Understanding Loss Sensitive Insurance Programs
"Loss Sensitive" is a catch-all phrase for insurance programs where the final cost is at least partially determined by the losses incurred during the policy term. My goal in this short article is to make it easy to understand the four basic types of loss sensitive programs. Think of them as a gradual progression from a standard guaranteed cost insurance program. With each step, you are increasing the potential for savings based upon controlling your firm’s claims. On the other side of the coin, you are also taking on more financial risk if your claim results are poor. Risk and Reward—We all know the correlation.
Dividend Plans allow for a partial premium refund if losses are below a certain level. With a dividend plan, the insured will never pay more than standard premium but still has the possibility of a return premium. The problem is that dividends are not guaranteed. They must be declared by the Insurance Company’s Board of Directors.
Retrospective Rating Plan is a contractual arrangement between the insured and insurance company. The insurance company keeps a portion of the premium for expenses. The final cost is the sum of expenses and incurred losses… subject to a pre-determined minimum and maximum. The advantage is that return premiums are contractually guaranteed. The downside is that the insured may pay more than standard premium if overall losses are excessive.
Large Deductibles really bring the client into the game with the carrier. The client is responsible for reimbursing the carrier up to a certain amount for each claim, and the carrier pays the remainder of the claim, up to their policy limit. Deductible amounts range from $100,000 to $1,000,000 per claim, with $250,000 being the most common. In order to protect the client from a catastrophic claim year, there should be an aggregate stop loss in place which caps the annual deductibles payable.
Usually there will be a requirement that the client provide some sort of collateral such as a Letter of Credit or a Cash Account to ensure that there is money available to pay their share of the losses. With longer tail business, such as Workers Compensation, this can result in a substantial amount of capital being taken out of circulation for many years.
Initial premiums for large deductible programs are significantly lower than Guaranteed Cost or Retro programs. If you can control your claims to a level that is less than expected by the underwriters, you will reduce the cost of your overall program. If you exceed those levels, you will pay more.
Self-insurance differs from large deductible programs primarily based on the amount of administrative duties handled by the client. With self insurance the client takes much more responsibility for handling of claims and loss control. This can either be handled by internal employees or outsourced. The carrier will generally charge less for the insurance, since the client is providing much of the service. Self insurance is only appropriate for larger, sophisticated organizations with the ability to competently handle the complex issues associated with administering their risk management program, as well as the financial risk of self financing the majority of their loss picture.
Conclusion
The decision to utilize a loss sensitive program should not be undertaken lightly. There are potential rewards, but there are very real risks. Your broker should help you understand what your best, average, and worst claim scenario looks. Only with that information can you make an intelligent decision for your company.