What is a Workers Compensation Retrospective Rating Plan?
Retro or Retrospective Rating Plans for Workers Compensation are sophisticated rating programs designed where the final premium paid is based in some fashion on actual losses incurred during the policy period. These plans are complicated and many times used as an alternate funding mechanism. When used and managed properly they can be a valuable tool in controlling the total cost for a workers compensation program. When used or managed improperly they can lead to costly overpayment of premium and expensive legal disputes and litigation between the insurance carrier and the employer. A retro plan is not a workers compensation insurance policy but is an endorsement to a policy that modifies the standard policy and includes the retrospective rating formula used.
There are several different types of workers compensation retrospective rating plans and include a Tabular Plan, Incurred Loss Retro, Paid Loss Retro and Depressed Payroll Retro. Two of the most common are the Incurred Loss Retro and the Paid Loss Retro. The Incurred Loss Retro Plan is probably the most popular due to the lower upfront cost to setup and begin the plan and typically reserved for those with premiums in excess of $200,000+. Paid Loss Retro's are reserved for larger clients, they are more difficult to attract insurance carriers, much more costly to setup and usually reserved for those clients paying premiums in excess of $1,000,000.
A Video About Workers Compensation Retrospective Rating
How does a Retrospective Rating Plan work?
Actual premium is based partly on the loss/claim history incurred during the policy period. Final premium calculations are performed after the end of the policy period once the tabulation of claim or loss information is completed. At this time the insurance company will use the retrospective rating formula and rating factors which have been approved for use by the state department of insurance. In the typical incurred loss retro plan insured policy holder, employer, pays a premium to the insurance company who in turn makes claim payments to the injured employees or claimant. Then after the end of the policy period, a retrospective adjustment to the insured's policy premium is made based on losses incurred during the policy period. Sounds simple right? Don't be fooled, it's not!
How do claims effect a Workers Compensation Retrospective Rating Plan?
Claims, and just as importantly, claim handling by the carrier, have an enormous effect on the retro and the ultimate premium an employer will pay. Remember, the whole idea around a retrospective rating plan is that the policy holder, employer, is responsible for paying the claim cost which is determined by an annual recalculation of the retro after the development of losses for the policy period in question. So this type of plan is all about the claims! It cannot be stressed enough that proper claim handling must occur. Every year the employer must have their claims reviewed by an outside source. Without this independent look, the employer trusts the insurance carrier to do their best with the employers money! The employer gives the insurance company an open check book while trusting they will make the right decisions regarding claim handling. The insurance company has none of their own money on the line! And this is a dangerous situation for the employer!
How is premium calculated for a Workers Comp Retrospective Rating Plan?
It's complicated. Calculation of premium for a retro plan involves many different parts. The ultimate cost for an employer is based on a combination of items, subject to minimum and maximum premium factors and the recalculation or adjustments of the retro premium after the development of losses for the policy period in question.
Here's an example of a basic retro calculation formula:
[Basic Premium + (Losses x Loss Conversion Factor) x Tax Factor + Non Subject Premium] = Retrospective Premium
Calculation of final premium:
Typically a minimum of three retrospective premium adjustments occur:
the first six months after the expiration of the policy;
the second eighteen months after the expiration of the policy;
the third, thirty months after the expiration of the policy.
It's these adjustments that will determine the final premium, of course subject to the minimum and maximum.
What are some standard components of a Retrospective Rating Plan?
Standard Premium- The standard premium is typically developed by multiplying the correct rate by the exposure unit.
Basic Premium- The basic premium is developed by multiplying the Standard Premium by a basic premium factor which is developed by the insurance carrier. The basic premium includes the insurance charge by the insurance company; loss control expenses; rating authority expenses; administration expenses and commissions paid to producers. Basic premium charges vary a great deal between insurance carriers.
Minimum Premium- The minimum premium an employer will pay for workers compensation coverage under a retro plan. The minimum is generally stated as a percentage of the standard premium or is subject to a formula calculation minimum. There are pros and cons for each method.
Loss Conversion Factor- Is developed by the insurance carrier and includes; Allocated and unallocated loss adjustment expenses and claims handling expenses;
Tax Multiplier- The tax multiplier typically includes; Premium Tax; Other Applicable Taxes; Required Contributions to Miscellanious State Funds and State Departmental Assessments such as the Department of Labor, etc.
