Cost Comparison of Rating Programs for Traditional Insurance

Traditional commercial insurance policies may be priced through a guaranteed cost rating, a dividend program, or a retrospective rating. Each of these alternatives has distinctive features that could affect the effectiveness of a risk management program.

Guaranteed Cost or Prospectively Rated policies are priced at a set amount at the beginning of the policy. The price or premiums paid for the policy will not vary throughout the term of the policy. Regardless of the number or size of losses during the term of the policy, the total cost of the coverage is known to the insured. This certainty of price may be a factor in the insured’s risk management plan that will outweigh possible benefits of policies with variable costs.

Dividend Programs are a variant of the guaranteed cost rated policy that set a maximum cost for the term of the coverage but also offer the chance of a return of a portion of the cost in the form of a dividend. Dividend programs may be designed to return a dividend according to the relationship of the insured’s premium to premiums of all insureds under the program. Alternatively, dividend programs may be designed to return some portion of the premium paid if losses prove less than anticipated. With either type of dividend program, losses in excess of a specified ratio will cause the loss of any anticipated dividends. For programs that return dividends based upon losses that are less than anticipated, insureds will be rewarded for successes of their risk management programs when viewed together under the program.

Retrospectively Rated Programs allow each insured to benefit based upon the success of its particular risk management program in reducing insured losses. Under a retrospectively rated program, the insured’s final cost is not set until after expiration of the policy period. The final cost will vary within minimum and maximum amounts set at the beginning of the policy according to the losses occurring during the term of the policy. Both the insurer and insured can plan based on the outer limits of the price that will be paid for the coverage while the insured will be rewarded if losses can be held down to less than expected at the outset of the policy.

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