The details of the experience rating process are beyond the scope of this discussion article. Below is an overview of several actuarial principles that experience rating is based on. So, the widget business segment automobile liability claims will be compared to the claims of the average company with 10 automobiles. Experience rating acknowledges that a portion of historic claims are random and do not affect the company's future claim costs. Experience rating will lead to the conclusion that the widget division will experience more insurance losses in 2002, but not 1,000 times more losses.
Experience rating considers the effect of claim frequency as well as claim severity.
The more claims that were filed against a company, regardless of cost, the higher the expected future claim costs will be. The effect of a company's historic claim experience is more significant for companies with more exposure. Therefore, claim experience will have a greater influence on the insurance cost allocation for the sprocket business segment than for the widget business segment. Conclusion Insurance cost allocation provides a valuable tool to allow business entities to fairly and equitably distribute its cost of managing risk. Some of the benefits resulting from cost allocation include stable budgeting and a fair and equitable matching of insurance costs to the business segments that incur those costs.