Workers' Compensation Retrospective Rating Plans
Retrospective Rated Plans (Retros)
These are plans that literally compute the ultimate premium after the policy expires, or retrospectively, meaning "looking back on."
These are not guaranteed cost plans since the ultimate premium is determined by the loss experience of the policy year.
Plans other than guaranteed cost are also referred to as "loss sensitive plans." From this point on, the issue of risk vs. reward becomes germane. As the premium size grows, expanding the ability to hold loss, accounts with predictable loss experience may explore whether they wish to participate in the risk.
Retro plans are the simplest mechanism for many accounts. In a retro plan, the carrier issues the policy at a rate per class and determines an estimated policy premium. The insured pays the policy premium in full during the policy year. Typically six months after expiration, a calculation is made to determine the retro 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 the "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. Workers' compensation cost for the current year is easily budgeted. 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.
The most irksome 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, and work with your broker 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
- Simplest way to share in risk
- Ability to pay less
- Expenses stay with the carrier
- Collateral usually not required
Disadvantages
- Can increase cost
- Recalculations may negate returns
- Multi-year process
- Larger premium size needed