Chapter 12 Experience Rating using Bonus-Malus

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Bonus-Malus

Bonus-malus system, which is used interchangeably as “no-fault discount”, “merit rating”, “experience rating” or “no-claim discount” in different countries, is based on penalizing insureds who are responsible for one or more claims by a premium surcharge, and awarding insureds with a premium discount if they do not have any claims (Frangos and Vrontos, 2001). Insurers use bonus-malus systems for two main purposes; firstly, to encourage drivers to drive more carefully in a year without any claims, and secondly, to ensure insureds to pay premiums proportional to their risks which are based on their claims experience.

NCD and Experience Rating

No Claim Discount (NCD) system is an experience rating system commonly used in motor insurance. NCD system represents an attempt to categorize insureds into homogeneous groups who pay premiums based on their claims experience. Depending on the rules in the scheme, new policyholders may be required to pay full premium initially, and obtain discounts in the future years as a results of claim-free years.

Hunger for Bonus

An NCD system rewards policyholders for not making any claims during a year, or in other words, it grants a bonus to a careful driver. This bonus principle may affect policy holders’ decisions whether to claim or not to claim, especially when involving accidents with slight damages, which is known as ‘hunger for bonus’ phenomenon (Philipson, 1960). The option of ‘hunger for bonus’ implemented on insureds under an NCD system may reduce insurers’ claim costs, and may be able to offset the expected decrease in premium income.