What is a composite rate?
A composite rate is an insurance premium based on the average risk profile of a group rather than the risk profile of an individual insured. A composite rate implies that all members of a particular group pay the same insurance premium for coverage against a specific risk.
Composite rates apply to group benefits, such as insurance, that an employer or other organization provides to its workers or members. For group life insurance, for example, a composite rate is used with coverage guaranteed to all members of the group. Unlike individual policies, these group insurances do not require a medical examination.
Key points to remember
- A composite rate is used in insurance underwriting for group coverage policies.
- Unlike an individual rate which generates risk premiums corresponding to an individual’s demographic and behavioral factors, composite rates instead use a population or sample average.
- The composite rate is often applied to all covered individuals in a group, regardless of individual differences.
Understanding composite rates
When an insurance company guarantees a new policy, he undertakes to compensate the insured against a particular peril in exchange for the payment of a premium. Determining the amount of premium to be charged to the insured is a critical step in the underwriting process. Underestimating the seriousness or frequency of possible claims may lead the insurer to underbill the insured’s coverage. Underpricing can cause the insurer to dip into its capital reserves, which will make the policy unprofitable.
Insurance companies use several different methods to determine how much premium to charge for a particular insurance policy. The process used varies depending on whether the assignment of a rate is for a single risk, such as health insurance for an individual, or for a group, such as health insurance for a business with multiple employees.
Determination of individual and composite rates
To determine a rate for an individual, the company will examine the risk profile. In the case of health insurance, this profile includes the potential insured’s age, smoking status and place of residence. The insurer will use actuarial tables to determine the likelihood of the policyholder making a claim and set the premium accordingly.
An insurance company will approach setting a composite rate differently than it does for individual policies. Rather than looking at a single risk profile, the insurer looks at the risk profile for the entire group. The number of group members is used to determine the average composite rate. The underwriter will combine the risk profiles of all individuals and arrive at the average risk profile. They use this average profile to set the premium. Each group member will pay the same premium.
Composite rates benefit older and less healthy people because everyone pays the same price. Younger, healthier people may be able to find less expensive individual policies. Although policies may be less expensive, the employer-sponsored plan offers insurance tax benefits and time savings by not having to research countless options.
If composite rates allow all employees to individually pay the same health insurance premium, the price will be different for employees with different family situations. The employee can apply as a single member, member plus spouse or member plus family. Each level of coverage has a corresponding premium. As the policy is a composite rate, an employee with one child will pay the same family rate as an employee with four children.