Continuing in the theme of Steve's recent Blog on deductibles prompts me to think "When should you increase them?" This is a question most insurance buyers will ask their insurance broker at some point and the answer should always be......"it depends".
You cannot begin to evaluate a deductible change (either up or down) without understanding the attendant cost/benefit relationship. Obviously, you would expect to get a reduction in premium if you raise the deductible, but with this benefit will come the potential cost of an increase in uninsured losses.
Let's consider an example. A large shopping center currently has a $1,000 deductible under its Commercial General Liability policy, due to the frequency of slip and fall claims that generate medical costs. With the ever-increasing cost of medical care, the shopping center is finding that many of these claims are creeping up to the level of $3,000 to $5,000.
The insurer is faced with the need to raise the premium for the coming year by 15% because they believe these claims will continue to escalate. The policyholder considers this an overreaction and does not agree claim costs will continue to rise. The insurance broker is suggesting that the deductible be raised to $10,000 for each loss occurrence or accident and believes that this will yield a measurable reduction in premium. Keep in mind that when discussing deductibles you will always want a per occurrence rather than a per claim deductible. If two people are injured in the same event you don't want to pay a double deductible.
Both the owner and the broker have analyzed the historical claims and project the additional self- insured claims would be approximately $20,000. This assumes 8 claims $1,000 and under along with 2 claims that exceed $1,000. The insurer considers this an aggressive approach by the owner and is willing to reduce next year premium by $30,000. This means that if the broker and owner are right in their loss estimates the owner will benefit by $10,000.
Next, if we assume the loss estimates are wrong in one of next three years there will be a cushion of $30,000 over this period to pay for the unanticipated large claim or an increase in frequency. It is not expected there will be a frequency of severe claims, so the owner will not be faced with paying multiple $10,000 claims in a given year. In this example the owner is justified in taking on the additional risk based upon the projected savings.
This same process can be used when evaluating change on programs like Workers Compensation that typically have larger deductibles. The difficulty here is that moving from a $100,000 to a $250,000 deductible will not often provide the needed premium savings to justify the additional risk assumed. Usually, we see the impetus for change in this area to be forced by the insurer due to loss penetration in the insured layer. Logically, there then should be some reasonable premium reduction since some of the expected losses will fall back into the self-insured layer. Retentions at this level put greater responsibility on the insured to prevent and control claims, because at a $250,000 deductible most if not all claims will be self paid. Unfortunately, the premium negotiations here are most productive after several years of additional experience where all claims are retained under the deductible. Here, the insurer will be forced to reduce the future premiums to reflect this favorable experience.
Finally, another important factor when considering deductibles or retention levels is management's attitude towards risk. Some businesses have an aggressive posture, while others are conservative and risk averse as a corporate personality. A business that is conservative by nature will be less likely to look at higher retentions, even when analytics supports the decision.
Whenever considering the cost benefit of changing retentions it is best to follow the tried and true insurance maxim of "Don't Risk a Lot for a Little".
