DESCRIPTION OF RESTROSPECTIVE RATING PLAN

1. Purpose and Background
2. Legal Authority
3. Plan Operation

1. Calculated Dates
2. Pool Deposits
3. Allocated Losses

DESCRIPTION OF RETROSPECTIVE RATING PLAN

I. PURPOSE AND BACKGROUND

The purpose of this report is to provide a description of the Pooled Liability Program retrospective rating formula which is used by the program.

During the formation and development of the CSRMA program, it was the intention of all parties involved to design the Pooled Liability Program in such a way that member agencies with favorable experience would be rewarded with either lower future pool deposits, or immediate return of pool deposits. Conversely, agencies with poor loss experience would be charged additional pool deposits. Also, since the CSRMA program was designed to retain (selfinsure) some risk in the pool per occurrence above each agency's deductible, it was necessary to construct a funding mechanism which would allow for the pool to collect additional deposits in the event losses and expenses were greater than revenues (deposits and interest income).

In principle, retrospective rating works to determine an agency's deposit at the expiration of a rating period on the basis of actual losses during that period. Such a rating program allows an agency to more directly determine insurance costs through the control of its own loss experience. This concept of individual cost determination on the basis of an agency's actual incurred losses is significant in that:

1. an agency that controls losses is allowed the opportunity to generate a final deposits substantially lower than deposits developed by a typical insurance program (e.g., guaranteed costs);
    
2. an agency which has historically not controlled losses, is provided with incentive to do so; 
    
3. each agency has the opportunity to earn a reasonable final deposit based upon its own actual losses. Retrospective rating provides more immediate recognition of favorable (or unfavorable) loss experience. 

To accomplish these objectives, the basic plan design was formulated to include a retrospective rating feature. The legal basis for such a rating plan was then incorporated in the Joint Exercise Powers Agreement and the Program Participation Agreement.

II. LEGAL AUTHORITY

1. As stated in the previous section, the program legal documents were drafted to incorporate a description of the CSRMA's authority to make special premium assessments and retrospective rating adjustments.The governing document, the "Joint Exercise of Powers Agreement for the California Sanitation Risk Management Authority," establishes the general authority to charge annual premiums and levy assessments when necessary in the context, "premium" and "deposit" are interchangeable. Section 20(b)(ii) and (iii) provide the following:
    
2. Annual Premium. Except as provided in iii. below, all postdevelopment costs of an insurance program shall be funded by annual premiums charged to the Member Agencies participating in the program each policy year, and by interest earnings on the fund so accumulated. Premiums shall be determined by the Executive Board upon the basis of a cost allocation plan and rating formula developed by the Authority with the assistance of an actuary, risk management consultant or other qualified person. The premium for each participating Member Agency shall include that Member Agency's share of expected program losses, program reinsurance costs and program administrative costs for the year, plus that Member Agency's share of Authority general expense allocated to the program. Annual premiums shall be billed by the Authority at the beginning of each policy year and shall be payable within thirty (30) days of the billing date. At the end of each policy year, program costs shall be audited by the Authority. Any deficiency or surplus in the premium paid by a participating Member Agency, as shown by such audit, shall be adjusted by a corresponding increase or decrease in the premium charge to that Member Agency for the next succeeding year, unless the Member Agency withdraws or is cancelled from the program.
    
3. Assessment. If the Authority experiences an unusually large number of losses under a program during a policy year, such that pooled funds for the program may be exhausted or depleted excessively before the next annual premiums are due, the Board of Directors may, upon consultation with an actuary, impose assessments on all participating Member Agencies, which, in total amount, will assure adequate funds to the Authority for the payment of all incurred losses
    

In addition, the "Participation Agreement for the Pooled Liability Program" was drafted to incorporate specific language about the sharing of program expenses (i.e., losses and operating expenses) for the pooled layer and the excess insurance layers. The Agreement also includes a description of the retrospective premium adjustment formula, a key portion of which provides that:

In general, any deficiency or surplus in the Deposit Premium amounts shall be adjusted by a Retrospective Premium Adjustment. The Retrospective Premium Adjustment (audit) process examines all claims and expenses for the Policy year in review to determine if Deposit Premiums were adequate. At this time, investment income is also allocated back to each Program Participant on a pro rata basis. If Deposit Premiums were not adequate to meet costs of all expenses, an "assessment" to make up the difference, can take place (refer to Agreement, Section 20(b)(3)). If there is a surplus of Deposit Premium funds, a refund or a credit will exist for Program Participants. The Retrospective Premium Adjustments will be conducted in conjunction with the Deposit Premium calculations for the following year (refer to CSRMA Agreement, Section 20(b)(2). 

