What Is a Composite Rate?

Composite Rating Will Not Reduce Your Premium

Child's drawing of pupil calculating

Composite rating is an insurance pricing method in which a group of risks with similar characteristics are charged the same rate rather than rated individually. It is used for convenience and is not intended to increase or decrease the premium. Composite rating is used in group health insurance and on some commercial insurance policies.

Advantages

Composite rating utilizes a convenient exposure base, like sales or units, instead of the multiple exposure bases that would normally be used to rate a risk. It offers some advantages to both policyholders and insurers.

  • It makes premiums easy to calculate.
  • It simplifies the audit process.
  • It facilitates cost accounting. When composite rating is used, policyholders can allocate insurance costs to specific projects relatively easily.

How It Works

Composite rating may be used in auto liability, auto physical damage, or general liability insurance. The underwriter begins the process by calculating the annual premium in the normal manner. Next, he or she selects a convenient exposure base to use as a substitute for those normally used. The underwriter then calculates an average rate by dividing the premium by the number of exposures.

An insurer will agree to use composite rating only if the exposure base (payroll, sales, etc.) accurately reflects the risks generated by the insured.

Commercial Auto Example

The following example 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 to restaurants and grocery stores. 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 in three months. 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. If the bakery owns 30 trucks on the policy expiration date, it's annual premium will be adjusted to $60,000 ($2,000 times 30).

General Liability Example

Composite rating is also used in rating general liability policies. Here is an example:

Carl owns three businesses: a chain of self-service car washes, a rug-cleaning service, and an office building that he leases to a tenant. All three operations are insured under a single commercial general liability policy issued by the Elite Insurance Company.

Carl's policy will expire soon and he asks his insurer to use composite rating on the renewal. Elite Insurance agrees. The insurer begins by calculating the annual renewal premium using the standard methods for general liability rating. It uses the class codes listed in the table below.

Class Codes and Premium Bases
Description Class Code Premium Base
Car Washes - Self Service 10368 Sales
Carpet, Rug, Furniture or Upholstery Cleaning  - On Customers' Premises 91405 Payroll
Buildings or Premises - Lessors Risk 61212 Area

Each of the three class codes has a different premium base: gross sales for the car wash operations, payroll the carpet cleaning business, and square footage for the office. Carl's policy premium includes three elements: a premises and operations premium for the car washes, a premises and operations premium for the carpet cleaning business, and a premises and operations premium for the office building.

Note that none of the three class codes includes a separate charge for products and completed work. For both the car wash and carpet cleaning class codes, the products and completed work premium is included in the premises and operations premium. With regard to the building, there is no products and completed work exposure so no premium charge is applicable.

For many general liability class codes, separate rates apply to premises and operations coverage and products and completed work coverage.

The insurer determines that Carl's renewal premium is $100,000. Elite and Carl agree to use a composite rate based on gross sales. The rate will be applied to each $1,000 in gross sales. Carl's three businesses generate $25,000,000 in annual sales. To determine the composite rate, Elite divides the $100,000 annual premium by $25,000. The composite rate is $4. When the composite-rated policy expires, the insurer will conduct a final audit. It will calculate Carl's final premium by multiplying the $4 composite rate by the company's annual sales and dividing the result by 1,000.