Property and Casualty Insurance Practice Exam

What does a retrospective rating determine regarding an insured's premium?

1. It is based on the market average for similar risks.

2. It is determined by the insurer's discretion.

3. It is based on losses incurred during the policy period.

4. It is calculated using a fixed percentage of the standard premium.

The correct answer is: It is based on losses incurred during the policy period.

A retrospective rating plan is designed to adjust an insured's premium based on the actual losses incurred during the policy period. This means that the premium is not fixed at the outset; instead, it varies according to the loss experience of the insured. At the end of the policy period, the insurer examines the claims that have arisen and compares them against a predetermined loss threshold. If the losses are lower than expected, the premium may decrease, resulting in a potential refund. Conversely, if losses exceed expectations, the premium may increase. This approach incentivizes policyholders to maintain safety and reduce risks, as their premiums can directly reflect their loss experience. The key feature of a retrospective rating plan is its responsiveness to actual performance, making it more tailored to the specific risk profile of the insured compared to standard rating methods that rely on historical averages or set percentages. Other options would not adequately reflect this unique characteristic of retrospective rating.