Navigating Rising Insurance Premiums: Exploring Four Alternative Options for Businesses

In today’s volatile market, businesses often face the challenge of rising insurance premiums, which can significantly impact their bottom line. When the cost of insurance seems disproportionate to the value received, it’s crucial for companies to explore alternative risk management strategies. While the commercial insurance marketplace functions as a reasonably effective means to transfer insurance related risk, it is by no means a perfectly efficient model. Commercial insurance carrier expenses such as commissions, marketing, advertising, premium taxes and many overhead expenses are incorporated into the final premiums paid by policyholders, resulting in a deadweight loss to the risk transfer process.

Additionally, insurance companies price policies to cover the long-term average expected losses and charge a premium for the risk they assume (profit and contingency load/charge). The insurers use the risk premium to increase their capital and surplus over time to provide for funds needed in years with high claim costs that will deplete capital and surplus. By retaining more of the risk, the expense component and risk surcharge of the insurance premiums paid to carriers would be reduced or eliminated, potentially producing significant savings for the policyholder.

This blog delves into four viable options we have identified over decades of actuarial consulting: self-insuring, forming a captive insurance company, creating a risk retention group or risk purchasing group, and starting a traditional insurance carrier. Each option comes with its own set of pros and cons, which we’ll explore to help you make an informed decision. The ideal option depends on a multitude of variables, most importantly the size of the company.

Option 1: Self-Insuring

What Is Self-Insuring? Self-insuring occurs in various forms, including electing or increasing deductibles or self-insured retentions, increasing co-insurance/quota-share percentages, setting up a certified self-insured entity or self-funding risk – that is, not purchasing insurance coverages at all. Each option consists of a company setting aside its own funds to cover all or some potential losses rather than purchasing first dollar insurance from a third-party provider.

Pros:

• Cost Savings: Avoids and/or reduces the premium costs associated with traditional insurance.
• Simplicity: Options such as increasing deductibles or self-insured limits are very easy to implement and don’t require significant changes to the underlying insurance policy.

Cons:

• Financial Risk: Potential for significant financial exposure in the event of large or unexpected claims. This also increases the variability of the underlying company’s financial performance.
• Capital Requirements: May require substantial upfront capital to ensure sufficient reserves.

Option 2: Forming a Captive Insurance Company

What Is a Captive Insurance Company? A captive insurance company can take on various forms, the most common of which is a wholly owned subsidiary created to provide insurance to its parent company and possibly its affiliates. This entity operates like a traditional insurer but serves only the needs of its parent organization.

Pros:

• Customization: Ability to design insurance coverage tailored to specific business risks without the constraints of standard insurance policies.
• Cost Efficiency: Potential for long-term savings and profit from underwriting income.
• Risk Management: Improved risk management and loss prevention practices due to direct oversight.

• Tax Benefits: Potential for favorable tax treatment under certain conditions.
• Control: Direct control over claims handling and risk management.

Cons:

• Initial Costs: High setup costs and ongoing administrative expenses.
• Regulatory Oversight: Subject to insurance regulations, which can vary significantly by jurisdiction.
• Management Complexity: Requires expertise in insurance management and regulatory compliance.
• Capitalization: Need for adequate capitalization to meet regulatory and risk-bearing requirements.

Option 3: Risk Retention Groups (RRGs) and Risk Purchasing Groups (RPGs)

Risk Retention Groups (RRGs) and Risk Purchasing Groups (RPGs) are both mechanisms that allow businesses to manage and finance risk, particularly in the context of liability insurance. Here’s a high-level discussion of their pros and cons:

Risk Retention Group (RRG)

Pros:

• Customization: RRGs allow member businesses to tailor insurance policies specifically to their needs, leading to potentially better coverage.
• Cost Savings: By pooling resources and avoiding the commercial insurance market, RRGs can reduce insurance costs.
• Control: Members have more control over the insurance process, including underwriting, claims handling, and risk management.
• Stability: RRGs can provide stable insurance availability even in hard markets when commercial insurance becomes expensive or unavailable.
• Flexibility: Can cover a wide range of liability exposures, except workers’ compensation.

Cons:

• Capitalization Requirements: Establishing an RRG requires significant initial capitalization, which can be a barrier for smaller businesses.
• Regulatory Complexity: While RRGs are regulated under federal law, they must also comply with some state regulations, which can be complex and burdensome.
• Limited to Liability Insurance: RRGs can only provide liability insurance, not other types, such as property insurance.
• Risk Concentration: If the group is not well-diversified, losses can be substantial, affecting all members.

Risk Purchasing Group (RPG)

Pros:

• Access to Insurance Markets: RPGs allow members to access insurance markets and products that they might not be able to on their own.
• Purchasing Power: By purchasing insurance as a group, RPG members can often obtain better rates and terms than they could individually.
• Not Capital Intensive: RPGs do not require a significant level of capitalization.
• Regulatory Simplicity: RPGs are generally subject to less regulatory oversight as compared to RRGs and captives.

Cons:

• Limited Control: Members of an RPG have less control over the insurance policies and terms since they are purchasing group policies from insurers.
• Standardization: Insurance policies purchased through RPGs are less likely to be customized to the specific needs of each member.
• Dependent on Insurers: RPGs still rely on commercial insurers to provide the coverage, which can lead to issues if the insurer decides to exit the market or change terms.
• Limited Coverage Scope: RPGs are typically limited to liability insurance and might not be able to meet all the insurance needs of their members.

Option 4: Starting a Traditional Insurance Carrier

What Is Starting a Traditional Insurance Carrier? Starting a traditional insurance carrier involves creating a fully operational insurance company that not only provides coverage for the parent company but also can offer insurance products to external clients. In general, without an experienced actuarial consulting partner, this isn’t a viable option for most individuals coming from outside the insurance world.

Pros:

• Revenue Generation: Opportunity to generate revenue by offering insurance to third parties.
• Market Influence: Ability to influence market practices and set industry standards.
• Brand Extension: Enhances brand presence and adds a new dimension to the business portfolio.

Cons:

• High Barriers to Entry: Significant financial investment, regulatory hurdles, and operational complexities.
• Operational Risk: Exposure to underwriting, market, and operational risks inherent in the insurance industry.
• Regulatory Compliance: Must meet stringent regulatory requirements, including capital adequacy and solvency.
• Management Expertise: Requires specialized personnel who have knowledge and experience in running an insurance business.

Conclusion

When faced with rising insurance premiums, businesses have several strategic options to consider. Self-insuring, forming a captive insurance company, creating an RRG or RPG, and starting an insurance carrier each present unique opportunities and challenges. The right choice depends on the company’s size, financial strength, risk appetite, and long-term business objectives. By carefully weighing the pros and cons of each option, companies can make informed decisions that align with their risk management strategy and overall business goals.

Take Action: If you’re considering alternative risk management strategies, consult with the actuarial consulting and risk strategies experts at Perr&Knight today to explore the best option for your business. With the right approach, you can gain greater control over your insurance costs and enhance your company’s financial stability.

Contact Perr&Knight today to get started.