Policy Year Modification of Losses

The process of rate-making consists essentially of dividing losses by exposure, and then loading for expenses. Unfortunately for simplicity, it is usually necessary to modify the experience somewhat in order to anticipate conditions during the period when the rates will be used. This would not of itself cause complications, and most complications arise only because it is necessary to combine several years of experience before calculating rates. The necessity of both combining and modifying experience produces some interesting results, since experience which has been combined and then modified differs from experience which has been modified before being combined. It is the purpose of this paper to investigate these differences. The illustrations are drawn entirely from workmen's compensation insurance, though some of the principles involved would apply equally well to other lines.