What is Experience rating?

Last week we covered manual rates and how they are calculated. This week we are going to take a closer look at Experience rating. Experience rated benefits typically have a higher volume of claims, making them easier to predict from year to year. EHB, Dental and Short Term Disability are often experience rated.

When a benefit is experience rated it means that some portion of previous claims are taken into consideration when setting future rates. This is far from an exact science, you are in effect using the past to try to predict the future. Every group has it’s own unique set of circumstances, employees get sick and recover, employees leave and are replaced, generic drugs become available and new drugs are developed. The benefit plans themselves are not static either, with changing maximums, waiting periods and co-insurances all having an effect on the groups overall experience.

How experience is calculated, and the portion of previous claims that are taken into account, depend on a number of different factors:

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Credibility

Credibility, simply stated, is how likely a groups claims experience is to be similar next year. It is stated as a % from 0 to 100% credible. Larger groups enjoy greater credibility as a single employees claims have less influence over the overall experience, which makes the groups experience more stable and easier to predict. Put a different way, one employee suddenly experiencing higher claims will have less of a dramatic impact on the experience of a large group. There is also a greater spread of risk on large groups, meaning that for every certificate with high claims there will be several with lower claims, creating an offset that helps to balance the overall experience.

Having a higher credibility may not necessarily be an advantage if the groups claims experience is high. For groups with credibility below 100%, the difference is made up using the insurance carriers manual rates for that benefit. These are calculated using a number of factors such as demographics and province of residence. The groups experience and manual rates are blended together to calculate the overall experience rate.

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Multi-year experience

Particularly at quote time, several years experience may be taken into consideration when determining the correct rates for an experience rated benefit. When multiple years are used they may be weighted equally or more weight may be given to more recent years experience. Every carrier has their own methodology for how many years experience to use and how to weight each year.

Trend and Inflation

Items such as drugs and dental work typically get more expensive over time, which is commonly referred to as inflation. However other factors are also taken into account for this calculation. Are dispensing fees increasing? Is utilization increasing due to the aging workforce? What cost shifting is occurring from provincial plans? Are alternative treatments to existing conditions becoming available, for example the recent advancements in treating Hepatitis C. All of these things are taken into consideration to calculate an overall trend.

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Target Loss Ratio

We’ve already covered TLR’s in depth in a separate post, but to recap they play a major part in an experience rating calculation. Even a group that looks like the claims are below premiums may still require a rate increase to align with the overall target loss ratio. Higher TLR’s are considered better as more premium dollars are available to cover claims.

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Stop Loss/EP3

We’ve covered Stop Loss before too, but as a reminder the stop loss is an upper threshold that removes all claims from a groups experience that exceed the stop loss. For example if a group has a $10k Stop loss and an employee has $20k of drug claims, only the first $10k of those claims will be included in the groups experience rating calculation.

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Incurred But Not Reported (IBNR)

We’ve covered IBNR in detail, but as a summary it refers to a reserve held by the insurance company to cover claims that have already been incurred but have not yet been reported (and therefore are not currently reflected in the experience). IBNR charges are removed from experience rated calculations, increasing the loss ratio.