Retrospective rating plans allow insureds to benefit from their success at controlling losses. Under such plans, an insured’s initial premium is based on a retrospective premium calculation using an estimate of projected losses. The final premium is determined after the policy expires using the insured’s actual losses. Although retrospective rating is not as prominent as it was in the past, many insureds still prefer retro plans due to their simplicity and the opportunity to reduce premium without taking on as much risk as other loss sensitive plans.
Insurers have a few reasons of their own to like retro plans. For one, they provide insureds with an incentive to control losses. More importantly, under a retro plan the insurer retains control of claims adjusting and the corresponding charges for such services. It is here that an inherent conflict of interest arises. Under a retro plan, an insured benefits the most when losses are minimized, which in turn results in the lowest amount of revenue for the insurer. An insurer actually benefits from higher losses, from which it generates more revenue from claims adjusting and other charges. This inherent conflict can lead to disputes between insureds and insurers over retrospective premiums. In this issue of Risk Financing Perspectives, we offer a brief summary of some recent court decisions on such disputes.