Risk Financing Opportunities That Can Help Control Insurance Costs

FEBRUARY 7, 2023

Many buyers of workers’ compensation, automobile and general liability insurance are on a guaranteed cost program structure, where they pay a fixed premium in exchange for full coverage of a loss. While they enjoy the convenience and budget stability of these programs, many insureds have experienced significant rate increases, tight underwriting standards and cashflow problems.

We anticipate this challenging market will continue in the coming months, as we discussed in our 2023 Commercial Property & Casualty Market Outlook. As a result, insureds may find it increasingly difficult to maintain an affordable guaranteed cost program, and should look at loss sensitive options to reduce their total cost of risk (TCOR).

Advantages of Loss Sensitive Programs

Organizations with a good loss experience, effective loss control, and proactive claims management can reduce total cost of risk, reflected in lower premium and claims costs, among other benefits.

Loss sensitive programs assume a larger portion of risk, typically through higher deductibles, which means lower premium. Higher risk retention will generally result in greater savings on premium. These structures can provide several advantages, including:

• Improved cashflow and investment income. Switching from a guaranteed cost program (paying a premium immediately) to a loss sensitive program (paying a lower premium immediately and paying retained losses over time), insureds can postpone loss payments. You can quantify the value of this approach by estimating when the future payments will be made and factoring in the discount rate (interest rate) you can earn by reinvesting in your organization.
• Lower premium. The insured can receive 20% to 70% in program savings compared to guaranteed cost premium, depending on the loss sensitive program. Premium savings are achieved by paying claims within a chosen deductible and reducing carrier profit, admin, taxes, and fees on claims.
• Savings through aggressive loss control and claims handling initiatives. The incentive to control and reduce losses by the insured is often greater since savings accrue directly back to the company itself.
• Hard market mitigation. Loss sensitive programs can help reduce TCOR in a hard market environment.

5 Effective Loss Sensitive Programs

These are among the most popular and effective loss sensitive programs:

1. Dividend Plans. These provide insureds with the potential for a return of premium after the policy’s expiration in the form of dividends. Sliding scale is the most common dividend plan type, wherein the dividend becomes payable based on a ratio of incurred losses to premium. The benefits are a paid dividend if losses are lower than expected, and in many cases, there is no penalty if losses are greater than expected.
2. Deductible Programs. The insured pays losses within a chosen deductible, reducing fixed costs. Any savings from improved losses accrue back to the insured rather than the carrier. Cash flow advantages come from paying claims over time versus prefunding losses or paying premium up front.
3. Group Captives. The insured prefunds any expected losses up to a certain level (subject to a maximum and minimum) and pays a fixed cost. The ultimate cost depends upon actual incurred losses, limited to the per-occurrence loss limitation. Benefits include lower fixed costs and a more competitive maximum premium than incurred loss retrospective plans. Group captives are becoming increasingly attractive, especially for middle-market companies with premiums of $150,000 to more than $2 million.
4. Retrospective Rated Plan: Premium is calculated (subject to a maximum and minimum) based on ultimate incurred loss experience for the period, plus fixed costs.
5. Self-Insurance. Funds are set aside to cover losses that would ordinarily be covered by an insurance policy. This can be cost-effective from a pricing perspective, depending on the industry and states in which the insured has payroll and operations, as certain markets can offer very competitive pricing.

To learn more about the various risk financing options for your organization, contact your USI representative or email pcinquiries@usi.com.