Retrospective rating plans compute the ultimate premium after the policy expires, or retrospectively. These are not guaranteed cost plans since the ultimate premium is determined by the loss experience of the policy year. Retro plans are the simplest mechanism for an account paying $150,000 to $500,000 for a guaranteed cost plan.
| • | In a retro plan, the carrier issues the policy at a rate per exposure and determines an estimated policy premium. The insured pays the policy premium in full during the policy year. |
| • | Typically six to twelve months after expiration, a calculation is made to determine theretro premium. |
| • | A percentage of that premium, referred to as "basic," is retained by the carrier to cover expenses for costs and factors other than claims. A separate provision for taxes may also apply, called a "tax multiplier." To these amounts is added the losses incurred (paid loss + open reserves) multiplied by a "loss conversion factor (LCF)." The sum is the retro premium. |
| • | The retro premium is subject to a "minimum," (the premium that is the lowest possible regardless of losses) and a "maximum" (the ceiling for ultimate cost). |
| • | The retro premium is compared to the policy premium and the insured either receives a return or owes additional premium. |
It sounds complicated, but it really isn't. Typically, recalculations will be made for three to five years, with the premium adjusted upwards or downwards at each calculation, usually six months after the policy expires, then at twelve-month intervals thereafter.
A retro provides a simple manner of making premium cost loss sensitive. Expenses remain the responsibility of the insurance company. The account usually does not need to provide collateral in the form of a letter of credit for future losses. For accounts that effectively control losses, the ultimate premium is lower than on a guaranteed cost plan.
There are also important disadvantages:
| • | If losses are above those expected, the ultimate cost is greater than on a guaranteed cost plan. |
| • | Some plans require collateralization. |
| • | Rather than closing out costs after one year, the ultimate premium is not determined for several years. |
| • | Another significant disadvantage is the recalculation provision. It is very common for an account to get a return one year and then have to pay all or some of it back the next year, or even pay more than the return, as losses develop. |
When looking at a retro option, it is vital to be able to reasonably predict losses and loss patterns to determine what factors work best for your exposures and your experience. All of the factors -- basic, minimum, maximum and LCF -- can be varied to match your particular situation.
Advantages |
Disadvantages |
| • Simplest way to share in risk | • Can increase cost |
| • Ability to pay less | • Recalculations may negate returns |
| • Expenses stay with the carrier | • Multi-year process |
| • Collateral usually not required | • Larger premium size needed |
If you would like more information, please contact our Large Accounts Division at (800) 224-6363 or by email at arm@armonline.com.
