How Much Insurance is Enough? Risk Financing Decisions

My friend, an insurance broker, was lamenting the disconnection between her association and nonprofit clients and the insurance industry. Her clients expect their property and casualty insurance premiums to decrease while insurance companies are seeking increases. This disparity forces insurance brokers to market their accounts in search of reduced pricing. The marketing efforts can produce lower costs but usually because the incumbent carriers cut their prices to keep the account.

The insurance industry has programmed insureds to expect premium decreases. The insurance marketplace is cyclical and it has been in a “soft” market since 2005 with declining rates. However according to MarketScout’s research, the market started to turn last fall when rates stayed flat and then slight increases. Since November 2011, average premiums have increased with April recording a 3% increase compared to last year. Conning Research’s Property-Casualty Forecast & Analysis predicts net premium growth of 4% in 2012, +5% in 2013 and +5.5 in 2014.  Premium increases will be higher in catastrophe-exposed regions especially for property coverages.

What does this mean? Associations and nonprofits should expect their annual premiums to increase for the next few years. But nonprofit organizations are still recovering from the Great Recession and money is tight. Many have already reduced their insurance costs by lowering policy limits, increasing deductibles, and/or eliminating coverages. How much lower can they go?

Although you may still need to cut costs, reducing your insurance coverages can be a false savings. Having adequate insurance is important to your financial well-being but what is “adequate” for you? How did you decide where to cut your insurance costs?

 Risk Financing Strategy

In a perfect world every nonprofit has a risk management policy but few have one. It is valuable to discuss how to manage your risks and then adopt a formal policy. A plan for financing your risks – how you will pay for losses – is a part of your risk management program. A risk financing strategy helps you make these difficult risk financing decisions. Most associations have policies or strategies for their investments and reserves but not for financing its risks.

Risk Financing Techniques

There are two ways to finance risk; retention or financial transfer. An organization retains a risk when it pays for all or part of a loss. A deductible is one form of retention; not purchasing insurance for an exposure is another. Hopefully your types and amounts of retention are conscious decisions but you can passively retain a risk when unaware of its existence and have no plans for paying for a loss. A good risk identification process may prevent an unexpected risk retention.

With financial transfer another party is financially responsible for a loss but you need to make sure they have the financial resources to meet their obligations. Purchase of insurance is a financial transfer. Indemnification or hold harmless provisions in contracts are another transfer technique since another party has to pay for certain types of losses. For all financial transfers make sure the other party can meet their financial obligations.

Insurance

Insurance is the primary risk financing technique for nonprofit organizations. Every nonprofit has an informal risk financing strategy based on the scope of its insurance program but it would be better to formalize your strategy.

Insurance purchasing guidelines, a part of a risk financing strategy, are similar all organizations. An organization should:

  1.     1.        Assume risks whenever the amount of the potential loss would not significantly affect the organization’s financial position; and
  2.     2.        Insure risks whenever the amount of potential loss is significant or insurance is required by law or contractual agreement.

The first step is to decide what is a “significant loss.” Often a “significant loss” is one that threatens the organization’s survival. You may have established your loss threshold when setting your reserves level.

Another consideration is your association’s risk appetite – how much risk the association is willing to accept in pursuit of its strategic objectives. In some pursuits you are willing to accept more risk than others. These factors affect your insurance purchasing decisions.

Your association may be subject to certain laws or regulations requiring specific insurance coverages and limits. For example most states mandate Workers Compensation insurance and the Employee Retirement Income Security Act (ERISA) requires Employee Dishonesty insurance for your fiduciaries.

Contracts are often an overlooked exposure due to an indemnification or hold harmless agreement as well as specific insurance requirements. The person responsible for the insurance program isn’t always informed of the contractual requirements so the insurance program is non-compliant. You could inadvertently breach a contract or have an uninsured exposure.

Think Before You Cut

Before you make cuts in your insurance program adopt a risk financing strategy. Decide what you want to do via retention and financial transfer. Make retention a conscious decision matching your risk appetite. Insurance is another option but don’t forget you can transfer a risk or operation to another party (outsourcing). Just make sure the other party has the right types and amount of insurance to protect both you and them. When necessary buy insurance but base your decisions on your risk financing strategy and organizational goals. You’re less likely to be surprised.

Advertisements
  1. Leave a comment

Your thoughts?

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: