Retrospective rating plan

A large American group insures its workers' compensation with an estimated premium of two million dollars, to be recalculated at eighteen months, then every year, based on what the insurer has actually paid. That is a retrospective rating plan. The standard formula is: final premium = (basic premium + converted losses) × tax multiplier. The basic premium covers the insurer's expenses and profit; converted losses are actual losses, capped per claim and per period, multiplied by a conversion factor that adds claims handling expense. The result is bounded by a minimum and a maximum premium, set at the outset, which limits the effect of loss experience in both directions. A policyholder with a claim-free year pays the minimum and gets money back, one with a bad year pays the maximum, and the adjustment is settled over several years, until the claims are closed. The plan is common in the United States in workers' compensation and liability for large companies. In reinsurance, the loss-adjustable premium of an excess of loss treaty follows a similar logic. The tool brings the policyholder closer to its own risk, but creates a long-term receivable from it, which the insurer secures with letters of credit or deposits.