All large individual risk rating is a form of experience rating as they need to reflect the entity’s actual experience, or the features that may affect the experience. Experience rating is ideal, when with appropriate adjustments, the past experience can predict the future.
Thus losses need to be adjusted to reflect the economic and social inflation, changes in the number, size and types of units, and changes in policy limits, terms and conditions. Social inflation means changes in the attitude of society whereby such items as change in litigation mentality, the change in judicial activism and trend of awards, and legislation by the various government arms directly or indirectly affect the frequency of claims and the cost of settling claims.
The experience component must be related to the exposures affecting the entity rated. The following combinations are generally used :
(i) Actual paid losses to expected paid losses
(ii) Reported losses and expected losses
(iii) Projected ultimate losses
(iv) Projected ultimate losses for the experience period adjusted to the current exposure and inflation levels.
Courtesy : General Insurance Underwriting Book published by Sashi Publications