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@example.com.