The document defines key terms related to insurance pricing such as rate, exposure unit, pure premium, and loading. It describes the objectives of insurance pricing from both regulatory and business perspectives. The types of rating discussed include judgment rating, class rating, merit rating, schedule rating, experience rating, and retrospective rating. Class rating and two methods for determining class rates, pure premium and loss ratio, are explained in detail with examples. Merit rating adjusts class rates based on individual risk characteristics and loss experience.

1. Lincy P. T.

2. Definition – Insurance pricing
 A rate is the price per unit of insurance.
 An exposure unit is the unit of measurement used in insurance
pricing. It varies by line of insurance.
 The pure premium refers to that portion of the rate needed to
pay losses and loss adjustment expenses.
 Loading refers to the amount that must be added to the pure
premium for other expenses, profit and a margin for
contingencies.
 The gross rate consists of the pure premium and a loading
element. Finally, the gross premium paid by the insured consists
of the gross rate multiplied by the number of exposure units.

3. Objectives of
Insurance Pricing or Rate Making
Regulatory Objectives
Business Objectives
 Adequate Rates
 Simplicity
 Not Excessive
 Stability
 Not unfairly Discriminatory
 Responsiveness
 Encouragement of loss
control

4. Types of Rating
 Judgment Rating
 Class rating
 Merit rating
 Schedule rating
 Experience rating
 Retrospective rating

5. Judgment Rating
 Judgment Rating means that each exposure is
individually evaluated, and the rate is determined
largely by the underwriter’s judgment.
 This method is used when the loss exposures are so
diverse that a class rate cannot be calculated or when
credible loss statistics are not available.
 Eg: Ocean marine insurance.

6. Class Rating or Manual Rating
 Class Rating means that exposures with similar
characteristics are placed in the same underwriting
class, and each is charged the same rate.
 The rate charged reflects the average loss experience
for the class as a whole.
 Class rating is based on the assumption that future
losses to the insureds will be determined largely by the
same set of factors.

7. Advantages of Class rating
 Simple to apply.
 Premium quotations can be quickly obtained.
 Ideal for personal lines market.

8. Class rating is widely used in:
 Home owner’s insurance
 Private passenger auto insurance
 Workers compensation
 Life and health insurance, etc.

9. Methods of Class Rating
 Pure Premium Method
 Loss Ratio Method

10. Pure Premium Method
 The pure premium can be determined by dividing the
amount of incurred losses and loss adjustment expenses by
the number of exposure units.
 First step:
Pure premium =
Incurred losses and loss adjustment expenses
Number of exposure units
 Final step:
Gross Rate = Pure Premium
1 – Expense Ratio

11. Illustration
 Assume that in auto collision insurance, 500,000
automobiles in a given underwriting class generate
incurred losses and loss adjustment expenses of Rs.30
million over a one year period. Expenses ratio expected
to be 40%.

12. Illustration
 Assume that in auto collision insurance, 500,000 automobiles in a
given underwriting class generate incurred losses and loss adjustment
expenses of Rs.30 million over a one year period. Expenses ratio
expected to be 40%.
 First step:
Pure premium =
Incurred losses and loss adjustment expenses
Number of exposure units
= 30,000,000
500,000
= Rs. 60
 Final step:
Gross Rate = Pure Premium
1 – Expense Ratio
= Rs. 60
1- 0.40
= Rs. 100

13. Loss Ratio Method
 Under the loss ratio method, the actual loss ratio compared
with the expected loss ratio, and the rate is adjusted
accordingly.
 The actual loss ratio is the ratio of incurred losses and loss-
adjustment expenses to earned premiums.
 The expected loss ratio is the percentage of the premiums
that is expected to be used to pay losses.
 Rate Change = A – E
E
where A= Actual loss ratio
E = Expected loss ratio

14. Illustration
 A line of insurance has incurred losses and loss-
adjustment expenses in the amount of Rs.800,000 and
earned premiums are Rs.1 million. The actual loss
ratio is 80%. The expected loss rate to be 70%.
Calculate the rate.

15. Illustration
 A line of insurance has incurred losses and loss-
adjustment expenses in the amount of Rs.800,000 and
earned premiums are Rs.1 million. The actual loss
ratio is 80%. The expected loss rate to be 70%.
Calculate the rate.
 Rate Change = A – E
E
= 0.80 – 0.70
0.70
= 0.143 or 14.3%
where A= Actual loss ratio
E = Expected loss ratio

16. Merit Rating
 Merit rating is a rating plan by which class rates
(manual rates) are adjusted upward and downward
based on individual loss experience.
 Merit rating is based on the assumption that the loss
experience of a particular insured will differ
substantially from the loss experience of other insureds.
 Thus class rates are modified upward and downward
depending on individual loss experience.

17. Merit rating - Types
Schedule rating
2. Experience rating
3. Retrospective rating
1.

18. Merit rating - Types
1.
Schedule rating
Under a schedule rating plan, each exposure is individually
rated. A basis rate is determined for each exposure, which is
then modified by debits or credits for undesirable or
desirable physical features.

19. Merit rating - Types
2. Experience rating
Under experience rating , the class or manual rate
is adjusted upward or downward based on past
loss experience.
Insured’s past loss experience is used to determine
the premium for the next policy period.

20. Merit rating - Types
3. Retrospective rating
Under a retrospective rating plan, the insured’s loss
experience during the current policy period determines
the actual premium paid for that period.
Under this rating plan, a provisional premium is paid
at the beginning of the policy period. At the end of the
period, a final premium is calculated based on actual losses
that occur during the policy period.