Self-Insure Strategically and Save Money - October 12th 2018

Based in Kamloops and Winnipeg, Strategiq Risk Consulting provides market allocation exercises, self-insurance strategies, and enterprise risk management (ERM) plans for mid-to-large companies in Western Canada. My intent in this blog post is to broaden your understanding about how risk can be financed and ensure your self-insurance plan has the best chance of saving your company money.

“I’m sorry this letter is so long. I didn’t have time to make it shorter.” (Fyodor Dostoevsky)
Last month I promised to follow up with a discussion of basic self-insurance strategies. I crafted a “basic” write up and asked a friend for feedback. He came back with “I don’t know what you’re talking about.” Crap. So, based on that sample size of one, I have decided to provide the best explanation I can without sounding like an insurance text book. In football “going long” usually means something exciting is about to happen. In blog posts, not so much. I hope you will persist to the end.

Disclaimer: This post is not insurance advice. I am not advocating that any organization set up a self-insurance program without engaging the services of professionals. The intent of these blog posts is to broaden and deepen your understanding of how risk can be financed and money can be saved. As we say on our home page, “Insurance, you were my whole flat world, till the day I discovered it was round.”

Insurance is the predominant method of financing risk. And your insurance premium is therefore the predominant (but not the only) cost of risk. Perhaps in a future post we can discuss the concept of total cost of risk.

Just Like People, Self-Insurance Functions Best When It Has A Purpose

The purpose of self-insurance is to reduce the cost of risk over the long term. The savings happen because the organization pays for a portion of its own losses, thereby avoiding the markups, fees and commissions that accompany an insurance premium. A secondary purpose is to create, or at least incentivize, a culture of safety and risk control within the organization, which reduces costs still further by reducing the frequency of losses.

What It Is

In its simplest form self-insurance is a program in which an organization keeps a formal record of certain types of losses and establishes a budget for paying for them.
What types of losses? Self-insurance is most appropriate for losses that are of high frequency but low severity. Low frequency losses are less appropriate because they are unpredictable, and high value losses are too expensive to cover using operating cash.

Think of a trucking company that has to deal with windshield repairs and replacements on a regular basis. These high frequency losses provide data that permits identification of patterns and a certain amount of predictability. The trucking company may have a good sense of how many windshield incidents happen in an average year, and decide to build this expense into its operating budget and drop the coverage from its insurance policy. This will result in the insurance premium going down. This same company, now that it’s paying for windshields directly, will almost certainly start to examine windshield incidents more closely and look for ways to reduce their frequency.

Who’s a Good Candidate for Self-Insuring?

This is a general guideline only, but our view is that an organization should be paying at least $100,000 per year in annual insurance premium for the type of risk (or perils) that it is considering self-insuring. The higher the better. Anything less than $100,000 and it may not be worth your while. That is, the potential savings may not provide enough incentive to offset the added administrative burden.

First step: Understand Your Claim History

Data is your friend, and the more data you got, the more friends you got (roughly paraphrased from the Flintstones). Start pulling files and examine your organization’s history of insurance claims and settlements. You may wish to include incident reports, etc. for events that did not result in insurance claims for whatever reason. Quick tip: Call your insurance broker and request a 5 year authentic claims report. This report will provide a summary of approved insurance claims and payments and serve as a good baseline of information. It will quickly become apparent what types of claims (and amounts) are most common. Questions and areas worth investigating further will jump out at you. For example, if your organization has a low deductible (say $5,000) but has never had a claim under $25,000, why are you insuring something (that layer between $5,000 and $25,000) that never happens? Does a higher deductible make sense and will it reduce your premium?

You Won’t Find Pearls if You’re Swimming on the Surface

Choose a line of insurance that is somewhat predictable, i.e. high frequency but low severity as described above. This could turn out to be most or even all of your insurance, or perhaps just a single line such as property, workers compensation or general liability. This is where your deep dive starts: examining claims and other recorded incidents for patterns and trends. Is there a layer in which most insurance claims seem to fall? Patterns and trends, by definition, are not random. This is your invitation to look behind the numbers and do a little root cause analysis. It is no accident that self-insurance programs and internal risk management programs tend to go hand in hand. Don’t have the time? Contact us, we do this stuff for a living.

Keep in mind there are costs associated with managing the program: keeping records, accounting, hiring adjusters to evaluate claims, occasional mediation or litigation with claimants, and setting up loss reserves. One clean solution is to contract the program management to a third party. The advantages include access to expertise and preserving management/employee relations in the event of claim disputes. The third party can manage the program on an ongoing basis or just set up the systems for you and provide periodic advice.

Where will your organization find the money to cover the payout of claims and cost of plan administration? The reduction in your current insurance premium should more than cover these costs.

The Bottom Line

Organizations that set up self-insurance plans are purposefully retaining a well understood set of risks, including the cost of probable losses. This model, combined with “found money” from a lower insurance premium, assure the organization has the financial resources to cover losses. It also generally means that the organization feels a genuine motivation to embrace risk management in order to prevent those losses from occurring. Far from introducing new risk into an organization, thoughtful self-insurance is absolutely a winning strategy. Substantial savings will accrue and go straight to your organization’s bottom line.

We will follow up with a much shorter post in next couple weeks, explaining the pros and cons of self-insuring.

Some of you may wonder if essentially we are talking about increasing insurance deductibles in order to push down the overall premium. To a large degree, yes that’s where I am going with this, but the discussion is more nuanced than that. This will be the subject of a separate post shortly, and will round out the whole self-insurance discussion.