Designing Equitable Merit Rating Plans
Author(s)Ferreira, Joseph Jr.
Throughout the United States it is common practice for automobile insurance premiums for a particular policy to vary depending upon the driver class and geographic location of the policyholder as well as the type and number of vehicles covered by the policy. In addition, most states also permit so-called "merit rating" plans whereby each policyholder's annual premium is adjusted up or down depending upon the insured's claims experience and traffice violation record during previous years. Although these merit rating plans may be viewed as a special type of risk classification, the rationale underlying their use is quite different from the justification for driver class and territory differentials. This paper develops a methodology for evaluating merit rating plans that are used in conjunction with other risk classification criteria. A theoretically equitable merit rating plan is designed and compared with plans commonly used throughout the country. The differences are striking, especially among high risk classes. For example, most typical merit rating plans overcharge good drivers in high risk classes -- often by more than 25%. 1.0 The Purpose of Merit-Rating The popular rational behind merit-rating is straightforward: Merit-Rating keeps "good" drivers from subsidizing "bad" drivers and, because having any accident or traffic violation means higher rates, it promotes safe driving and
Massachusetts Institute of Technology, Operations Research Center
Operations Research Center Working Paper;OR 057-76