Loss sensitive rating plans, retrospective rating plans, have been used by workers compensation and general liability insurance carriers for many years as a premium development method for a variety of employers. Often presented to an employer as a vehicle through which they can better leverage cash flow while controlling losses incurred. Unfortunately this sales pitch often turns into a costly nightmare for employers caught up in the web of retrospective rating! Just where do retrospective rating plans go wrong?
Workers compensation insurance is known as a “long tail” insurance product. This means that claims, which occur during one year, will not become fully developed for several years into the future. Think about it. An employee who has suffered a major on the job injury may incur extensive medical expenses and lost income that will be stretched out over many years to come. Even with full recovery the ultimate expenses incurred from the claim will not be known until a future date. This is what is meant by “long tail.” As a claim “seasons” the ultimate cost will become more predictable. But this takes time. And for an insurance company, the predictability of ultimate claim costs is of paramount importance when setting rates, profitability standards, and projecting future direction for its stockholders or policyholders. Something they don’t have to worry as much about when it comes to retrospective rating products.
You see, in a retrospective rated workers compensation program, the employer ends up paying claims out of their own check book. Retrospective rating is unlike guaranteed cost workers compensation plans where an employer pays a premium to the insurance company and the insurance company pays the claims out of their check book. Rather, in retrospective rated plans the employers pays a reduced premium, a premium at cost so to speak, to the insurance company and then the employer opens up their check book to the insurance company to use for paying claims.
Sure there’s some safeguards in place to protect the ultimate claim cost that an employer may have to pay. However retrospective rating plans are notorious for leaving an employer on the hook with open claims and large reserve adjustments that they must pay many years after the retro plan has ended.
Here’s what often happens.
- An employer is sold on the idea that they can reduce workers compensation costs by partnering up with an insurance company on a retrospective rating plan.
- The employer initially sees a reduced premium over what they may pay for a guaranteed cost plan.
- As claims begin to come in the insurance company sets reserves and bills the employer.
- As more claims come in the employer begins to see that the cost of paying for a workers comp claim out of their own pocket may not be such a great thing after all.
- The insurance company continues to pay and settle claims using the employers check book.
- The employer becomes more and more disheartened in the way the insurance company establishes reserves and settles claims.
- The employer realizes they must stop the retrospective policy.
- The employer secures workers compensation elsewhere.
- The employer has forgetting the “long tail” effect and that even though they no longer have coverage through the retro carrier, the retro agreement stays in place and they will continue to be billed for new claims, reserve adjustments and settlements until all claims have run their course.
- The employer ends up facing many years of retro adjustments.
- Someone gets sued.
Ok, I know this may not be accurate for all employers using a retro plan, but we’ve seen and have worked on many cases where they came down just like this.
An employer may have no choice. It may not be up to them as to whether they end up in a retro plan or not. For example many workers compensation assigned risk plans will force an employer into a retro if their premium is over a certain level, usually $200,000 or over. And some employers, those who have consistently had bad claim experience, it may be the only way they can secure coverage.
For some employers, a retro plan will work out just as it was sold to them. But never forget, these are extremely sophisticated plans. They are complicated and should never be used without a full understanding of how they work and knowing where they go wrong!
Hope this helps you out and thanks for reading!