Class Rating in insurance
Previously we explored how insurance pricing was determined. Today we are going to dig a little deeper into "Class Rating" and provide some example of how it works.
Class rating is a type of manual rating that places similar consumers into the same underwriting category. Each person is charged the same rate, making it simple to price and ideal to use when you have a large group of consumers.
For example, most yoga instructors can qualify for a class rating because their operations can be grouped by a similar trait - teaching yoga.
Pure Premium Method
This type of rate is calculated based on the number of claims and the number of insureds. It covers the portion of the premium that is allocated towards claims.
For example, if there are $1,500,000 in claims and we have 10,000 yoga instructors, the pure premium is $150.
The gross premium is the price given to the consumer and is designed to cover all costs and profit that go in to pricing. The gross premium would take into consideration things including administration, selling, and desired profits. This gross premium is expressed as a "loading ratio" and is added on top of the pure premium.
For example, if 30% is the loading ratio (20% for expenses and 10% for profit), the gross premium would be calculated as follows:
Pure premium $150 / ( 1 - .3) = $214.29
Loss Ratio Method
Loss ratio pricing is determined by comparing the actual expenses to the expected expenses for claims.
For example: $1,500,000 in expected losses / $2,000,000 in premiums earned = .75 expected loss ratio
If the actual loss ratio was determined to be .80 we would have a deficit and the insurance pricing would need to increase.
For example: actual loss ratio .80 - expected loss ratio .75 / expected loss ratio .75 = 6.66% rate increase.
If we had a 6.66% increase to our $214.29 premium the new price would be $228.56.
What do you think?
The Base Team
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