 premium to $180,000. The finance director records the $20,000 reduction as a direct return on the safety budget.
Example
A software firm with 150 employees has had no workers' compensation claims. Its factor is below 1.00, and the insurer offers a discount at renewal. Finance still checks whether the factor has been calculated using the correct payroll and classification.
Example
A mid-sized manufacturer suffers three serious injuries in one year. At the next renewal its factor moves to 1.30, so the premium rises by 30%, and the company must also commit to a safety plan before the insurer will continue to quote.
Formula
Calculation
Experience factor = Actual losses / Expected losses (simplified)
Premium = Manual premium x Experience factor
A company's standard, or manual, premium is $100,000. Over the rating period its expected losses were $80,000, but its actual losses were only $60,000. Experience factor = 60,000 / 80,000 = 0.75. Premium = 100,000 x 0.75 = $75,000, a saving of $25,000. Real schemes add credibility weighting, so the actual discount would usually be smaller.Case study
Seen in the real world.
Stonebridge Fabrication is an illustrative, fictional steel company with a standard annual premium of $400,000. Two years of poor safety results had pushed its experience factor to 1.20, so it was paying $480,000.
The new operations director introduced daily safety briefings, replaced worn equipment and set up a modified-duty scheme to bring injured staff back sooner. These steps cost $60,000 in the first year.
Over the next three years the factor fell to 0.90, which meant a premium of 400,000 x 0.90 = $360,000. The annual saving against the old level was 480,000 - 360,000 = $120,000, and the illustrative lesson is that insurance cost is partly within management's control.
Watch out
Common mistakes.
- Treating the premium as fixed, when experience rating means that your own claims record directly changes the price.
- Ignoring small claims, which can add up and raise the factor even when no single claim is large.
- Expecting an immediate discount after one good year, when most schemes look back over several years.
Questions
People also ask.
What is an experience modification factor?
It is a multiplier applied to the standard premium, where 1.00 is average, below 1.00 is a discount and above 1.00 is a surcharge.
Is experience rating the same as merit rating?
They are closely related, but experience rating uses a formula based on the customer's claims data, while merit rating can be more general.
Can a new business be experience rated?
Not at first, because it has no claims history, so it is usually charged the standard premium until enough data exists.
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