Non-Subject Premium- Premium that is not included in the retro rating formula and indicates that this part of the premium is not adjustable as a part of the formula. Typical items included would be the premium paid for excess insurance or for coverage over the loss limits.
Maximum Premium- The maximum an employer will pay. In establishing a maximum premium factor here are some of the items that should be considered: The premium size; Information generated from loss forcasts and projections; The potential for severe or catastrophic loss; Experience rating issues and Economic effects.
Who should consider using a Retro Plan for Workers Compensation Funding?
Employers who are approached to use a retrospective rating plan should consider these typical factors. Retrospective rating plans work best for accounts;
With large workers compensation premium;
Who are stable and established;
Who are financially stable and sound;
Who have experienced some claim frequency;
Who have valid, consistent claim data available for analysis;
Who have had better than average claim experience;
A thorough examination of loss tabulations, claim experience and projections along with projected cash flow and tax impact is required in order to make a viable decision in consideration of use of a retrospective rating plan. Comparisons between other available alternate funding options like guaranteed cost, large deductible, self insured and even captive insurers must be made before making the commitment to proceed with a workers compensation retrospective rating plan. A good broker will guide you through the decision making process. But don't just rely on your broker or insurance company representative. Do your own homework, know how your plan will work before making the commitment and signing the contract.
Who should not use a Workers Compensation Retro Plan?
There are definitely some red flags that must be paid attention to when it comes to the use of a retro plan for workers compensation. Employers who may fall into these categories should be very cautious and probably not chose the retro option for funding their workers compensation plan.
With small workers compensation premium;
Who are not stable;
Who have financial difficulties;
Who have poor loss experience;
Who are subject to catastrophic exposures;
Who have experienced wide premium fluctuation;
Making the decision to use a retro plan for funding your workers compensation insurance coverage should not be taken lightly. At the onset, positive cash flow, lower initial cost and potential positive return on investment is an attraction but an attraction that requires use of experienced insurance carrier representatives, brokers and acturarial consultants providing the correct information for you to make that decision.
Be wary! There are many employers who chose to use a retrospective rating plan when they should not!
What are some common problems found with a Workers Compensation Retrospective Rating Plan?
Claims and the mismanagement of claims by the insurance carrier pose a very big problem. It's estimated that over 60% of claims settled by insurance carriers are done so in error costing employers an enormous unknown amount in additional premium payments at the retro adjustments. It cannot be stressed enough that employer using a retro plan should have their claims reviewed by an independent source for verification of proper adjustment calculations.
Cash flow may be worse when using a retro plan than with other options. When the final premium is calculated, including loss adjustments and the basic cost of the retro plan, it may be discovered that the initial attraction of the plan, proposed positive cash flow, may have gone south! These plans are very sensitive to the proper settlement of claims by the insurance carrier and unlike other funding mechanisms, specifically a guaranteed cost plan, the ultimate cost of a retro plan is not determined until many months after the end of the policy period.
Cost is subject to potential large swings. While the employer is protected under the retro plan contract with the minimum and maximum, everyone seems to think they will only be paying the minimum. This is not what happens in the real world. While in a very good plan year, one with few losses, an employer may pay only the minimum thus realizing a savings and positive cash flow over other funding options, it's the large losses that may bring on huge unexpected additional costs. And it's these potential large swings in cost that can cause problems for an employer.
What type of premium errors occur on a Retro Plan?
Retrospective rating errors can be extremely expensive to an employer! Because of the complexity of the rating formulas and variety of developed factors that go into the cost calculations you'll find that Retrospective Rating Plan errors and mistakes occur with astounding frequency. Not only errors and mistakes found between the state filed formulas and rating factors and those actually used by your insurance carrier, but mishandled claims and claim procedures all lead to potentially very large premium mistakes. Retrospective rating formulas and rating factors are all filed for use by each individual insurance carrier within each individual state. These filings are maintained and updated each year. The state filings dictate how the retro premium calculations apply. Here are some of the typical premium errors and mistakes we see:
Wrong or Incorrect Retrospective Rating Formula Applied - With each insurance company filing and maintaining multiple retro rating formulas for each state it's easy to understand how an incorrect formula may be applied to an employers adjustments.
