A group that uses the refund accounting underwriting arrangement to fund it's plan is essentially prospectively rated however choosing to share in the financial results of the program. Under both prospectively rated and refund accounting the group is rated based on it's own claims experience (to varying degrees based on calculated credibility), however the key difference between the two methods lies in the financial accounting process. Under the refund accounting arrangement, the employer shares in the financial results of the plan. In years where the plan is performing well, the employer will benefit from plan surpluses and consequently, refunds from the plan. On the other hand, when the plan's claims experience is unfavourable, the employer will be required to pay back deficits either through a lump sum payment or through a deficit recovery margin built into renewal rates.
Insurance companies require that groups be of a minimum size, either by headcount or premium, to enter into a refund accounting arrangement. The requirements vary by line of benefit and are based on the volatility of the benefit. The more volatile the benefit, the larger the size requirement. For instance, since STD, Medical and Dental claim amounts per incidence are small and more predictable, insurance companies are willing to underwrite these benefits under a refund accounting underwriting arrangement usually with a minimum of 150 employees and a minimum annual premium of $150,000. This level is a guideline that varies considerably from insurer to insurer.
Alternatively, for Life and Long Term Disability, insurance carriers will require that groups be much larger with a much larger annual premium base given the comparatively higher claim amounts, lower incidence, and greater ongoing liability involved.
Under a refund accounting underwriting arrangement, premium rates are determined using the group's own claims experience (same as prospectively rated). The only difference is that a deficit recovery margin may be added into rates to recoup a financial deficit should it arise as part of the refund accounting arrangement.
An annual financial accounting is completed by the insurer for groups underwritten on a refund accounting arrangement. The financial accounting report outlines the following calculation:
- Paid premiums
- Claim charges
- Insurer expenses and applicable taxes
- Interest credits or charges
The calculation entails paid premium plus interest credits, less claim charges (paid claims, changes in reserves, pool charges, conversion charges), insurer expenses, taxes and and interest charges.
A positive balance results in a plan surplus and is refunded to the employer after funding of the claims fluctuation reserve(CFR)* to the maximum level required. A negative balance results in a deficit and if not recoverable through the CFR is carried forward into the next financial accounting year and is recouped either through a lump sum recovery or through a deficit recovery margin incorporated into premium rates.
As part of sharing in the financial results of the plan the employer is required address any deficits arising from the plan's claims experience. However, since the employer has no legal or contractual obligation to pay deficits, it can terminate the plan and leave the deficit to the insurer. Since a refund accounting plan is insured regardless of the financial accounting arrangement, the risk for claims incurred under the plan still lies with the insurer (remember the employers liability is limited to the cost of the premium under an insured arrangement) including any deficits under the program.
* The CFR is an employer fund held on account with the insurance company and assists in stabilizing rate fluctuations from adverse claims experience from year to year. The usual funding requirement is 10% to 25% of annual premium.