Using a simplified definition, a retrospective rating plan (retro) is a pricing plan available in which your workers compensation premium is developed, in its final form, by the losses sustained during the policy period.
First let’s go over the components of a retro:
Maximum Premium: This factor represents the percentage over and above the standard premium, which can be collected in the event of adverse loss performance during the policy period. Example: A $50,000 policy with a 1.25 (125%) maximum could potentially be billed $62,500 if you had a high claims amount. This factor is part of the negotiating your agent should do on your behalf. It is subjective and set by the underwriter.
Minimum Premium: This factor represents the ultimate return to the insured in the event you had no losses. Example: The same $50,000 policy with a.60 (60%) minimum premium would pay only $30,000 in premium if you had no losses. This factor is in direct correlation with the maximum. The higher the maximum, the lower the minimum and visa versa. In other words, take more risk get more reward, take less risk get less reward.
Loss Conversion: This factor represents the cost the insurance company is going to charge you to administer the claims you incur. Example: The retro is issued with a 1.10 (10%) loss conversion factor and you incur a $10,000 claim. The insurance carrier will calculate this claim as $11,000 ($10,000 x 1.10 = $11,000). This factor is also negotiable and set by the underwriter. This factor has a direct correlation with the minimum. The higher the loss conversation factor the lower the minimum premium and visa versa.
Tax Multiplier: Because retro’s deviate from the standard policy pricing, which has the premium taxes the insurance company pays included in the premium the tax multiplier is shown separately on the retro. This factor is set by the state and is not negotiable.
Now that we have covered what the “factors” represent, here is an example of how a retro is calculated. In this example we will use a $100,000 standard premium and $40,000 in losses the following factors (The factors vary by insurance company these being used are only an example):
- Maximum: 1.25
- Minimum.50
- Loss Conversion: 1.10
- Tax Multiplier: 1.07
$100,000 (standard premium) x.50 (minimum premium) = $50,000
$40,000 (losses) x 1.10 (loss conversion factor) = $44,000
$50,000 Minimum Premium + $44,000 losses plus conversion factor = $94,000 premium
$94,000 premium x 1.07 Tax Multiplier = $100,580 final premium
In this example the final premium after the calculation was not above our maximum premium of $125,000 (standard premium x maximum premium factor) so the final premium remains as calculated.
Because the losses were high in relation to the premium size this retro did not work in favor of the policyholder costing $580 more than a standard policy would have. However, using a total claims amount of $22,000 following the same calculation formula the final calculated premium would have been $81,620 saving you $18,380 on your workers compensation policy.
Summarizing this example, the maximum risk to you would be to pay an additional $25,000 towards your workers compensation but your potential savings could be $50,000.
There are two types of retro plans, these plans are identical and differ only in the manner in which they are billed:
Incurred Loss Retro: Under this plan you pay in your standard workers compensation premium each month. The benefit to this program is the policyholder does not have to put up collateral.
Paid Loss Retro: Under this plan you pay in your minimum workers compensation premium each month plus the losses that were incurred that month. This plan can have a significant cash flow advantage to the policyholder but often times the insurance company will require collateral.
As you can see, retro’s can be a valuable tool in reducing your workers compensation cost but do come with some risk. You should work with an insurance agent that is experienced in retro’s to decide if one is right for your business.