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Workers' Compensation Insurance

June 14th, 2011

Retrospectively Rated Workers Comp Insurance Plan

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Martin Summers

Insurance Agent

Under the standard insurance plans issued in the market place, the insurance company will look at your past losses, amounts of your payroll, the type of business you are involved with and attempt to predict what your premium payment should be. In its simplest form, if the carrier correctly “guesses” what your losses will be and theses losses are less than premiums paid, the insurance company wins. To the contrary, if losses exceed premium amounts, the carrier loses (without considering investment income, the value of cash flow, etc.) This is not, however, how a retro plan works.

Under a retro plan, the carrier does not predict what your losses are going to be and charge you a premium for that prediction. Rather, there is a look back (retrospectively) to the previous year’s experience and based upon your previous year’s losses and possibly reserves for losses (depending on the type of retro plan), the premium calculation is made. There is no “guess” as to what your losses will be. These losses are quantitatively determined by looking at actual numbers. At a given time after the policy period ends, the insurance carrier will value your claims and at that time calculate the premiums due.

From a philosophical standpoint, the retro plan concept permits the employer to participate in the “bet” along with the carrier as to whether the employer’s losses will create a profit or loss. If losses are less than expected, the employer participates in the profits by paying less premiums. If losses are more than expected, excessive premiums are potentially payable by the employer as part of this “bet.”

There are minimum or basic premium calculations and there are maximum premium payments under these plans, sometimes in excess of that which you would ordinarily be responsible for paying under a guaranteed cost plan. When comparing retro plans and their prices you should limit, if possible, the minimum or basic premium. You should realize that you should choose a high maximum premium exposure, you could be subjecting your company to potential substantial liability should your losses for a given year be excessive. From a price standpoint, you might want to increase the amount of the maximum premium payment.

Added to the calculation of the premium amount is what is known as a “loss development factor” (LDF), which basically is intended to offset the administrative and claims handling costs incurred by the insurance carrier. Obviously, you want to minimize this factor (usually expressed as a percentage of paid or incurred losses)/ thereby reducing your ultimate payout. There is also a tax modifier that will take care of any state assessments such as for the special Disability Trust Fund and the Administration Trust Fund. A simplified formula for computing a retrospective premium is as follows: retrospective premium + (basic premium + converted losses) x tax multiplier.

The positives in choosing a retro plan primarily relate to cost and cash flow. There can be a significant savings. The negative, however, involves the situation where you losses are greater than expected. In such circumstances, you might be paying more in workers’ compensation premiums than you would be due had another plan of coverage been chose. (There is some indication that some of these plans in the market place are placing the maximum exposure at amounts payable if a guaranteed cost plan is chose, i.e., standard premium. If this is the case, maximum payouts would be limited.) Another negative is the almost “built in” conflict between the carrier and employer on pricing incurred losses for premium calculation. The employer’s primary goal is to minimize these amounts: this may not be the goal of the carrier.

If you choose a retro plan, you must be willing to be an active participant in your workers’ compensation program and most importantly, have confidence in your insurance company’s ability to properly manage your claims. This is one instance where you must have complete trust that your claims handler will provide proper and attentive service. You must also be comfortable with their knowledge of the law, their aggressiveness in handling claims, and their reserving practices. In addition, you should be an active participant in choosing the doctors to whom your injured workers are sent. In summary, you must be completely familiar with your duties and responsibilities and willing to work closely with the adjuster handling your account.

You should be aware of the fact that retro policies remain in effect until all claims have been settled or otherwise resolved, which sometimes can take ten or more years after expiration of the policy. Adverse development of claims (sometime years after policy expiration) can cause the payment of additional premiums. Sometimes insurance companies will agree to a cut-off date for recalculations.

A retention dividend plan is a hybrid of a retro plan and a dividend plan. It operates as a cost-plus plan, i.e., premium payments are like the retro-plan but returns are paid like dividends. The maximum premium amount is no higher than a guaranteed cost policy. However, unlike the retro plan, savings depend on the insurance company’s declaration of a dividend.

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