In the not-too-distant past, we were in a sustained soft market. Then astonishing rate increases, and the disappearance of capacity, ignited like a blazing wildfire on steroids. As the dealership insurance market continues to “harden” with pricing and coverage options in fiery disarray, it is a prudent time to explore avenues to control and stabilize these costs.
First, let’s examine why markets fluctuate and then explore the mindset of insurance company actuaries and underwriters.
Breaking Down Premium Costs
Insurance carriers, like all businesses, are profit-driven and charged by their Board of Directors and shareholders to keep the balance sheets in the “plus” column. Inside each policy are two parts:
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- Administrative Costs: 35% to 42% of the Premium
- Claims Funds: 65% to 58% of the Premium
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The administrative portion of the premium represents the costs to operate the insurance company. These include such expenses as underwriting, legal, accounting, claims administration, management, and more. The balance of the premium is pooled and used to pay claims. Together, these are known as the Combined Loss Ratio and measure the profitability of an insurance company.
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- Administrative Costs + Claims = Combined Loss Ratio
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Because many claims, such as liability and workers’ compensation, are paid out over a prolonged period, insurance carriers can secure investment income on the claims funds. If the return on investment is high (3 to 5 percent), then the Combined Loss Ratio can exceed 100 percent, and the company will still be profitable.
Entering the Mind of an Underwriter
Insurance company underwriters typically target loss ratios of 35 percent for their insureds/risks. They understand some of their insureds will have no claims, but some will vastly exceed the 35 percent. By using 35 percent as a target, insurance companies can underwrite the Company’s book profitably and remain substantially under the available claims fund levels.
In theory, this is true. However, unforeseeable losses from natural or human-made disasters and changes in litigation trends can put a kink in the predictability models. Certain risks seem to persist as the underwriting community grapples with systemic changes in the risk landscape.
Thus, the instability and volatility of our industry.
Bottom line, when losses surpass the available claims funds and the investment income level is low, insurance companies must implement changes in their underwriting strategies, such as increased pricing or canceling certain classes of business. As you can see, the claims/losses and the financial market/investment income drive the cycles.
Controlling Claims at Your Dealership
So, how do you escape or stabilize the volatility of insurance expenses? The answer lies in controlling claims at your dealership and the use of Loss Sensitive programs.
Controlling claims will inevitably make your dealership the “A+ Customer” every insurer wants. However, you will still be subject to market volatility in the form of premium increases or the insurance company withdrawing from your specific industry.
We have seen this time and again.
Exploring Alternative Risk Management Options
Loss Sensitive programs allow dealerships to participate in the profitability of their own account by removing themselves from the insurance pool.
There are three types of Loss Sensitive programs in the marketplace:
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- Large Deductible Plans
- Retro Plans
- Captive Programs
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Programs of this type are based on the same administrative cost/claims fund models but include a risk management strategy. Loss Sensitive Plans offer a reward for superior loss experience but include a financial risk if the performance is poor. Essentially, with good experience, the final premium can be lower than the standard market, but it can be higher with adverse performance.
The requirements for a successful Loss Sensitive program are premium size, typically over $250K in “pure” premium, and a loss history that makes the venture financially viable.
Note that alternative risk programs are not for everyone. Many dealers prefer to pay the market price and ride the industry waves. However, for those dealers who have their claims under control and want more than the standard market will offer, it is worth the look to explore Loss Sensitive programs and Alternative Risk Options.