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3. IL-09-03

Retrospective Premium Endorsement - Three Year Plan - Standard Premium Basis (IL 09 03)

The IL 09 03 Retrospective Premium Endorsement - Three Year Plan - Standard Premium Basis is an insurance policy provision that modifies how the final premium is calculated. Instead of a fixed premium determined at the beginning of the policy period, this endorsement allows the premium to be adjusted based on the actual losses incurred by the insured over a three-year period. This "cost-plus" approach means the insured's premium is more directly tied to their own loss experience during the rating period.

The retrospective premium is calculated using a formula that typically includes several key components:

• Standard Premium: This is the premium that would have been charged if the policy wasn't subject to retrospective rating. It's based on authorized rates, experience modifications, and other applicable factors, but generally excludes premium discounts and expense constants.
• Basic Premium: A percentage of the Standard Premium, this covers the insurer's administrative costs, loss control services, and an insurance charge related to the minimum and maximum premium limitations. It does not typically cover premium taxes or claims adjustment expenses.
• Incurred Losses: These are the actual amounts paid or estimated to be paid by the insurer for losses during the three-year rating period, including reserves for open claims.
• Loss Conversion Factor: Applied to incurred losses, this factor accounts for claims adjustment expenses.
• Tax Multiplier: This factor is applied to cover state premium taxes.

The final retrospective premium is the sum of the basic premium and converted losses (incurred losses multiplied by the loss conversion factor), all then multiplied by the tax multiplier. This amount is subject to pre-agreed minimum and maximum premium amounts, which limit the potential swing in premium for the insured. The rating plan period is three years, beginning with the effective date of the endorsement.

Classes of Business It Applies To

This endorsement is typically used for larger businesses with significant premium volume where there's a desire to more directly correlate insurance costs with their own loss control efforts. While it can be applied to various commercial casualty lines, it's commonly seen in Workers' Compensation insurance. Eligibility often depends on the estimated Standard Premium meeting a certain threshold over the three-year period (e.g., $75,000).

Real-world examples could include:

• Large manufacturing companies with established safety programs looking to benefit from their good loss history.
• Construction companies with multi-year projects where a longer-term view of loss experience is beneficial.
• Businesses in industries with fluctuating risk profiles where a three-year average can smooth out premium volatility compared to a one-year plan.
• Organizations with multiple policies (e.g., Workers' Compensation, General Liability, Auto Liability) that wish to combine them under a single retrospective rating plan.

Special Considerations

There are several important points to consider when using the IL 09 03 endorsement:

• Optional Plan: Retrospective rating is an optional program that must be agreed upon by both the insured and the insurer.
• Eligibility Thresholds: Minimum Standard Premium requirements must be met. For a three-year plan, this is often around $75,000 in estimated three-year Standard Premium, though this can vary.
• Loss Control Incentive: The primary appeal of this plan is that it provides a direct financial incentive for the insured to control and reduce losses, as lower losses will result in a lower final premium.
• Cash Flow Implications: The initial premium paid is the Standard Premium. Adjustments (either additional premium owed by the insured or a return premium from the insurer) occur after the rating period ends and losses are evaluated, and then typically annually thereafter until all claims are settled or closed. This can impact budgeting and cash flow.
• Complexity: Retrospective rating plans are more complex than guaranteed cost programs. Understanding the formula, the various factors, and the timing of adjustments is crucial.
• Cancellation: If the policy is cancelled by the insured before the end of the three-year period, the Standard Premium may be calculated on a short-rate basis, which can be less favorable to the insured. The maximum retrospective premium may also be adjusted. Cancellation for non-payment can also have specific implications for the maximum premium calculation.
• Combination of Policies: This endorsement can be used to combine multiple lines of insurance (e.g., Workers' Compensation, General Liability, Commercial Auto) for the purpose of retrospective rating.
• Not a Substitute for Experience Rating: Retrospective rating is applied on top of any experience rating modifications.
• Premium Discount Inapplicable: Standard premium under this plan is generally not subject to premium discounts.

Key Information for Agents and Underwriters

Agents and underwriters should be mindful of the following when dealing with the IL 09 03:

• Risk Assessment: A thorough understanding of the insured's loss history, financial stability, and commitment to risk management is critical. Businesses with volatile or poor loss experience may not be suitable candidates, as they could face significant additional premiums.
• Pricing and Factor Selection: The Basic Premium Factor, Loss Conversion Factor, and the minimum and maximum premium percentages are key negotiable elements. Underwriters need to carefully assess the risk to set appropriate factors that balance the insurer's exposure with a competitive offering for the insured.
• Explaining the Program: Agents must clearly explain the mechanics of the retrospective rating plan to the insured, including the potential for premium adjustments (both up and down), the timing of these adjustments, and the impact of loss control.
• Coverage Gaps: Ensure all intended coverages and entities are correctly included in the retrospective rating plan schedule.
• Long-Term Relationship: A three-year plan implies a longer-term relationship between the insurer and the insured. Stability and consistent communication are important.
• Data Integrity: Accurate and timely loss data is essential for calculating the retrospective premium adjustments.
• State Variations: While the form is applicable in all states, specific rules or parameters for retrospective rating can vary by state, particularly for Workers' Compensation. Underwriters must be aware of any state-specific regulations.
• Financial Stability of Insured: Given the potential for significant premium adjustments, the financial capacity of the insured to pay additional premiums if losses are higher than expected is a key underwriting consideration. The endorsement may contain provisions for special valuation if the insured becomes bankrupt or insolvent.
• Elective Elements: The plan may include elective elements such as a loss limitation, where the amount of any single loss included in the retro calculation is capped. This comes with an additional premium (Excess Loss Premium). Another elective element could be a retrospective development premium.