• The retrospective adjustment will be calculated within six (6) months of the conclusion of each program (policy) year and annually thereafter until all claims are closed; 
• The results will be communicated to each agency one month after the calculation; and 
• The retrospective premium shall not be "greater than 150% of the Deposit Premium for that layer, nor less than 75% of the Deposit Premium for that layer."

This last provision, therefore, limits the amount of credit for favorable loss experience to 25% of the selffunded layer premium and the debit for poor experience to 50% of the selffunded premium.All member agencies were provided with and were required to sign the Joint Powers Agreement and the Liability Program Participation Agreement.

 II. PLAN OPERATION

The basic retrospective plan will operate as described in the Participation Agreement. Additional description is provided in this section.

A. CALCULATION DATES
The retrospective rating calculation dates are established at six months following the conclusion of each Program Year.

The first calculation will be done as of July 1, 1988 for the CSRMA's first program year, 1987. Subsequent adjustments will be made each year thereafter until there are no more open claims which occurred in that year. The results of the calculations will be provided to each agency at the renewal of the program or prior to the deductible.

B. POOL DEPOSITS
CSRMA will collect a pool deposit from each member for each Program Year. These deposits have been calculated using rating formulas and criteria adopted by the program members. This formula uses various exposures, such as miles of sewer lines (collection), average dry flow (treatment) and number of vehicles. An appropriate deductible credit is given for the selected deductible (ranging from $2,500 to $500,000). This deposit formula may be modified by the membership. Added to the pool deposits, premiums are collected for the cost of commercial excess insurance.

Excess insurance costs are not included in the retro calculation as this money is transferred to an insurance company.

C. ALLOCATED LOSSES
Six months after the end of a Program Year, each member's share of the pooled costs (losses and administrative charges) will be calculated. Each member's share will reflect that member's proportionate share of the deposit paid for that year (which reflects its exposure) and its actual incurred loss costs in the pooled layer (above its deductible up to the excess insurance attachment point). Losses under the deductible or over the excess attachment point are not counted in the calculation.

The formula for calculating the retrospective adjustment is as follows:

 

The Retrospective Adjustment for each Program Year shall be calculated for each Program Participant by adding the sums of (A) and (B) below, less the deposits on hand (or "on deposit" with the Authority):

1. An amount equal to the individual Program Participant's incurred losses and share of expenses and interest income for such layer; provided, however, that such amount shall not be greater than 150% of the Deposit Premium for that layer, nor less than 75% of the Deposit Premium for that layer;
    
2. Each Program Participant's proportionate share (based upon the amounts determined pursuant to (A) above) of the difference between the sum of the individual amounts calculated pursuant to (A) above, and the total of all incurred losses, reserved, expenses and interest income for such layer

Any adjustment (credit or debit) will be applied to the deposit premium for the following year. For example, if the formula results in a $2,000 credit for the first program year, the agency's deposit premium for the third year will be reduced by $2,000 (The second year's premium would not be affected since the calculation is not due until six months into the second year.).

Exhibit B contains three examples of retrospective premium calculations for the CSRMA. Each example computes the retrospective premium adjustments using different loss levels as follows:

• Example 1 is based on the actual 1987 experience of the CSRMA through July 1987. The actual pool losses incurred through July have been doubled to approximate the experience for a 12month policy period. Only two agencies have incurred losses that are expected to impact the pool. This example results in a substantial "profit," or unencumbered reserve, in that the total "Net Pool Costs" (column 10) is only $175, 321, compared to the total premium collected of $623,903.  
  
  In this example, all agencies except Capistrano Beach and MidCoastside would receive the maximum 25% retrospective premium credit allowed under the formula. However, since retrospective premium credits are limited to 25% and incurred losses are substantially less than the formula premium (column 13), the pool would retain $294,714 as an unencumbered loss reserve.  
  
  Column 14 illustrates each agency's share of the equity (profit) which is computed annually in the event the pool, at a future date, distributes this equity to members in the form of a dividend or premium credit.

• Example 2 illustrates the effect of the formula when net pools costs exceed the final formula premiums. Total losses projected are as follows:

Paid  
Incurred Reserves 
IBNR & Loss Development Reserves

$125,000 
$350,000 
$100,000

Total        $575,000

The final retrospective premium adjustment (credit or debit) is shown in column 16. A net adjustment of $15,418 is required. This allocation is subject to the condition that no agency's retrospective premium can be more than its maximum premium. 

• Example 3 presents losses in a worst case scenario. Total losses are as follows:

Paid  
Incurred Reserves 
IBNR & Loss Development Reserves

$220,000 
$750,000 
$100,000

Total    $1,060,000

In this case, the maximum retrospective adjustment for all agencies is (+50%) insufficient to cover anticipated losses, consequently, an additional levy must be made, referred to as a "Special Allocation" in column 15. This allocation is made proportionately based upon the "Formula Premiums" in column 13