What Is Retrospectively Rated Insurance?

Retrospectively rated insurance is an insurance policy with a premium that adjusts according to the losses experienced by the insured company, rather than according to industry-wide loss experience. This method takes actual losses to derive a premium that more accurately reflects the loss experience of the insured. An initial premium is charged and adjustments are performed periodically after the policy has expired.

Key Takeaways

  • A retrospectively rated insurance policy adjusts a policy's premium based on actual losses during the policy period.
  • This method of insurance is in contrast to premiums that are based on industry-wide losses.
  • An insured entity can benefit or be hurt by a retrospectively rated insurance, as premiums rise and fall depending on how many losses they incur.
  • Companies have an incentive to implement further safety and loss controls to avoid increased premiums.
  • Workers' compensation, general liability, and auto liability are some areas where retrospectively rated insurance applies well.
  • The adjustment of premiums for retrospectively rated insurance is calculated differently than for experience rated insurance.

Understanding Retrospectively Rated Insurance

A retrospectively rated insurance policy begins in a typical fashion, with premiums based on expected losses. Once the policy expires, the premium is adjusted to reflect the actual losses incurred during the term of the policy.

This method serves as an incentive to the insured company to control its losses since the price of the policy is likely to decrease if the insured is able to limit risk exposure. The premium can be adjusted within a certain range of values, and the policy premium is subject to a minimum and a maximum amount.

When evaluating insurance coverage options, companies weigh the risk that they are willing to take on against the amount of premium they are willing to pay. The more risk the company wants covered, the higher its premium will be. In some cases, companies may want to retain more risk but may want the option of using a retrospectively rated plan that adjusts the premium over time.

Companies that purchase retrospectively rated insurance policies may use them to cover a variety of risks, from general liability and workers’ compensation to property and crime. Retrospective plans can cover multiple risks under the same policy, rather than requiring the insured to purchase a new policy to cover each risk type. The types of risks covered tend to have a low probability of being catastrophic, though the losses may occur frequently. These factors of high loss frequency and low loss severity make the losses highly predictable.

Retrospectively Rated Insurance vs. Experience Rated Insurance

A retrospectively rated insurance policy adjusts premiums differently from an experience rating insurance. An experience rating involves an adjustment based on previous policy periods, while retrospective rating involves an adjustment based on the current policy period. While retrospective policies may consider past losses, current losses hold more weight.

An experience rating is most commonly associated with workers’ compensation insurance, and it is used to calculate the experience modification factor. Insurance companies monitor the claims and losses that arise from the policies that they underwrite. This evaluation includes determining whether certain classes of policyholders are more prone to claims, and are thus more risky to insure.

Not all companies are suited for retrospectively rated insurance. Companies that have small premiums or premiums that change substantially from one policy period to the next, or that have unstable finances, are not well-suited.