Insurance companies offer loss sensitive pricing plans for risk tolerant clients. In the most fundamental case, the client pays a standard premium, and receives a dividend or return premium based on losses.
More sophisticated pricing plans are available for clients willing to assume more risk. Retrospective rating plans (retros) provide an incentive for companies with excellent internal loss control processes.
Retros begin with a basic premium. This portion of the overall premium reflects the fixed cost of the program. The insurer charges administrative costs, some premium tax, loss control services, sales commissions, and underwriting costs in this premium. Basic premium is about twenty-five percent of the standard premium.
Added to the basic premium are the reserved losses multiplied by a loss conversion factor – usually about 1.15 – which includes claims and legal expenses. Total retro premium is basic plus converted reserved losses, with two other factors.
Retros generally have a minimum and maximum premium. Higher minimums and maximums allow less long-term risk transfer to the insurance company. The companies will reward this decision with lower basic premium, lower loss conversion factor, or better cash flow options.
Lower minimums and maximums will cost the insured in higher basic premiums, loss conversion factors or cash flow.
So how does a consumer use this information?
Do not consider a retro program unless your premium is at least two hundred thousand dollars.
The best time to enter a retro is after a bad claims year when your modification rises and will remain up for three years. A retro allows you to recapture some of that higher premium. But you must have losses under control.
Many retro plans are based on reserved losses. A reserved loss is an estimate of costs to be paid over the life of the claim. This number is not discounted. The company sets the reserves based on claims history. This number can obviously adversely affect the final premium without the insurance company actually paying a claim out.
Retro audits resolve this issue by resetting claims reserves annually and recalculating premium accordingly. So, expect three annual audits to reset the premium. It’s a long-term partnership between the insurer and the insured.
Forecast your own losses for the next three years. Decide what retro factors work in your favor – can you risk a higher maximum premium? Negotiate with the insurer about paid loss accounting rather than reserved losses, especially on medical only claims.
Negotiate a deductible on medical only claims to avoid the loss conversion factor add-on.
The self-insured program is the ultimate retro. You act as your own insurance company. Know your premiums will be above one million dollars per year for the foreseeable future before considering this funding method.
You will still encounter some fixed fees, like actuarial work, taxes, filing fees, and administrative costs. It still costs legal and investigation time to handle claims. The biggest advantage is cash flow on claims. Since you control reserves, you control cash flow.
The biggest disadvantage is when you decide to stop self-insuring and purchase insurance commercially. Be certain you will self-insure for a very long time.
