Loss-sensitive programmes are effective throughout the insurance cycle. Historically, it has not been possible to take the cycle out of the market, but it is possible to make the market cycle work for your company. Such solutions, however, are not in any way short term, and should be accepted as a first step toward self-insurance, possibly leading into a captive insurance programme.
Although I am sure these techniques go back to the early beginnings of insurance, it was in the early 1950s that we first saw the start of risk retention as we know it today, mainly in order to alleviate the spiralling costs of US workers compensation insurance. This gave birth to what we now know as the 'three-line retrospective rating plans' for workers compensation/general liability/auto. These took some time to develop as they sucked premium out of the insurance companies or state funds, which needed the revenue to pay the long tail claims they had developed with inadequate rating.
Loss-sensitive programmes are only effective throughout the cycle of insurance for companies that have a risk retention philosophy. Such companies tend to be proactive rather than reactive, and believe that they can control the predictability and possibility of loss. Those that can benefit from this approach include:
- companies with loss frequency and predictable losses such as:
- large automobile fleets
- consumer retail establishments
- workers compensation/employers
- liability exposures on and off shore
- professional indemnity insurance
- products liability exposures
- property
- marine cargo/marine transit
- crime
- property owners (offices/hotels/restaurant chains/catering/retail and wholesale outlets)
- mass transit
- facilities with large crowd concentrations
- environmental insurance liability
- fraud
- companies who wish to buy unavailable coverage
- companies that have no wish to swap money with the insurance market and believe they can control loss.
The latter is particularly the case with long tail losses. The key questions to be answered are: 'Who do you want to hold the money to pay claims?' and 'Who do you want to be the beneficiary of the investment income on these funds?'
Simply put, these techniques are for financially secure companies that want to control their destiny with respect to insurance costs. They should be backed up with a sound risk management philosophy that is driven downward through the organisation by senior management, and the company should be seeking a long-term partnership with its insurance carriers.
A number of loss-sensitive products are available for companies that take this approach. They can combine both retention and transfer of risk, and include:
- premium rating plans
- premium adjustable on loss
- per loss protection with maximum and minimum premium caps
- deductible programmes
- funded
- unfunded
- self insured programmes
- excess of loss for third party lines/self insured retentions
- deductibles for first party coverages
- captive programmes
- single parent
- protected cell
- rent a captive
Some companies feel that they cannot influence the 'chance of loss', and believe that since insurance is easy to buy, why bother about losses occurring - that is the insurer's problem. Or is it? This short-term approach actually feeds the insurance cycle, as losses find their way back into the cycle in the form of premium charges and rate increases.
Some carriers also do not want to offer large retentions as they then deny themselves the revenue to fuel incurred but not reported (IBNR) requirements that they themselves created. It could be argued that by doing so, they too perpetuate the cycle. Low premium also means low commission, so this is not favoured by some in the brokerage community although others that are more forward thinking have set up claims/risk management units to serve clients.
Retentions for loss frequency as well as 'intermediate layers' can take the cycle out of the market and can consequently provide less volatility.
Companies are then positioned to make their own funding decisions based upon proactive loss control and loss mitigation actions.
Find a suitable partner
Financial strength is of paramount importance in choosing a suitable partner. There must be a long-term commitment from all parties. The carrier also needs to be experienced in both the set up and administration of such programmes and must give clients the confidence that they are in for the long haul, with the capability to make future loss settlements.
The structures also need to be set up in such a way that they can flex with the insurance cycle to allow full advantage to be taken from the risk transfer elements of the programme.
Claims handling, reporting and administration are the key to successful loss retention programmes. The company is going to use this information as the basis of its risk management programme, so data must flow in a timely and accurate manner.
Once these issues are dealt with effectively, the programme will allow the company to gain control. There will probably always be an insurance cycle. But a proactive approach will take the broad swings of expense out of insurance and only impact catastrophic premiums. This is where companies can take advantage of the cycle by retaining when hard and buying when soft.
- Stewart Lovett is senior vice president, regional risk management, AIG Europe, Tel: +33 1 49 02 41 47, E-mail: stewart.lovett@aig.com
