Experience-Rating Mechanisms in Auto Insurance: Implications for High-Risk, Low-Risk, and Novice Drivers

Using a unique data set that rates a cohort of drivers on two distinct experience-rating mechanisms, we examine the impact of these experience-rating mechanism on premiums charged to low-risk, high-risk, and novice drivers. The first mechanism is a pure no-claims discount that classifies drivers by 0 to 6 or more years of at-fault claims-free driving. The second is a bonus-malus system with 32 driving record (DR) classes. Using standard stochastic modeling techniques, we find that having a greater number of DR classes does not result in lower prices for the new drivers nor does it create significant savings to the lowest risk drivers. And, not surprisingly, with an increasing number of malus DR classes, the highest risk insureds pay a substantially higher premium that may not be sustainable over time. Due to its mandatory nature in most countries, monitoring the fairness of the classification mechanism and the affordability and availability of auto insurance are common regulatory goals. Charging novice drivers excessively high premiums may conflict with affordability and fairness objectives. Thus, we conclude with an examination of other pricing mechanisms that can be used for novice drivers.