The Bigger the Deductible, the Smaller the Cost?

While corporations can cut insurance expenses by taking on casualty risk themselves, the cost to post collateral might be prohibitive.

With the cost of workers’ compensation and other kinds of casualty insurance headed skyward, should small and mid-size companies continue to pay through the nose for insurance that covers every potential loss? Or can they lower the price by taking on some of the financial risk themselves via a deductible?

For many companies today, the choice is simple. That’s because the price of “guaranteed cost” insurance – in which the insurer, not the insured, absorbs all the financial risk – is becoming prohibitive, insurance brokers say.

“The guaranteed cost, or no-deductible, programs are less attractive to the insurance underwriters and therefore are getting some further upward rate push than we’re seeing on the deductible side,” says Joseph McCarthy, chief operating officer of the casualty practice of Aon, the insurance-brokerage firm.

Because they’re less in a position to absorb risks via deductibles than bigger companies typically are, small and mid-size companies are experiencing the biggest price hikes, says Doug O’Brien, national casualty and alternative-risk practice leader for Wells Fargo Insurance Services.

Further, small companies are less able to parlay good loss histories into cheaper prices. In contrast, companies that can assume higher deductibles are often privy to “loss-sensitive” coverage, too. Under such policies the insured gets premium dollars back if it experiences fewer losses than a stipulated amount.

While buyers of “high-deductible” loss-sensitive policies are also experiencing rate increases, the increases are not as great as those facing customers that purchase first-dollar or low-deductible coverage, O’Brien says.  “As a consequence [smaller companies are] being forced to assume a higher deductible or move from guaranteed cost to a loss-sensitive program — or pay the premium that they’re being dealt.”

Six months in advance of their companies’ insurance renewals, CFOs of organizations covered under guaranteed-cost or low-deductible policies would be smart to begin mulling over what the structure of their casualty insurance should be, the Wells Fargo broker advises. “They may very well need to consider some alternatives,” he says, predicting that workers’ comp rates will continue rising through much of 2014.

Finance chiefs of companies insured under high-deductible plans also have some thinking to do – especially about the issue of how much collateral they’re willing to post to back up their insurance arrangements.

Even though corporations are responsible for paying for losses incurred under the deductible, the insurance company is ultimately responsible to pay victims of the loss should the client company default.

Consequently, insurers of loss-sensitive plans often demand collateral from the insured, usually in the form of a bank-issued letter of credit, to back up the company’s obligation to meet its deductible requirement. Insurance companies tend to prefer LOC’s over the use of a trust or cash, because unlike the latter two vehicles, LOC’s are “bankruptcy-remote,” according to O’Brien.

For example, if the insured customer were to default or go bankrupt, cash or a trust could be seized as an asset by the estate manager instead of being used to pay workers’ comp claims, he says. On the other hand, an insurance company could convert an LOC to cash “and use it to pay for what it’s there for, which is the claims from workers’ comp,” O’Brien says.

From the company’s view, however, there can be at least two considerable downsides to taking out an LOC: (1) it can be quite expensive, and (2) it can eat up a company’s borrowing capacity.

In fact, whether or not to buy a policy that demands collateral is often the “deciding factor on whether or not to go loss sensitive,” O’Brien says. To illustrate, he describes the current situation of a client in the nursing-services field that he says should have bought a high-deductible, loss-sensitive workers’ comp policy.

But the requirement that the company, which takes in about $75 million in sales a year, had to post $700,000 collateral was just too onerous. “The impact on their revolver would have been so detrimental that they just couldn’t do it,” says O’Brien.

Denied coverage by private insurers, the company bought its insurance from a state-run assigned-risk pool. Such pools, which cover risks that no other insurers will cover, subject insured companies to the possibility of more complicated regulation. However, the broker notes, “That was the only other option they could do.”

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