There are many alternatives to traditional guaranteed cost insurance policies.
“In order to receive the financial benefits of these alternatives, companies must be
able to effectively control their losses,” says
Kevin D. Smith, senior production specialist
with The Graham Company.
“Loss-sensitive programs are not necessarily a way to find cheaper insurance because it
all begins and ends with the losses,” he says.
“If you’re going to commit to a loss-sensitive
program, you have to be committed to mitigating and managing your losses.”
Smart Business asked Smith to shed some
light on the various alternative insurance
offerings and how to decide if one might benefit your business.
How does a typical insurance program work?
A typical insurance program is something
we call ‘guaranteed cost.’ This means that the
policy has a premium that does not change.
The total cost of your insurance program
does not vary with the dollar value of the
claims, or losses, that are paid under the policy. This approach is very safe because the
plan transfers the maximum amount of risk
to the insurance company. The downside of
these programs is that you can’t recover any
of the premiums you’ve paid.
What are some alternatives to ‘guaranteed
cost’ programs?
Loss-sensitive programs are the alternative.
These programs take many different forms,
including self-insurance, large deductible
programs and retrospectively rated programs. In a loss-sensitive program, losses
incurred during the year directly affect the
costs for that year. If your losses are higher
than expected, you could pay more than you
would normally pay in a guaranteed cost
plan. And the opposite is true as well; if losses are much better than expected, you could
pay substantially less in that given year.
With a large deductible program, companies take deductibles of $100,000, $250,000 or
$500,000 per occurrence. If the value of the
claim goes above the deductible, then the
insurance company steps in and pays the
rest. By taking on this risk, the cost of an
insurance policy can go down significantly.
Retrospective-rating programs work a little
differently. With these programs, you pay a
premium at the beginning of the year based
on estimated losses for the upcoming year. If
the losses are higher than estimated, then
you may owe additional money at the end of
the year; if the losses are lower, then the
insurance company may return a portion of
the premium.
Captives, another form of a loss-sensitive
program, are essentially insurance companies created to finance the risk of their owners. There are single-parent captives, which
are set up by a single owner to ensure its own
exposures, and group captives, which are the
same thing but are set up to ensure the risk of
several owners. A rental captive involves
renting space in somebody else’s captive
facility to insure your own risks.
Why might a company want to consider one
of these plans?
There are two primary reasons that companies end up on a loss-sensitive-type plan —
because they can save money and because
they want more control. By taking on some
of the risk, companies who manage their
risks well can save money because their losses will be less than their peers. They can also
gain control because taking on some risk
reduces their dependency on whether or not
insurance companies will give them insurance coverage at competitive rates.
It comes down to a simple risk-reward decision. Business owners have to evaluate how
much risk they’re willing to take, and then, at
the same time, understand how well they’re
protecting their company in terms of safety
and loss-control procedures. They really do
need to rely on their broker. It then becomes
a point of analyzing data and past experiences and determining how their loss has
trended over the years to know what kind of
plan would work for them in the future.
Are there elements critical to the success of
an alternative program?
I think what’s most important to the success of the program is selecting the right program, but also making sure that you’re going
to manage and mitigate your losses. And
management has to buy in to it. It’s often easier when you’re on some kind of loss-sensitive plan for management to buy in because
they’re putting their money where their
mouth is. So it gives them some incentive to,
from the top down, push loss control and
safety as a primary goal.
Can insurance market conditions affect a
business’s decision?
Current market conditions are certainly a
factor in a situation where the insurance
company is going to require a business
owner to take on some portion of the risk.
This happens primarily in tougher market situations. For businesses considering a loss-sensitive program because they feel that
there’s an opportunity for them and they’re
doing all the right things, then market conditions shouldn’t really be a factor. Interest certainly rises when the markets are more difficult, but when the market is soft, like it has
been for the last year or so, alternative products will still make sense for them. It’s just a
matter of the competition out there for the
guaranteed cost dollar changes.
KEVIN D. SMITH, CPCU, ARM, is a senior production specialist with The Graham Company. Reach him at (215) 701-5323 or
[email protected].