Bonus-malus systems

This chapter presents the theory behind bonus-malus methods for automobile insurance. This is an important branch of non-life insurance, in many countries even the largest in total premium income. A special feature of automobile insurance is that quite often and to everyone’s satisfaction, a premium is charged that for a large part depends on the claims filed on the policy in the past. In experience rating systems such as these, bonuses can be earned by not filing claims, and a malus is incurred when many claims have been filed. Experience rating systems are common practice in reinsurance, but in this case, it affects the consumer directly. Actually, in case of a randomly fluctuating premium, the ultimate goal of insurance, that is, being in a completely secure financial position as regards this particular risk, is not reached. But in this type of insurance, the uncertainty still is greatly reduced. This same phenomenon occurs in other types of insurance, for example when part of the claims is not reimbursed by the insurer because there is a deductible.

That lucky policyholders pay for the damages caused by less fortunate insureds is the essence of insurance (probabilistic solidarity). But in private insurance, solidarity should not lead to inherently good risks paying for bad ones. An insurer trying to impose such subsidizing solidarity on his customers will see his good risks take their business elsewhere, leaving him with the bad risks. This may occur in the automobile insurance market when there are regionally operating insurers. Charging the same premiums nationwide will cause the regional risks, which for automobile insurance tend to be good risks because traffic is not so heavy there, to go to the regional insurer, who with mainly good risks in his portfolio can afford to charge lower premiums.