Exposure Rating

What Is Exposure Rating?

Exposure rating is a methodology used to compute risk exposure in a reinsurance treaty. The loss experience of a portfolio of comparable, however not indistinguishable, risks is analyzed to decide the possible losses of a client. This cycle is typically initiated if the reinsurer doesn't have adequate trustworthy claims history from the insured party being referred to.

Exposure rating is one of two risk computations utilized in the insurance industry — the other being the experience rating method.

Understanding Exposure Rating

Treaty reinsurance is insurance purchased by one insurance company from another. A contract is drawn up between the ceding insurance company and the reinsurer, who consents to acknowledge the risks of a foreordained class of policies throughout some undefined time frame.

While fostering the reinsurance treaty price, the reinsurer must estimate the probability that a loss will surpass the damage amount retained by the ceding company. Some of the time, reinsurers might execute a excess of loss reinsurance treaty, in which the reinsurer consents to pay for losses over the specific amount retained by the cedent. Excess of loss settlements may likewise cap the damages for which the reinsurer is responsible.

Regardless, both reinsurance deals require the reinsurer to estimate the frequency and seriousness of claims, making a general risk profile that they might reference while setting the treaty price.

Insurance companies closely monitor the claims and losses that come from the policies that they underwrite to decide if certain classes of policyholders are more inclined to claims, and are accordingly more risky to protect.

Utilizing either exposure rating or experience rating, a reinsurer will decide their risk-to-remunerate horizon. Reinsurers frequently use exposure rating when the company needs more historical data to foster an experience rating. Exposure is likewise helpful when the likelihood that a specific loss will happen is viewed as low.

Exposure Rating Method

An exposure rating is generated by looking at the loss experience of a portfolio of comparable, yet not indistinguishable, risks. The assumption is that risks in comparative risk gatherings will display comparative loss experiences.

The consequence of an exposure rating is an assessment of the expected losses the company could hope to experience for a specific event. The method communicates loss as a percentage of the amount of value insured.

The data will generate an exposure curve. As you move along the curve, the cumulative loss, as a percent of insured value, approaches 100 percent. Exposure rating allows the reinsurer to look at [loss severity](/normal seriousness) in layers, and will at last allow the reinsurer to set prices for risks that are estimated to fall inside every one of the different layers.

Ruth Salzmann developed the exposure rating method during the 1970s while expounding on the relationship between homeowners fire loss and the comparing amount of insurance. The pricing structure that she developed became known as the Salzmann Curves.

Exposure Rating versus Experience Rating

Exposure ratings vary as a matter of fact ratings in that they don't need the reinsurer to have had direct historical experience with the specific risk.

With experience rating, a reinsurer will look at historical loss data their company has experienced in association with a specific risk event. For example, the reinsurer may take a gander at the value of claims they covered for tremors in a specific region. The reinsurer will utilize their historic experience and will change historical loss data to estimate future losses to a similar specific risk.

Limitations of Exposure Rating

One weakness of the exposure rating method is that it makes a zone in each layer in which the losses approach, yet don't come to, the next level of retention. Reinsurers might utilize a dissemination table to set the rate for the lower limits of the layer.

An extra drawback is that the reinsurer must assign a high degree of credibility to data sources that are not its own. It must rely upon the data derived from different insurers and third-party rating systems to set its risk exposure. Hence, the experience rating method might be the preferred approach.

Highlights

• Exposure rating is a method used to work out risk exposure in a reinsurance treaty.
• The loss experience of a portfolio of comparative, however not indistinguishable, risks is inspected to estimate the expected losses of a client.
• The assumption is that risks in comparative risk gatherings will display comparative loss experiences.
• This method is in many cases utilized when the reinsurer doesn't have adequate tenable claims history from the insured party being referred to.