The purpose of any risk management program is to manage enterprise wide risks, which will, ultimately, lead to a reduction of the total costs associated with these risks. Businesses assume costs of risk to operate, the question is, what is the dollar value of managing these risks and how can these costs be reduced?
Sophisticated insureds with a thorough understanding of their exposures and historical loss experience, may seek more affordable options as opposed to the high cost of traditional insurance coverage. Risk-sharing programs, also known as loss sensitive programs, have provided this alternative for casualty lines for many years. These programs provide a financial incentive for insureds to implement safety and loss control measures. Examples include retrospectively rated premium programs, dividend programs and large deductible programs.
By implementing a large deductible program, an organization is taking a calculated risk that their loss control and claims management efforts are going to meet or exceed their historical loss experience and outperform similar companies in their industry. The expectation is that the insurance premium saved by choosing a higher deductible will exceed that of the claims costs in a given policy year. With this in mind, a company will develop annual operating budgets that project the direct and allocated costs of its expected claims, including excess insurance. However, what often is overlooked in this analysis is the cost of collateral that will be required by either insurer-funded or policyholder-funded large deductible programs. This financial commitment that can accrue over time as carriers increase collateral demands to support new policy years.
While the need for collateral by insurers is legitimate, it is just as legitimate for insureds to proactively monitor how much collateral is being required.8 Since collateral demands will increase each year until claims level off, insureds should have an understanding of exactly how carriers determine the amount required as liabilities accumulate. Transparency by the insurance carrier is essential.
As large deductible insurance programs gain in popularity, insureds considering the use of them must have a thorough understanding of both the benefits and challenges. Some insureds, by retaining losses and proactively managing risk, can see significant cost savings. Others, however, find themselves struggling with the financial demands placed upon them in trying to meet the collateral requirements of their insurer. This does not have to be the case as collateral can be managed and negotiated. MSG Consulting’s experience in this area and knowledge of the insurance market can be a powerful asset which can help turn a challenging situation into a positive one.