When asked to comment on liability insurance policies, we are often struck by the deductible or retention structure we find, and it’s close cousin, policy premium. We see many financially strong companies with modest deductibles or retentions and the high premiums commanded by them. And we are often surprised at the limit purchased—usually it is lower than we would expect in a risk-sensitive company carrying a low deductible or retention.
Many companies go year-in and year-out with the same deductible structure. For companies with revenues between $500 million and $2 billion, we often see a general liability (GL) deductible of $250,000, and sometimes even lower. At renewal, a routine conversation occurs with the broker. Benchmarking data is consulted. The outcome is almost reflexive. Usually, the deductible stays the same, even as limit is increased. (It is remarkable how as companies grow, the amount of insurance purchased tends to increase more significantly than the retention or deductible.) And keep in mind that benchmarking data is merely a way of seeing what others are doing. It does not mean others are doing it right!
Get the CFO’s Insights
In most companies the CFO receives an annual insurance renewal briefing. But how often is the following proposition put to the CFO: “Our current retention is $250,000. We’re a fairly large company. Would it really be a serious financial problem to us if we suffered a $2 million loss in a given year?” In our experience, many CFOs will answer: “No. But I wouldn’t want two or three of them in a year.”
In other words, most CFOs look at liability risk in periodic aggregate terms. Repeated big hits must be insured against because they aggregate to serious consequences. But the rare, single big hit can be tolerated, as can routine lower value losses. Conventional thinking about retentions and deductibles, on the other hand, almost always looks at the risk in terms of per occurrence or per claim, with the same retained exposure for each and every one of them, whether it’s the first claim or the fiftieth in the policy period.
Where is it written that all SIRs and deductibles must attach or apply at the same level for all occurrences or claims? It isn’t written anywhere. It’s just the way it has nearly always been done, and, unfortunately, without enough linkage to the company’s true risk appetite or consideration of alternative structures.
We think “drop down” retentions (sometimes referred to as “corridor” retentions or deductibles) deserve much more attention than they receive, especially for companies without high frequency loss histories and good cash flow. A $1 billion revenue company with a good loss history and a per occurrence or per claim deductible of $250,000 or less, will significantly reduce premium cost by moving to a $2 million retention for the first (or first two) covered occurrence or claim in the policy period, with its original lower retention or deductible applying to additional occurrences or claims, should there be any to pierce it. For most good risks, there won’t be.
The Bottom Line:
There are ways to work from the CFOs appetite and look at deductible structure more creatively. And many CFOs will be pleased by the results. Why? Because by rethinking your deductible approach, the true concern of the enterprise—losses large enough to impair the balance sheet—can be protected, while the premium component, (the certainty component) of Cost of Risk (COR), can be reduced, or redeployed to increase limits, thereby meeting what should be the real objective: insurance against disaster. You may well find that by restructuring your deductibles, you can buy smart, and buy more, if you should be, for the same overall expenditure.