Loss-sensitive rating plans2

Question 1

large deductible plans

Answer 1

• often just written as full coverage policies with an extra endorsement specifying that insured will reimburse the insurer for losses below per-occurrence deductible possibly up to an aggregate limit
• deductible may or may not include alae

Question 2

large deductible plans: policy premium vs full coverage

Answer 2

• since deductible is in place, policy premium will be much lower than premium for full coverage policy including expected premium for retro rated policies
• this means that employer is taking on more of insurance risk so it is possible that their total costs in given year would be higher than purchasing full coverage
• since some expenses are variable to lower net premium, expenses will be lower in amount compared to full coverage but expected excess loss can be relative to expenses so expense ratios can be quite high

Question 3

from loss standpoint, self-insured retention with excess policy is similar to

Answer 3

large deductible plan

Question 4

key differences between self insured retention and large deductible plan

Answer 4

1. for required coverages, regulator approval is required for self-insurance with excess policy
2. since with self-insurance and excess policy, the insured is responsible for adjusting claims; insure only incurs alae for claims that exceed retention
   - usually retention applies to loss only and alae is shared pro-rata
   - ulae is much lower since insurer doesn’t handle claims below retention which reduces premium and amount of premium related expenses
3. on these plans, insurer pays insured for loss amounts above retention instead of paying ground-up loss and seeking reimbursement from insured like on large deductible plans; insurer does not have credit risk on these plans
4. since limits are generally not reduced by retentions but are reduced by deductibles, specification of these plans will often be slightly different than large deductible plans in order to provide same loss coverage

Question 5

dividend plans

Answer 5

basically regular policies that allow for some profit to be returned to insureds if losses are lower than expected subject to approval by insurer’s board of directors

• money returned is considered to be expense for insurer not premium
• if insured losses develop upward after dividend paid, some of that dividend may need to be paid back to insurer

Question 6

clash coverage

Answer 6

protects insureds from single occurrences that impact multiple of their loss sensitive policies each with separate per-occurrence retention

• single clash deductible aka clash aggregate will represent the aggregate amount the insured will need to retain from occurrence and insurer will cover loss above that amount
• example: employee car accident triggers both WC and AL could cause insured to retain full per-occurrence deductible from both lines but clash coverage can cap this at single aggregate amount retained

Question 7

class coverage- estimating expected losses

Answer 7

-can be difficult and may require simulations and assumptions about frequencies, severities, and correlations between LOBs

Question 8

basket aggregate coverage

Answer 8

aka account aggregate; policies cap insured aggregate reimbursable or ratable losses across multiple loss-sensitive policies at single aggregate retention up to specified limit; insured will be reimbursed for losses above aggregate retention up to limit

-with this, underlying loss-sensitive insured policies are usually written without aggregate limits on deductible losses or maximum ratable loss amounts so coverage provides main source of aggregate loss protection

Question 9

multi-year plans

Answer 9

some loss-sensitive plans can be written on multi year basis instead if single year; longer time period is thought to result in more stable expected losses thus reducing the insurance charge for aggregate losses being too high

-get popular during soft markets since insureds want to lock in lower rates

Question 10

adjustments for longer policy period

Answer 10

Per occurrence and aggregate excess charges need to account for longer loss trend

Contract wording should allow for significant changes in exposures during policy terms

Credit risk increases since insured financial condition can deteriorate over a longer period of time

Question 11

captives

Answer 11

very large insureds can create their own insurance companies called captives to insure their own exposures;

often accomplished by typical insurer providing a policy to insured and then ceding most of exposure to captive

Question 12

credit risk

Answer 12

-loss sensitive plans in which insured may need to further pay or reimburse insurer subject insurers to credit risk

Premiums for retro rating

Deductible amounts for large deductible plans

Return of dividends on dividend plans

Question 13

credit risk is especially relevant for

Answer 13

for longer tailed lines and when higher amounts are involved since credit risk will involve greater amounts of risk over longer period of time

Question 14

-insurers can protect themselves from credit risk with

Answer 14

security

ldfs

holdbacks

Question 15

security

Answer 15

insurer can hold collateral for expected future insured payments

Question 16

LDFs

Answer 16

for incurred retro rating plans and dividend plans, insurers can use LDFs to estimate ultimate losses instead of basing retro premium or dividend formula on actual losses to date

Question 17

holdbacks

Answer 17

insurers and insureds can delay retro premium adjustments or dividend payments until a later maturity

Question 18

there are 4 considerations when deciding upon retention levels for a loss-sensitive plan

Answer 18

1. insured should retain higher frequency predictable working layer of occurrence losses and insurer should cover less predictable losses about that level
2. insured should be comfortable with risk implied by their retention
3. insurer should be comfortable with credit risk implied by retention level
4. retentions should increase over time due to loss trend

Question 19

capital for loss sensitive plans v guaranteed cost plans

Answer 19

• since with loss sensitive plans other than dividend plans insured is retaining most of risk for primary losses, capital needed by insurers to support these plans is lower than needed for guaranteed cost plans
• since insurer is keeping riskier portion of losses, profit provision will be larger as % of insured loss

Question 20

since loss-sensitive plan can continue to develop over many years

Answer 20

at some point insurer and insured will agree to close plan

• retro rating plans are closed by closeouts which means applying LDFs to losses to determine a final premium amount
• large deductible plans can be closed using a buyout or loss portfolio transfer which in either case results in insurer or reinsurer assuming responsibility for insured’s remaining loss obligations
• self-insured retentions are closed using loss portfolio transfers