Insurance companies offer loss-sensitive pricing plans for risk-tolerant clients. In the most fundamental case, the client pays a standard premium and may receive a dividend or return premium based on actual losses.
More sophisticated pricing plans are available for clients willing to assume more risk. Retrospective rating plans (retros) reward companies that maintain strong internal loss control and claims handling practices.
Retros begin with a basic premium that reflects the fixed costs of the program. That basic premium covers administrative costs, premium taxes, loss control services, sales commissions, and underwriting—and is commonly about 25% of the standard premium.
Added to the basic premium are reserved losses multiplied by a loss conversion factor, typically around 1.15, to account for claims handling and legal expenses. Total retro premium is basic premium plus converted reserved losses, adjusted by other contractual factors.
Retros generally include a minimum and maximum premium. Choosing higher minimums and maximums transfers less long-term risk to the insurer and is usually rewarded with a lower basic premium, a lower loss conversion factor, or more favorable cash flow terms.
Lower minimums and maximums cost the insured through higher basic premiums, higher loss conversion factors, or less attractive cash flow options. Retros are most suitable for organizations that can tolerate variability in cost to gain potential savings.
Do not consider a retro program unless your annual premium is at least $200,000. The administrative and actuarial work required makes smaller programs uneconomical.
The best time to enter a retro is often after a bad claims year that raises your experience modification and is expected to stay elevated for several years; a retro can help recapture some of that higher cost. However, you must have losses under control and realistic loss forecasts.
Many retro plans base final premium on reserved losses rather than paid losses. A reserve is an estimate of the future costs of a claim and can affect the final premium even if no payment has yet been made.
Retro audits address reserve uncertainty by resetting claim reserves and recalculating premium annually; you should expect multiple annual audits as part of the program. If you prefer paid loss accounting, raise that point in negotiation to reduce reserve-driven volatility, especially for smaller medical-only claims—see Understanding Premises Liability and Workers' Compensation Insurance.
Negotiate a deductible or special handling for medical-only claims to avoid the loss conversion factor add-on when possible. Forecast your losses for the next three years and decide how much maximum premium exposure you can accept before signing a retro agreement.
The self-insured program is the ultimate form of retrospective financing: you act as your own insurer and control reserves and cash flow. Consider formal Self Insurance Programs only if your expected premiums will remain well above $1,000,000 per year for the foreseeable future.
There are still fixed fees—actuarial work, taxes, filing fees, and administrative costs—and you will still incur legal and investigation expenses to handle claims. The biggest advantage of self-insurance is control of cash flow through reserve management.
The biggest disadvantage comes if you stop self-insuring and return to the commercial market, which can be costly or difficult; be certain you can commit for the long term. Before making a decision, review the numbers and talk to an agent.
For organizations that prefer partial risk transfer, consider contractual structures such as Self Insured Retention Programs (SIR), which sit between full commercial insurance and full self-insurance and may better match your risk tolerance and cash flow needs.
Frequently Asked Questions
How does a retrospective premium differ from a standard premium?
A retrospective premium adjusts after the policy period based on actual losses and predefined factors, while a standard premium is fixed for the policy term.
What is a loss conversion factor?
The loss conversion factor multiplies reserved losses to include claim handling, legal, and other claim-related expenses when calculating the retro premium.
How many audits should I expect in a retro plan?
Retros commonly include one or more annual audits—expect multiple audits over the life of the program to reset reserves and adjust premium.
When is self-insurance a good option?
Self-insurance can be advantageous when expected premiums are very large, you have stable loss experience, and you can commit to handling claims and funding long-term liabilities.