Loss-Sensitive Rating Plans Flashcards
Advantages to insured, LSRPs
Incentive for loss control
Immediate reflection of good experience
Cash flow benefits
Reduction in premium taxes
Disadvantages to insured, LSRPs
Uncertain costs
Immediate reflection of bad experience
Impact on future financial statements
Ongoing administrative costs
Advantage for insurer, LSRPs
Insured incentive for loss control
Less capital required to write policies
Ability to write otherwise unacceptable policies
Disadvantages to insurer, LSRPs
Credit risk of insured
Reduction in cash flow
Tendency for insured to second guess (profit provision, handling of claims)
General retrospective premium formula
P = (B + cL)T
Losses are as of 18, 30, or 42 months
Components of retro premium formula
B = basic premium; reflects fixed charges
c = loss conversion factor; reflects variable expenses
T = tax multiplier = 1 / (1 - tax rate)
Balance principle
Retro premium = E[Guaranteed Cost premium]
Flawed because the transfer of risk and amount of required capital is different between the two plans
LRARO
Large Risk Alternative Rating Option
Common features of LRARO
Rating based on mutual agreement as insureds are knowledgeable and sophisticated
Can use losses on paid basis
Max/min ratable losses agreed upon
Why LDD plan can be priced similarly to retro plan
Deductible ~ per-occurrence ratable loss limit
Aggregate limit ~ aggregate ratable loss limit
Main differences between SIR and a large deductible plan
Regulator approval required for WC and auto
Insured responsible for adjusting/paying claims
Insurer does not inherit credit risk
Policy limit not eroded by SIR
Dividend plan
Dividends are paid if insured’s losses are lower than expected
Clash coverage
If multiple LOBs and policies impacted, clash deductible < sum (individual deductibles)
Basket aggregate coverage
Cap insured aggregate reimbursable or ratable losses across multiple LSRPs at a single aggregate retention, up to a specified limit.
Adjustments needed on a multi-year plan
Allow for exposures to change over term
Loss trends must be built in