A composite rate is an insurance pricing method in which a uniform rate is applied to a group instead of rating each member individually. Composite rating is often used in group health insurance and on some commercial insurance policies.
Learn more about when and why a composite rate is used and how it works.
What Is a Composite Rate?
A composite rate is one insurance rate applied across the board, rather than calculating a rate for each individual or unit. In group health insurance plans, there may be a variation depending on whether the policy is for a single member or a family.
Composite rating offers advantages to both policyholders and insurers:
- It makes premiums easy to calculate
- It simplifies the audit process
- It facilitates cost accounting and budgeting
How a Composite Rate Works
The underwriter begins the process by calculating the annual premium in the normal manner. Next, they select a convenient exposure base to use as a substitute for those normally used.
An exposure base is the basis a rate is set upon. For health insurance, it would be members; for commercial auto insurance, it would be the vehicles in the fleet.
The underwriter then calculates an average rate by dividing the premium by the number of exposures.
For example, for a company with 150 employees that receives a composite rate on health insurance, the 150 employees are the exposure base. The premium (in this instance, say it's $750,000) would be divided by 150 to find the average rate: $5,000. That $5,000 would be used as a composite rate per employee instead of rating each individual employee individually.
Under the Affordable Care Act, health insurance providers for small group markets (businesses with one to 50 employees, or up to 100 employees depending on state) must provide per-member pricing, but they can also provide composite premiums if they wish. If so, they must divide the covered members into two tiers—younger than 21 and older than 21—for compositing purposes. The exception is if a state has decided to use an alternate methodology for finding the composite premium. (For example, Texas uses a four-tier method based on family size, not age.)
How a Composite Rate Works in Commercial Auto Insurance
Here is an example that demonstrates how composite rating might be used in commercial auto insurance. Don owns Divine Delights, a large bakery that sells bread and other baked goods. The company owns 25 delivery vans that are insured for $1 million in liability insurance under a business auto policy issued by the Elite Insurance Company.
The vans are currently rated individually, but Don wants to switch to composite rating when the bakery's auto policy renews, and Elite Insurance agrees.
First, the insurer calculates the renewal premium using its normal commercial auto rating procedure. The insurer assigns each truck a rating territory, size class, user class, and radius class and then uses these factors to determine the liability rate. Elite classifies all of the vehicles as light trucks used commercially within a local (50-mile) radius. The insurer rates each vehicle separately and then calculates the total premium. The annual premium for the 25 trucks is $50,000.
Next, the insurer calculates a composite rate on a "per van" basis. The composite rate for each van is $50,000 divided by 25, or $2,000. Divine Delights' annual premium is $50,000, the same as it would have been had composite rating not been used. Don finds this rate convenient as he knows he'll pay $2,000 to insure any new van for liability.
When the company's policy expires, the insurer will conduct an audit and adjust the premium based on the number of vehicles in the fleet at that time. If the bakery owns 30 trucks on the policy expiration date, its annual premium will be adjusted to $60,000 ($2,000 x 30).
Composite rating makes it simple to predict insurance costs by standardizing the premium across units. Then those rates are typically locked in until the policy renews.
- A composite rate is one insurance rate applied to a group instead of calculated individually.
- Composite rates are convenient for both the insurer and the policyholder.
- To find the composite rate, the insurer looks at the risk profile of all of the members or units being insured to find a premium. Then it divides that by the number of individuals or units to find the average or composite rate.