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Retrospective insurance premiums: the law favors the policyholder.

INSURANCE POLICIES, PARTICULARLY workers' compensation insurance policies, frequently require the policyholder to pay additional premiums based upon the insurer's outlay to claimants. Even more significant, many of the policies base these additional or retrospective premiums on reserves -- the amount the insurance company estimates in advance of any actual payment that will ultimately be paid to the claimant. The insurer thus has the use of the policyholder's money for the years the claim is pending. Such insurance policies are called "loss sensitive and have "retrospective premium adjustments." These adjustments can be made on either a "paid-loss" basis or on an "incurred-loss" (reserve) basis, the latter of which risk managers should be particularly concerned about.

The premium adjustments, or requests for further premium, often come as a severe jolt to policyholders. The anomaly is that the bigger the reserves and losses, the bigger the premium and the bigger the insurance company's profits. Since the insurer has exclusive control over loss payments and reserves, it can control the amount and timing of additional premiums.

If a company bought insurance policies with a retrospective premium feature, its risk manager should be aware that the law protects the policyholder's interests. Do not hesitate to question the insurer about settlement of claims, its reserves, or any other problems with "retro" adjustments and bills for added premiums. Remember that some, but not all, insurance policies with retro premiums have "stop-loss" or loss limitation provisions that limit the policyholder's additional premiums should a particular loss or its aggregate losses go above the "stop loss."

The courts recognize the fact that the insurer is paying every claim below the retro loss limitation (if there is one) with the policyholder's money. Indeed, a Kansas court (in Transit Casualty Co. vs. Topeka Transportation Co., 1983) stated that, in a retrospective premium context, "when the insurer settled a claim it did so with the insured's money." The courts in recent years have said much more than this in favor of the policyholder who is asked to pay a retrospective premium.


The key aspect of recent court decisions regarding retrospective premiums is that the insurance company has certain duties toward the policyholder who is paying the additional premium. These duties stem mainly from the fact that the retrospective premium feature involves a possible conflict of interest between the insurer and the policyholder. The Delaware Supreme Court, in Corrado Brothers Inc. vs. Twin City Fire Insurance Co., 1989, noted that there is a potential for conflict between the insurance company and the policyholder if the settlement of a claim imposes consequences, such as an additional premium payment, upon the policyholder. If a company's policy has a retro premium, that company is, in reality, paying for moast settlements made by the insurer. Therefore, the policyholder is better off having claims paid at a low figure.

All retro premium fomulas have "add-ons" to "compensate" the insurer. These add-ons can be as much as 40 percent of the insurance company's reserve or payment on a claim. Given that the policyholder pays these add-ons in addition to the amount of the actual paid losses and reserves, the insurer has an incentive to settle higher so it can charge that policyholder more add-ons. At the very least, the insurer lacks the usual incentive to minimize loss payments. The conflict is obvious.

If the additional premium charged to the policyholder was dollar for dollar the amount the insurer paid to the claimant, the problems would be minimized. However, this is not the case. Insurance companies benefit from higher losses in three ways. First, there are the add-ons -- if the insurer pays a claimant one dollar, the insurer will charge a retro premium of as much as $1.40. Second, incurred loss retrospective premiums are based upon the amount the insurer "reserves" for future payment. Thus, an insurance company charging $1.40 for a $1.00 reserve has the present use of $1.40 to cover a claim it may not pay for several years. Third, the same reserves also go into the policyholder's experience rating. This fact usually leads to an increase in premium at renewal time for the policy. Thus, overrserving gives the insurer a "double dip" -- more of the policyholder's money to use in the present and a higher "standard" premium in the future.

This conflict of interest is the reason the insurance company has duties toward its policyholders. For example, insurers have a duty to exercise good faith when paying claims under retro policies. The Illinois Court of Appeals in National Surety Corp. vs. Fast Motor Service, 1991, has ruled in this regard. Other courts have echoed the Illinois decision. A key aspect of the duty of good faith -- as it relates to retro policies -- is that the economic decisions of the insurer have economic ramifications for the policyholder. In other words, the insurer should be responsible to its policyholders since it is spending their money. And this is particularly important in situations where the more the insurer spends of this money, the greater its profits.

Courts have also ruled that insurers have a duty to investigate claims paid under retro policies. The Supreme Court of Minnesota, in Transport Indemnity Co. vs. Dahlen Transport Inc., 1968, noted that the policyholder with a retrospective premium has delegated the duty to investigate claims to the insurance company. An important element of the duty to investigate is that the insurer alone has the information to determine the soundness and validity of the reserves, the claims and the settlements. The insurer must act in good faith because the policyholder simply lacks the legal right, the facts and the resources needed to investigate and evaluate claims.


Insurance companies must meet a "reasonableness test" when they settle claims under policies having a retrospective premium feature. Indeed, the burden of proof is on the insurer, not the policyholder, to show that settlements are reasonable. In this regard, the Delaware Supreme Court (in the Corrado decision) stated that the burden is on the insurance company to demonstrate "that it acted reasonably and in good faith." At least some of the insurers some of the time are aware of their duties. In one of its briefs in the Corrado case, Twin City (a member of the ITT Hartford Insurance Group) stated: "It is admitted, however, that Hartford's right to recover is conditioned upon a showing that it acted in good faith in settling the claim and that the settlement of the claim was reasonable." Here we have an insurer admitting to its duty of good faith, to its burden of proof and to the reasonablenss test.


Knowing that the law is on the policyholder's side, risk managers may next wonder what they should be aware of regarding retrospective premiums. What problems could arise? First of all, watch out for the insurance company settling claims just at, or close to, the loss limitation within the retro. If your company's policy has a $200,000 loss limitation, the insurer gets more premium dollars and more add-ons by reserving or settling a claim at $200,000 rather than at $100,000.

