Retrospective Rating Plans As an Alternative Risk Management Technique

These plans are typically used for Worker's Compensation insurance policies. There are prospective rating plans also. Retrospective rating plans adjust the final premiums at the end of the policy year based on the current loss experience during the current policy year. Whereas prospective rating plans do not adjust the policy premiums based on current or past losses. These plans are usually described as guaranteed cost plans.

The basic formula for a retrospective premium plan is the "basic premium plus the incurred losses". There is a little bit more math to the incurred losses and how that number is determined. Insurance carriers take the incurred losses times a loss conversion factor that they use internally times a tax multiplier.

Incurred losses are actual losses sustained plus the anticipated losses to be paid.

The tax multiplier is easy enough to ascertain as that is just incorporating the state premium taxes, fees or any other assessment that the regulators impose upon the insurance carrier. Usually that is set on an annual basis and does not fluctuate much.

The loss conversion factor, for lack of a better term is simply a fudge factor for the insurance company. Most workers compensation claims tend to grow and expand the longer the claim is open and not closed. Therefore for all open claims the insurance carrier multiplies this loss conversion factor times the incurred losses. The conversion factors vary greatly amongst insurance companies because all carriers have different inherent overhead cost structures. Many times on larger accounts the rating structure is pretty close for the competing carriers and it might come down to the loss conversion factors of each insurance carrier in determining which plan with which carrier is the most competitive. Most loss conversion factors are between 1.10 and 1.25 as a multiplier of the incurred losses.
Retrospective rating plans can offer many advantages for the insured but it can also have some disadvantages. One of the major advantages is that you can see premium reductions immediately based upon current losses. Businesses that have good loss experience and very predictable claims usually will come out on the positive side of this equation with a retrospective rating plan. Even if a business has had a catastrophic shock loss in the past this type a plan can be financially beneficial for that business's current situation of low claims or minimal losses. This rating plan is a two edge-sword in that if the claims and losses turned sour during the policy year, the insured will have to come up with the funds for the increased premiums immediately due to increase claims after the policy renews in 12 months. As a business owner, doing the math and crunching the numbers will determine whether this strategy, for primarily workers compensation premiums, is advantageous for your company.

R. Glenn Matsen, CEO, MBA, CPCU, ARM, CLU, ChFC has over 32 years of risk management experience in providing insurance solutions for the small business owners needs. His website contains detailed information on Small Business Insurance and Small Business Insurance Quotes.

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