A Workers’ Compensation Policy endorsed with a Retrospective (Retro) Rating Plan is a sophisticated rating program in which the final premium is based on an employer’s actual incurred losses during the policy period. These endorsed plans are rather complicated but can be a valuable funding alternative in controlling Workers’ Comp costs if losses and claims are managed properly. In this article, we’ll discuss how premiums are calculated for a Workers’ Comp Retro Rating plan and the ideal candidates for such a plan.
How Is the Premium Calculated for a Retro Plan?
The premium calculation for a Retro Plan involves several different factors including minimum and maximum premium factors. The premium will be re-calculated several times on scheduled intervals post-policy period to account for loss development, delayed claim filing, and open claim closures. Following are the principal factors involved in the premium adjustment calculation:
- Standard Premium: Multiply the rate per class by audited payroll plus any additional premium for increased Employer Liability Limits and the insured’s experience modification.
- Basic Premium: The insurer multiplies the Standard Premium by its basic premium factor listed on the Retro Endorsement. The basic premium covers loss control and general administration expenses of the carrier, and the insurance charge for the coverage.
- Minimum & Maximum Premiums: Defines the range of premiums to be paid on the policy. The minimum and maximum premiums vary depending on the Retro plan offered by the insurer.
- Loss Conversion Factor: Covers the claims adjuster expense.
- Tax Multiplier: Covers state premium tax.
If agreed upon between the insurer and the insured, a loss limit may also be included, which caps the amount of any one loss to be calculated in the Retrospective Rating Plan formula. Basically, the loss limit is used to limit the effect of catastrophic losses on premium.
Once the policy term ends, just as with a traditional Guaranteed Cost Workers’ Comp plan, a policy audit is performed to ensure that estimated payrolls and employee classifications used to calculate the “standard premium” are correct. A minimum of three retrospective premium adjustments will also occur: six months after the policy expiration and in twelve-month intervals thereafter. The reason for the premium recalculations is that often Workers’ Comp claims have long “tails,” taking months and even years for a claim to close, and the insurer wants to make certain there is adequate funding to pay for these claims.
Once the first retro premium calculation is completed, it is compared to the policy premium and the insured either receives a premium return or is billed for an additional premium. All future retro premium calculations are compared to the prior calculation for any needed premium adjustment.
Following is an example of how the Retro Plan premium calculation works:
Factors Used:
Audited Standard Premium for the Policy Term: $753,778
Developed Incurred Losses for the Policy Term: $250,000
Retro Rating Endorsement Factor:
Basic Premium Factor: .38
Minimum Retrospective Plan Premium Factor: .427
Maximum Retrospective Plan Premium Factor: 1.20
Loss Conversion Factor: 1.03
State Tax Multiplier: 1.042
Incurred Loss, Retro Rating Plan:
Premium Parameter and Basic Charge Calculations
Audited Standard Premium $753,778
Basic Premium Factor x .38
Basic Premium $289,450
Minimum & Maximum Premiums:
Audited Standard Premium $753,778
Minimum Premium Factor x .427
Minimum Retro Rating Plan Premium $316,586
Audited Standard Premium $753,778
Maximum Premium Factor x 1.20
Maximum Retro Rating Plan Premium $904,533
If the losses incurred are $0, the minimum the insurer will charge for the policy is $316,586.* If losses are more than $1 million, the maximum premium the insurer can charge is $904,533.*
Example Retro Premium Calculation Based on Above Factors:
Converted Losses:
Incurred Losses $250,000
Loss Conversion Factor x 1.03
Converted Losses $257,500
Total Premium:
Basic Premium $289,450
Converted Losses +$257,500
Total Premium before taxes $546,950
Tax Multiplier x 1.042
Total Premium Due* $569,921
To complete the retro adjustment, subtract the Audited Standard Premium from the Total Premium Due to determine the additional or (return) premium adjustment. Typically, there is a retro development factor applied to the initial calculations premium. It is not included in this example.
Audited Standard Premium $753,778
Total Premium Due* -$569,921
Additional/(return) premium $(183,855)*
(*) The premium does not include policy expense constant or Terrorism.
Who Should Consider a Retro Plan and Why?
Employers with robust loss control and safety programs, strong claims management, and good hiring practices in place along with a history of good loss experience are the most logical candidates to consider a Retro Plan. Additionally, employers with significant loss activity who are committed to implementing meaningful changes in both risk management and claims management to improve their loss experience moving forward could benefit from a Retro Plan. A traditional Guaranteed Cost Workers’ Comp program will not take the latter scenario into account.
A Retro Plan may also be a good option for insureds who have mitigated some of their exposures, for example, a company that dissolved a division with poor loss history. Unlike a Guaranteed Cost policy in which the company’s experience modification factor may continue to capture its historical losses, which would be reflected in a high premium, a Retro Plan would provide the insured an opportunity to lower the ultimate premium based on the reduction of actual losses sustained during the policy term.
There are drawbacks to Retro Plans, too: They are complicated to understand and require a sophisticated buyer and, most importantly, if the actual losses sustained exceed the expected losses, these programs can cost an insured significantly more premium dollars than some other types of plans.
Also, the claims involved may have a long tail, and the ultimate premium on a policy may not be known for three years or more.
The Prescient National Advantage
Claims management by the insurer has a significant impact on the Retro Plan and the ultimate premium an employer ends up paying. Prescient National’s average severity claims cost, based on NCCI data, over the last 10 years is 38% below the industry average, reflecting our committed and successful claims management approach. In addition, our expense load in our claims on average is 2% to 3% lower than other carriers, which also has a positive impact on claims costs.
Prescient National also works with insurance brokers and employers to help determine an insured’s capacity to take on risk and to evaluate whether a Retro Plan or other alternative loss-financing program is the best fit. Our creativity and flexibility as a partner distinguish us as we find a Workers’ Compensation solution designed for the insured’s needs. As the organization grows and changes, Prescient National has the products to meet a business’s evolving insurance need and requirements.
