An indicated rate change is a number on a page. Turning it into a premium a customer actually pays takes a rating algorithm, a set of business rules, and sometimes a decision to fix the book without touching rates at all.
Ratemaking analysis produces indicated rates and relativities. Implementation is the machinery that turns those into the exact dollars on a quote. That machinery is the rating algorithm: the sequenced instructions that build a premium from a base rate and a set of rating variables.
Each rating variable (territory, driver age, coverage limit) carries a relativity that adjusts the base rate up or down. Relativities combine in one of two ways.
A multiplicative structure multiplies the base rate by each variable's factor. A driver who is 1.30 for age and 0.90 for territory pays base × 1.30 × 0.90.
An additive structure adds or subtracts dollar amounts or additive factors from the base. A $40 age surcharge plus a $15 territory credit changes premium by +$25.
Common mistakes
- Confusing the expense fee with the minimum premium. The $25 fee is always added; the $350 minimum only binds when the calculated premium falls short. Treating the minimum as an additive charge overstates premium.
- Filing the raw fixed expense as the fee. The $20 fixed expense per exposure must be grossed up by the VPLR to $25. Filing $20 leaves variable expense and profit uncollected.
- Ignoring the minimum-premium offset. The minimum raises book premium, so you offset the base rate by 1 ÷ (1 + effect). Skipping the offset double counts the minimum's collection.
Bottom line
- A rating algorithm is the ordered set of steps that combines base rate, rating variables, fees, and rules to produce a policy premium.
- Multiplicative algorithms multiply relativities against a base rate; additive algorithms add or subtract dollars; the variable premium scales with the risk while the flat (additive) premium does not.
- Order matters when additive and multiplicative steps combine, so the algorithm must specify sequence exactly.
- The expense fee is derived, not raw: gross up the fixed expense per exposure by the variable permissible loss ratio, so the filed fee exceeds the bare fixed dollar.
Exam shortcut
Work the algorithm strictly in filed order: base rate, then multiplicative relativities, then additive fees, then minimum, then cap, then rounding. Skipping to the minimum or cap early is the classic wrong path. Distinguish the three floors and charges fast: an expense fee is always added, a minimum premium binds only when the calculation is too low, and a cap limits change versus the prior term.
The full lesson (about 3,619 words, 24 min read) adds 5 worked examples, all 8 common mistakes, a self-check, free in the app.
Learning objectives
- A17
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