Fisher.OtherLSPlans

Reading: Fisher, G. et al, "Individual Risk Study Note," CAS Study Note, Version 3, October 2019. Chapter 2. Sections 5 – 10

Synopsis: To follow...

In this article we look at a range of other loss sensitive rating plans that exist in addition to experience and retrospective rating plans.

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Estimated study time: x mins, or y hrs, or n₁-n₂ days, or 1 week,... (not including subsequent review time)

BattleTable

Based on past exams, the main things you need to know (in rough order of importance) are:

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In Plain English!

Large Deductible Plans

Large Dollar Deductible (LDD) rating plans are typically for casualty lines of business which have a per-occurrence deductible of over $100,000. The insurer pays all claims upfront and then bills the insured for deductible reimbursements up to the per-occurrence deductible amount.

Under this type of rating plan, losses subject to the deductible may or may not include ALAE but are subject to a per-occurrence limit. The deductible reimbursement could be capped at an aggregate deductible limit and there is no minimum deductible reimbursement.

Premium is generally fixed for a large dollar deductible plan. However, the insured's cost (premium + loss reimbursements under the deductible) are not fixed. So large dollar deductible plans are loss sensitive as the total cost varies based on the actual loss experience.

The premium doesn't cover losses below the deductible (on a per-occurrence and aggregate basis). The insurer handles all of those claims but bills the insured the full amount. Net premium is the premium less any outstanding deductible payments. Net premium must covered the expected per-occurrence and expected aggregate losses, expenses and an underwriting profit provision.

Key Differences with a Retrospective Rating Plan:

• Provisions for premium tax and some premium based assessments (net of deductible premium) are lower since deductible reimbursements are not premium.
• Commission provision can be lower if it is a percentage of net premium.
• The insured's expected cost is generally lower under a large dollar deductible plan.

As the deductible (or attachment point) grows, the expected excess loss shrinks, so the insured is charged less premium. This means the expense and UW profit provisions can make up a large part of the large dollar deductible premium. The risk load for the excess losses can be material in terms of parameter risk and process variance.

See Fisher.CaseStudy for an example of how to calculate the net premium under a large dollar deductible.

Self-Insured Retentions (SIRs)

Workers' Compensation and Auto Liability insurance in the United States are legally required coverages so regulatory approval is required to self-insure.

Under a Self-Insured Retention Plan (SIR), the insured is responsible for adjusting and paying claims but can outsource to a third-party claims adjuster (TPA=Third Party Administrator). The insurer reimburses the insured for loss amounts in excess of the self-insured retention, i.e. the insurer has no credit risk.

Since the insurer doesn't deal with claims upfront there is no ALAE for self-insured claims. ALAE is shared on a pro-rata basis with the insured for claims which exceed the retention. There is also minimal ULAE due to the insurer not handling all claims. This means premiums are lower for excess over self-insured retention coverage. In turn, lower premiums means lower premium based assessments and taxes.

A self-insured retention policy with a $1 million limit over a $250,000 per-occurrence retention covers the layer between $250,000 and $1.25 million. Contrast this with a large deductible plan with a $250,000 deductible and $1 million limit covers the layer between $250,000 and $750,000. The deductible is said to erode the limit and this typically doesn't happen with a self-insured retention policy.

Dividend Plans

In a dividend plan if losses are lower than expected then the plan returns money to the insured via a dividend. The dividend counts as an expense, it is not a premium credit. This means there are no savings on premium based assessments and taxes.

If losses are higher than expected then no additional money is collected. That is, dividend plans are not balanced.

Dividend plans are usually evaluated at 6-months after policy expiration and then annually. If losses develop upward then dividends decrease. Dividends paid earlier may need to be partially recouped from the customer which creates credit risk for the insurer.

Dividend payouts are not normally guaranteed in a contract and require approval from the insurer's board of directors.

Clash Coverage

When an insured event impacts multiple lines of business at once the insured could find itself paying out under each line for the same event. For example, suppose company has a large deductible policy for Workers' Compensation ($250k deductible) and an Auto Liability policy with $100k deductible. A serious at-fault auto accident injures their employee and a third-party. Without clash coverage, the insured would have to pay each deductible for the same accident. Clash coverage can be purchased to define a single deductible (of say, $300k for our example) that applies across all lines at once. This reduces the amount the insured is exposed to under a single event impacting multiple lines.

Clash coverage is difficult to price. It can require simulations with assumptions about frequency, severity and correlations between lines of business.

Basket Aggregate Coverage

When an insured has more than one loss-sensitive plan a basket aggregate (or account aggregate) policy puts a total aggregate limit on all ratable losses across the plans. Normally the underlying plans have no maximum ratable loss amount or aggregate deductible limit.

Basket aggregate coverage can be achieved by writing a General Liability policy for losses in excess of a maximum aggregate retention up to a policy limit.

Multi-year Plans

A multi-year plan stabilizes costs by lengthening the experience period so "good" and "bad" years should offset each other. Typically a three year experience period is used.

Contract wording for a multi-year plan should allow for rate adjustments when exposures change significantly during the policy period.

There is credit risk for the insurer as they must evaluate the financial condition of the insured over a longer period. Loss trends for a longer period must be built into the per-occurrence and aggregate excess exposure.

Multi-year plans are popular during soft markets when insureds try to lock in favourable rates.

Captives

Captives are insurance companies formed to serve the needs of their parent companies. Insurers write policies to provide coverage and then cede losses (normally primary and limited to an aggregate amount) to the captive.

Credit Risk

Retrospective rating, large dollar deductible, and loss sensitive dividend plans have credit risk because they depend on the insured being willing and able to pay for additional premium, loss reimbursements or return dividend amounts in the future. Credit risk increases with the size of the deductible (if applicable), the limits involved (if applicable), and length of the tail for the line of business.

Question:

How could an insurer protect themselves against credit risk?

Solution:

Collateral	By holding collateral (security) from the insured against expected recoverable amounts. The collateral requested is likely inversely proportional to the financial strength of the insured - financially stronger insureds may be required to post less capital.
Holdbacks	Both parties agree when the policy is written to defer all or a portion of the retrospective premium adjustments and/or dividend payments until the policy reaches a specific maturity. Doesn't usually apply to paid retrospective plans.
Loss Development Factors	Apply loss development factors to the losses used in incurred retrospective rating plans or the dividend formula. The factors are normally chosen when the retrospective rating plan is written. This isn't an option for large dollar deductible plans.

Alice: "In times of uncertainty investors often look to the Swiss Franc (CHF) to protect their assets."