Incorrect Minimum Applied - Consider an account who has experienced no claims during their retro experience period. After adjustment the insurance company agrees that the minimum applies and returns the difference ($200,000) between the estimated premium ($400,000) and the minimum premium ($200,000) to the employer. But the employers agreement indicated the minimum would be 25% of the estimated premium or $100,000. In this example the employer just lost a return of an additional $100,000 due to the simple misapplication of the rating formula. And while this is a very simple example, many more complex and detailed errors and mistakes lead to many thousands of dollars in unreturned premiums for employers!
Claim Handling Mistakes - With an incurred loss retro the employer opens his check book up and invites the workers compensation insurance carrier to use his money for adjusting claims. The employer places his complete trust in the hands of the insurance carrier, relying on them to make proper claim decisions all the while using the employers money to accomplish this act. It cannot be stressed enough that mishandled or mismanaged workers compensation claims lead directly to overpayment of premium by the employer using a retro plan. Claims must be monitored and reviewed by an outside source! This area leads not only to overpayment by the employer but results many times in litigation between the insurance carrier and the employer.
When errors and mistakes occur in a retrospective rating plan for workers compensation rest assurd those errors and mistakes will be costly! The numbers are usually very large and unfortunately occur with frequency!
How can errors and mistakes found on a Workers Compensation Retrospective (Retro) Rating Plan be corrected?
If the proper formula was used by the insurance carrier;
If the retrospective rating premium was calculated properly;
If the experience modification factor was applied correctly;
If the proper classifications were used;
If costly errors and mistakes were made on your retrospective rating plan.
Once workers compensation retro mistakes have been identified, our consultant will work with you and/or your attorney in developing a plan to move forward and have the mistakes corrected.
What are the advantages of a (Retro) Retrospective Rating Plan for an employer?
They can be the least expensive option for securing workers compensation coverage;
They are somewhat easily available, depending on the current market place and carrier availability;
The rating options and plan design are very flexible;
They create strong loss control incentive
They provide an excellent cash flow possibility
What are the disadvantages of a Retrospective (Retro) Rating Plan?
They can be the most expensive option…if alternatives are limited or if loss experience is poor during the retro period
The functions of the plan are not understood, lack of understanding how the adjustments work and creates a problem for an employers accounting and budgeting
Can lead to large annual cost of risk fluctuations
May require high collateral,
Poor handling of claims can cause higher cost
Workers compensation retrospective rating plans...otherwise known as retro plans...are loss sensitive alternate funding mechanisms for workers compensation premiums.
The key words are "loss sensitive." In fact, with a retro plan, the employer will participate in some manner in direct payment of claims incurred.
As compared with a typical fixed or guaranteed cost plan, where the employer pays a premium to the insurance company and the insurance company pays claims out of their own pocket...on a retro plan the employer pays a minimum premium to the insurance company and after the end of the policy period, in what's known as the retro adjustment, the insurance company tabulates claims incurred and collects from the employer the actual cost of those claims. There's generally some maximum limitations built into the plan so the employer may know their maximum cost for a single policy period up front. But in an incurred loss retro, the employer actually pays the cost of their own claims, allowing the insurance company to pay those claims, out of the employer's pocket!
You might ask...why would anyone do that? Positive cash flow, a positive return on investment and possible tax benefits are some of the reasons an employer may be attracted to using a retro plan.
These plans are sophisticated and are certainly not for everyone. It requires experienced, informed brokers and insurance company representatives...people who know what they're doing...to properly design and set up a retro plan.
Employers must be qualified before choosing to use such a plan. We've provided expert witness and litigation support on cases where employers were poorly informed about the pitfalls of these plans. Where they incurred large, unexpected additional premium bills from the insurance company and ultimately ended up in litigation.
So when these plans go wrong...they go wrong in a big way!
Be sure to visit the page on our website about workers compensation retrospective rating plans. You'll find out what a retro plan is, how it works, how claims effect them, how to calculate premium, who should and should not consider using them and how to correct problems when the occur!
I hope this information has been helpful and thanks for Watching!