By Joe Donohue
Many CFO’s or owners who handle the yearly procurement of their company’s commercial insurance coverages have probably heard the phrase “Performance Based Risk Transfer”. But what does this really mean? Performance Based Risk Transfer can take several forms; however, I am specifically referring to a Captive, which is the most efficient risk transfer tool the middle market can pursue to obtain the lowest cost of risk and maintain control of the insurance process. Captives are often mentioned (usually by the insured) but rarely discussed in detail as a legitimate option. But why is this? The main reason is much like the answer to many other challenges in life – it represents a significant change, and change is hard. Committing to change long-term is even harder. Have you ever decided to commit to exercising more, or give up something that would make you healthier? Most of the time in these circumstances there are very compelling reasons to make a change. A change that would provide significant benefits. But we all know how hard change is, even with obvious benefits. The other reason involves commission dollars, with most captive deals your broker takes a cut in what he or she earns, so there isn’t a burning drive to introduce this type of change.
Changing how you view and purchase insurance coverage for your business is also difficult. You’ve been doing it the same way for 20+ years, it’s painful, stressful and typically you’re not happy with the results. But you continue to do it that way because that’s the way you’ve always done it. Every year your broker tells you NEXT year will be different. Well I’m here to tell you, no it won’t. If you continue to buy insurance from the conventional marketplace, you’ll get your numbers when underwriting is ready. You see, underwriters work on business as it comes up (or renews). The fact that you want YOUR numbers 45 days in advance of your renewal has no bearing on their underwriting schedule. It’s not that your broker isn’t pleading your case, it’s just not possible in most cases when there are stacks of submissions on top of yours that renew 30 days prior to your renewal (which is a whole other topic). The stress of the traditional renewal process itself is a reason to consider a Captive.
Now, back to my point about Performance Based Risk Transfer .
Claims drive insurance costs. Period. Your premiums are impacted by YOUR claims, and everyone else’s. You can have the best safety record in the world and it will help, but you’ll never pay premiums that actuarily reflect YOUR performance in managing claims. You’ll always be subsiding those in the insurance market at large who consistently have a bad track record of claims, and the insurance carriers need your premiums to help pay those claims.
In a Performance Based Risk Transfer model or Captive, the better your claims performance, the lower your cost of risk becomes. The underwriting profits that the insurance carrier enjoyed from your good claims experience in your traditional insurance placement now come back to you! A captive is also typically more cost efficient as well in terms of operating and administrative costs. The price of insurance coverage purchased in the conventional market can often include mark-ups to pay the insurer’s acquisition costs, marketing expenses, high commissions, administration and overhead. Such pricing is specifically designed to deliver profit to the insurer’s bottom line. In the captive, the goal is to minimize those costs and enhance your bottom line.
Additionally, you are now permanently removed from the yearly cycle of reviewing multiple quotes from multiple brokers invariably down to the last minute prior to your renewal. The captive underwriter works only with the captive members, the process starts at 6 months and your renewal is typically in your hands 60 days in advance of the captive renewal or sooner.
Captives aren’t right for every company. There will always be a need for traditional insurance market channels. Captives take serious buy in and a safety culture change from the top down. Like I said change is hard, but it’s much easier when you are fully informed and have your expectations aligned with the process.
Would you like to learn more about Performance Based Risk Transfer – contact the insurance innovation experts at Lanier Upshaw.