Realistic Strategies Needed For Retention Planning

People are naturally optimistic. In business, however, that natural optimism needs to be tempered with a strong dose of intellectual honesty.

A realistic outlook is crucial for companies seeking to control rising costs. Insurance premium increases over the past two years have come in a tough economy that has sliced into corporate profits and put managers under severe pressure to control costs.

The current insurance market has created renewed interest in businesses taking higher retentions within their insurance program. Some companies with good loss control programs have taken on the responsibility of handling the smaller, routine losses, while leaving insurance companies to provide coverage for severe losses.

Others looked at higher retentionsin the form of larger deductibles or self-insured retentionand backed away, realizing that it's not as simple as it seems.

Doubling the deductible may help save money up front, but there are risks. Taking higher retentions requires money and a commitment to loss control and managing risk. Companies that do it right, however, not only improve their own business, they also become a better risk for their insurers.

The best strategy is to prevent losses in the first place. Risk managers spent an average of 17 percent more on loss control services in 2002 over the previous year. Despite this concentration on loss prevention, losses will always occur.

The question is: Who pays for it? Those companies that have taken higher retentions need to realize it is their money and resources now at stake. To some degree, they have become the insurance company up to their selected retention level. It takes a great deal of discipline to manage current losses, estimate future losses and their value, and reserve the money to pay for them.

Companies need to research their exposures, analyze loss trends, keep adequate records, follow designated procedures and meet regulatory requirements, state by state.

While larger companies may be able to handle higher retentions as a cost of doing business, the trade-offs become tougher for smaller and mid-sized companies. Some can handle it; some can't.

Companies also need to be realistic about their inherent exposures before considering higher retentions. A factory in Maine may find that ice damming is its biggest risk, while for a Florida-based retail establishment it is likely to be wind damage.

In some instances, companies may not even realize what their exposures are, nor the extent of escalating costs in certain areas. Risks can grow and change with a business, and new hazards emerge every day, such as cyber security and intellectual property.

Many companies have shifted spending on loss control, from traditional areas of concern including workers' compensation, property and product liability, to risks such as terrorism. While companies at risk of terrorism need to plan for that exposure, it must not be at the cost of preventing losses in workers' comp and product liability, which continue to be areas of risk.

Companies that already have good loss control practices in place and strong balance sheets are good candidates for higher retentions. Those companies might consider taking on more of their “routine” lossesperhaps going from a $50,000 retention to a $100,000 retention and relying on their insurance carrier for losses above that number.

Premium savings will depend on the loss history and the carrier. If a company has a frequency of losses within a $25,000 threshold, raising its deductible to $25,000 with no aggregate would likely result in a reduction of premium.

For example, if a factory has 50 small claims a quarter, and through a higher retention can remove 40 of those from being handled by the insurance carrier, a premium reduction would probably follow. However, if the company's experience reflects mostly severe losses, say $250,000 or more, raising the deductible to $25,000 won't result in a significant premium reduction, if any.

Companies taking higher retentions should have confidence in their ability to handle losses and be ready to take on the extra work associated with claims management. They need to manage the claims effectively, whether they do so in-house or hire someone else, such as a third party administrator.

They must implement and follow guidelines that not only work when the claim is settled within the retention, but also allow the insurance company to step in seamlessly when the loss exceeds that amount.

In the example above, the factory is now responsible for handling 80 percent of the claims, and it needs to be able to adjust the claims and pay the losses. Poorly handled claims could end up costing the company and the insurance carrier more money as the costs on the “smaller claims” mount because of mismanaged claims handling.

In the final analysis, companies must do a cost/benefit analysis when looking at accepting higher retentions. Unfortunately, the benefitlower premiumis more easily recognized than the higher costs of claim handling, loss control and resource allocation.

If prices for traditional insurance begin to decrease, companies may seek to transfer some of their risk back to their insurers. Those companies that instituted policies and programs to prevent losses and took greater responsibility for managing their risk are likely to find more willing insurance markets than those that tried to save money without the corresponding hard work. Companies hoping they will “get lucky” in the hard market are gambling with their futurewhich is not a great business plan.

Steven R. Pozzi, managing director and senior vice president, Chubb & Son, and chief underwriting officer for Chubb's Commercial Insurance business unit, is based in the company's Whitehouse Station, N.J., office. He can be reached at spozzi@chubb.com.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, September 1, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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Realistic Strategies Needed For Retention Planning

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