Guaranteed Cost insurance products are the most common type of products for small to mid-size businesses. These policies are defined by smaller “maintenance” deductibles, dedicated limits, and defined premiums. As businesses scale, additional insurance products become available. We call these Alternative Risk Financing options. Some include, retrospective rating programs, high deductible programs and captive programs. These types of products can be known as “Performance-Based” Insurance products.
Under a Guaranteed Cost plan, the rate and premium stay the same throughout the year regardless of frequency and severity of claims. These policies are auditable. If businesses generate more or less than the estimated audited exposures, additional or return premium will be due. Every year these policies can be re-rated to account for insured losses, carrier appetite, industry performance, etc. In short, the rate and limits are locked in for a year, policies are auditable, and the policies are re-underwritten annually.
When a company participates in a “Performance Based” insurance product, their premiums are a direct result of their performance throughout the year. This means there is a significant amount of upside for the insured, as well as downside. There are a variety of Performance Based products. Some of those products are listed below:
Retrospective Rating Plan – Primarily written on workers’ compensation policies, retro plans rate and charge premium based on actual losses incurred during the policy period. In contrast, guaranteed cost plans make rating adjustments on future policies based on previous year’s results. Retro plans generally start with a standard premium (based on estimated losses), this premium is adjusted by actual results from the policy period. If experience is worse than expected, the insured will be charged and additional premium. If better than expected, they will receive a return premium. Retro plans can be complicated, but offer significant premium savings based on loss performance.
Large Deductible Plans – Whereas retro plans and guaranteed cost plans start off with premiums generated by expected losses, loss adjustment expenses and other loss costs, Large Deductible Plans start with a smaller “base” premium. The insured is responsible for all claims up to the defined deductible amount (oftentimes between $100-$500k per claim). The insured has the control and flexibility to manage and negotiate claims up to their deductible amount. Once the deductible amount has been reached, the insurance company takes responsibility and starts to pay for losses. Large deductible plans are a great option for companies looking to manage cashflow and maximize premiums savings through sound risk management practices.
Captive Plans – There are a variety of captive products on the market. Single parent captives, group captives, micro captives, among others. For your traditional lines (Workers’ Compensation, General Liability and Auto), most mid-large size companies should consider one of these arrangements. Group Captives are the most popular for mid-market companies and they offer those companies the ability to capture underwriting profits. Simply put, entering a group captive is akin to owning an insurance company. There are certain sunk costs that go towards administration (roughly 40% of premium), the remaining amount is used to pay claims. There are several factors to consider when evaluating group captives. This model is proven and is very popular with middle market companies.
These are only some of the products that are alternatives to the standard guaranteed cost plan. Most all are performance based and allow businesses to maximize cost savings from solid risk management practices. Every mid-size company that might qualify for one of these products should have a basic understanding of the upsides, downsides and inner workings of the product. This will allow the business to make an educated decision on which product is best to protect their business, support best practices in risk management, and maximize cost savings.