Insurance companies may make generous settlements to avoid risking their exposure for amounts in excess of the loss limitation. An insurer knows that there is a risk that a lareger payment may have to be made to the claimant if a case is contested.

Also, it knows that larger payments in excess of the loss limitation would be made with the insurance company's money, not the policyholder's. It is a gamble, since the claimant might lose his or her case, resulting in a savings both to the policyholder and to the insurer. However, the insurance company might decide not to gamble with its money and pay the claimant a "beefed-up" settlement with the policyholder's money to close the claim. Risk managers should be cautious about this scenario. Risk managers should check their company's loss runs to determine whether too many claims are being reserved or settled at or just below the loss limitation. Risk managers have a right to demand information from their insurance company!

Risk managers should also look at the "names" of all the newly opened claims, and investigate those claims involving the names of claimants they do not recognize. Do not accept claims with the name "Unknown." Once again, request supporting documentation from the insurance company.

Beware of reserves set at a figure larger than the average for a similar type of claim. This situation may occur if, for example, a company has a number of back injury claims. There is an agerage figure that the insurer tends to use for newly opened back injury cases in a given geographic area at a given point in time. Risk managers who are concerned about the size of the reserves for newly opened claims should speak first with their colleagues in the industry, brokers or risk management consultants -- then with the insurance company.


Everyone has received holiday or birthday gifts he or she did not like. Remeber the purple necktie covered with green fish? Policyholders may receive unwanted gifts, too. Risk managers should chech their companies' records on older and current liability policies. Suppose an older general liability policy had per occurrence limits of $250,000, an aggregate of $2 million and a retro (still open) with no loss limitation. Make sure that the policy limits were not suddently, inadvertently "increased" to, say, $500,000 per occurrence. If this policy had to cover (for example) only three large occurrences, without ever being exhausted, then the retro premium would be higher than it would have been before the "gift." In other words, $1,500,000 x 1.4 is larger than $750,000 x 1.4.

Watch out for the assignment of a claim (especially a paid loss) to an improper line of insurance. Was a workers' compensation claim assigned as a general liability claim or vice versa? Was a premises-operations bodily injury claim wrongly assigned as a products bodily injury claim? Improper assignment of claims can adversely affect a risk manager's ability to access his or her excess insurance coverage. In other words, the company's underlying coverage, due to error, may not be exhausted. So, review the firm's loss runs -- for older policy years as well as for the present period.

Also watch out for the assignment of a claim to a policy year in which the retro is still open. Insurers are inclined to assign claims -- particularly multi-year losses -- to years that have an open retro rather than to a year with a closed retro on no retro.


When a policyholder is settling a dispute with an insurance company, it is always better to settle net of the retro. Policyholders have been surprised to find that after reaching an agreement with an insurance company pursuant to which the policyholder is to receive $1.00, the insurer then sends a bill for up to $1.40 (the settlement amount plus the retro-adjustment). If your company cannot settle net of retro, then agree in advance on the amount and method of retro chargeback. If the company is not in litigation with its insurer, then the risk manager should speak with the insurer about the retro. Giving an insurance company complete freedom on a retro chargeback could mean that the settlement could ultimately cost your company more than it receives from the insurer.


Beware of retro chargebacks of a "one occurrence" loss being classified by the insurer as multiple occurrencies. Once again the law is on the policyholder's side. Certain groups of claims, such as asbestos cases, are usually viewed by the courts as a single occurrence. This results in a single retro charge and the policyholder immediately reaching the loss limitation. If, on the other hand, such claims are treated as multiple occurrences, then the loss limitation for each of the many claims would probably not be exceeded. Instead of receiving any "real" indemnity after a single loss limitation has been reached, the policyholder would pay for all of the claims when it pays its retro premium. If multiple claims result from one common cause, it is usually better to have these treated as a single occurrence. This will reach a single loss limit and result in a larger amount of indemnity flowing to the policyholder, with a much reduced retro chargeback.

Furthermore, risk managers need to be wary of sets of loss runs from the same insurance company prepared within a few months of one another, covering the same policies but giving highly conflicting data. Perhaps the conflicting reports came from different insurance company data centers. Check into it. The policyholder has a right to get an accurate report.

Also, beware of routine mathematical errors. This may seem obvious, but remember that errors in calculations are common. Do not assume every retro adjustment is accurate. In fact, make certain the actual adjustment was done and that the "adjustment" is not merely a bill. Check the math on the losses, and always check the figures to make certain that the appropriate return premium has been collected. One number out of place could cost a policyholder thousands of dollars.

Retrospective premium agreements involve complex formulas. Risk managers should make certain they understand whether, for example, defense costs are to be included in both the premium calculations and the loss limitation for each occurrence. Check with an insurance consultant or attorney before putting a retro program into place. He or she might be ablt to negotiate a claim-size agreement with the insurer. Such an agreement states the maximum amount at which an insurer can settle any claim without the policyholder's authority. Indeed, risk managers may wich to check with these professionals in later years about monitoring claims handling. These consultants may, for example, be able to negotiate for a reduction of certain reserves that the risk manager believes to be too high. Additionally, risk managers are advised to meet with their insurers periodically to review retro calculations and claims data.

If a company has an insurance policy with a retrospective premium feature, the law is on the policyholder's side -- the insurance company has certain duties toward you, the policyholder. So stop, look and crunch those numbers. It's your money!
COPYRIGHT 1993 Risk Management Society Publishing, Inc.
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Author:Anderson, Eugene R.; Fields, Glenn F.
Publication:Risk Management
Date:Nov 1, 1993
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