In commercial accounts, retrospective rating is a fairly common concept. A retrospective premium program is exactly what its name suggests: a method to calculate the policyholder’s premiums for liability insurance “retrospectively.” While the formulae for calculating retro premiums can get pretty involved, the basics are as follows.
A retrospective premium policy, unlike a standard insurance policy, provides for retrospective determination of the policyholder’s premium obligations according to a formula based on the cost of claims actually paid by the insurance company under the policy. Conversely, a standard liability policy requires only the payment of a fixed premium. The retrospective policy establishes maximum and minimum premiums to be paid, and it states the “standard” premium that would be charged under an equivalent standard policy. (The policyholder pays the “standard” premium up front.) The minimum premium is computed as a fraction of the standard premium.
Retrospectively rated policies usually also contain “loss limitations.” A loss limitation modifies retrospective premium coverage by limiting the amount of a claim to be assessed to the policyholder for purposes of calculating the retrospective premium. If, for example, the loss limitation is $100,000, and the claim amount is $125,000, only $100,000 gets passed through the formula.
Depending upon the specific language of the program (and how good you and your broker are at negotiating), claims can be assessed on a “paid” basis or on an “accrued” basis. If assessed on a paid basis, only claims actually paid by the carrier get passed through the system (after they’re paid). If assessed on an accrued basis, then the claim gets passed through the system once the carrier reserves against it. That’s why, if you’re a policyholder, you need to monitor the carrier’s claim reserves very carefully.
In a couple of recent liability insurance claims I’ve handled, the carrier has tried to use a retro program as a defense to coverage in the first instance. In other words, the carrier has said, “we owe you X, but we get to deduct the retro premium BEFORE we pay you.” That’s not the way retro coverage is supposed to work. If the program is written on a “paid” basis, the policyholder is entitled to the cash flow protection built into the program – the carrier pays the claims and then the policyholder provides reimbursement after the annual (or periodic) review.
The key to controlling costs under a retro program is simple. Trust but verify. Read your program through in advance (despite the fact that it’s mind-numbingly boring) and make sure that all billing adjustments are proper and are properly applied. Don’t just blithely write checks to the carrier, because you may be waiving arguments you could make later. Use your broker, and if your broker won’t take the time to do things properly, get a new broker. Otherwise, you could be leaking a lot of money.