Retro Rating – Hard Market Solutions
Retrospective rating is a means to distribute premiums among various risks (e.g. individual doctors in a group practice) in accordance with actual experience. For the insured, it is a step closer to self insurance while minimizing the down side of risk taking should a period of adverse loss or losses develop. The tables allow for a premium loading to cover this occasional unprofitable period. Over the long run, a retro plan should be both profitable to the company and insured, in addition to protecting the insured’s borrowing capacity in the face of large claims.
Briefly, a retro plan is cost plus insurance. There is a charge for overhead (underwriting expense), commission/broker fees, taxes, and reinsurance. In addition, the actual cost of the loss investigation and expense indemnity is added. This is the calculated retro premium which is set against a minimum (the company’s bottom line limit) and a maximum (the insured’s limit of risk). A retro plan can include a loss limitation/aggregate (capping the losses and/or a deductible). The flexibility of the retro plan makes it most attractive; it is adaptable to all varieties of risk profiles.
Retro plans can be implemented for policies with premiums as low as $500,000 annually, but are most often found above $1,000,000. Groups, both single and multi specialty and association programs are candidates for retro plans.
The policy period is normally three (3) years with an optional two (2) year extension. Likely candidates for retro plans have the following:
Standard underwriting guidelines normally apply to candidates for retro plans. However, retro candidates generally fall into the two vast ends of the underwriting spectrum.
NOTE: One must keep the fact in mind that there is a difference between the higher medical liability risk, and the poor or standard one where standard of care issues are present.
Using past loss history, a likely retro candidate will earn a premium equal to 75% or less of the standard premium charged by the carrier for their traditional policy.
Policies are generally issued for a three year period. The standard premium will be adjusted each annual period. The various factors will remain the same and be endorsed into the policy. Should an insured cancel a policy before the three year period, the minimum premium will be the standard (i.e. no retro credit would apply). Non-Payment of premium terminates the coverage and is considered to be elective by the insured to cancel. The company normally may elect to cancel only for failure to comply with underwriting requests. The company may also elect to non-renew the retro plan or not to extend a retro period (i.e. only renew at standard rates) at the end of each policy year.
The insured may choose to extend the policy to five (5) years instead of accepting a company offer of a new three year policy. This would be advantageous if losses during the three year period would result in premium in excess of standard rates. (This is most likely when a single year’s losses impact the retro calculation.) An extension follows the same factors as the original policy while a renewal for a new three year term might use different factors.
An insured must elect a retro plan at the beginning of the policy period. The factors used to calculate the actual premium will be determined at that time and endorsed on to the policy. (Retro factors are calculated for the expected premium and premiums higher and lower. The final result is an interpolation between the three calculations.)
The Retro Process
Minimum and maximum premiums are set by negotiation. As a general guideline, the maximum credit one might expect for the larger ($1 million annual premium) more profitable risk would be 50-60% of the standard rates. The maximum premium would be about 125-135%. As a rule, the wider the difference between the minimum and the maximum, the lesser the loading for losses excess of the maximum premium. This is logical in that the retro plan is a cost-plus rating plan. With a high maximum, there should be a correspondingly lower probability of exceeding the maximum.
The expected loss ratio for most retro plans is contemplated between 20-75%. This is the statistical loss ratio and not the loss ratio expected for the specific insured.
Generally, there is a “loading” added to the basic insurance charged for losses excess of maximum premium. Although, the calculation for a retro seems complicated, it is a fairly straight forward insurance approach. Underwriting judgments play an important role in balancing the basic insurance charge against the minimum premium when setting the minimum and maximum. Actuarial support is always an important factor as well.
The retro premium is normally recalculated at 15 months, 27 months, and 39 months. The retro-plans return or additional premium should be reconciled at that time. Additional premiums are billed in full.
Retro plans are not a panacea for malpractice insurance problems. However, they do allow risks to distinguish themselves from others. Retro plans allow the cost of insurance to be distributed according to the true risk. It puts the broker, risk manager, insured and carrier into a working partnership in an effort to manage the risk, rather than merely the broker’s role to sell, the insured to purchase, and the carrier to take risk.