White paper: Casualty
When to consider a loss-sensitive
casualty program structure
By Doug O’Brien, National Casualty Practice
April 2015
Most middle-market companies have guaranteed-cost
programs for primary casualty insurance. In these
programs, also called first-dollar programs, you pay a fixed
premium in exchange for full coverage of a loss, including
damages, defense costs, claims handling, and other costs.
Companies have historically preferred the convenience
and budget stability of these programs. Plus, the entire
premium is a potential tax deduction, there are no
collateral requirements, and the insurance company is
somewhat motivated to help you control losses.
However, times have changed. Today, during this
tightening market, insurance companies’ capacity
for these programs is decreasing and premiums are
increasing — especially for workers’ compensation due to a
number of factors — which is creating volatility in pricing
from one year to the next. As a result, many companies are
considering a loss-sensitive program instead.
With this structure, you pay a lower premium in exchange
for partial coverage of a loss in excess of a deductible
borne by the insured, and you can further reduce your
retained costs by improving safety and claims-handling
procedures. For many companies, loss-sensitive programs
are proving more cost-effective than guaranteed-cost
programs.
Organizations choose to retain risks for several reasons,
and moving to a loss-sensitive program is not an easy
decision. As you evaluate your options, it’s important to
consider the differences between guaranteed-cost and
loss-sensitive program structures.
Drawbacks of guaranteed-cost programs
In the Wells Fargo Insurance book of business,
guaranteed-cost programs account for 65% to 70%
of the primary casualty structures for middle-market
companies with average revenues up to $250 million.
Although there are many benefits and they are suitable
for many organizations, these programs also have several
drawbacks:
• Price swings. During hard or tightening market cycles,
guaranteed-cost programs can experience significant
swings in premiums, carrier appetite, and degree of
coverage.
• Reduced benefit for good loss experience. Many lines
of business are rated by class, so you may not get credit
for your historically favorable loss experience. And, if
you do, it may be delayed. In workers’ compensation
insurance, for example, experience modifications take a
number of years to capture the impact of good loss
experience and many carriers are eliminating optional
schedule credit modifications.
• Less control over your costs. In a guaranteed-cost
program, you have less control over claims handling,
and you have less incentive to maintain safety
standards since your insurer will cover any loss on a
first-dollar basis.
• Less cash flow for you and more profit for the insurer.
Since you pay your premium up front, any investment
income on that money goes to the insurer — not to you.
Furthermore, for each dollar of guaranteed-cost
premium, approximately 60% is intended to pay losses,
while the remaining 40% goes to fixed costs, such as
taxes, claims handling, loss control, administration, and
broker commission. If your losses do not exceed 60% of
the premium, then the insurer makes a profit. (In a
loss-sensitive program, on the other hand, the more you
can impact the expected losses and the fixed costs
through proactive loss control and claims management,
the more you can reduce your total cost of risk over the
long term.)
The advantages of loss-sensitive programs
Compared to guaranteed-cost programs, loss-sensitive
programs require you to bear some portion of the loss —
usually on a vertical, per-occurrence basis. Some losssensitive programs have a built-in maximum premium
or provide the option to purchase an aggregate stop loss,
which will cap your retained losses (please see the exhibit
on page 5 for a comparison). This structure can provide
several advantages:
• Lower premium. In exchange for bearing some portion
of the loss, you receive a 20% to 70% credit on the
guaranteed-cost premium. Your premium depends on
the line of coverage, the amount and type of loss you
retain, your company’s historical and future loss profile,
your initiatives for loss control and claims handling,
general market conditions, and other factors. Although
there are programs with small deductibles ranging from
$1,000 to $25,000, you will derive the most premium
savings by taking on higher retention levels at $50,000
or more.
Wells Fargo Insurance white paper: When to consider a loss-sensitive casualty program structure | April 2015
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• Savings through loss control and claims handling. In
addition to taking a higher retention, you can further
reduce your costs by preventing losses, since any
reduction in losses below the chosen retention level
accrues directly to you — not the insurance company.
When you pay the majority of your own losses, you have
a clear and immediate incentive to prevent losses in the
first place and, if they occur, manage them more
proactively through aggressive claims handling,
return-to-work programs, managed care, and other
initiatives. Any reduction in loss has a direct impact on
your bottom line.
• Improved cash flow and investment income. Losssensitive programs can be structured on a pay-asyou-go basis, which enables you to improve cash flow
and receive investment income on the loss reserves —
instead of giving them to an insurer.
• Price stability and lower cost of risk. While losssensitive programs will not eliminate pricing volatility
entirely, they can help reduce the swings in pricing that
often come with guaranteed-cost programs. In addition,
over several years of good loss experience, effective loss
control, and proactive claims management, you can
often reduce your average total cost of risk versus a
guaranteed-cost structure. Of course, in any given year,
the total cost of a loss-sensitive program may exceed a
guaranteed-cost premium; nevertheless, companies that
switch to loss-sensitive programs are usually satisfied
with their decision.
Types of loss-sensitive programs
Middle-market companies have access to several
different loss-sensitive programs, including:
• Dividend plans
• Deductibles (paid and incurred)
• Retrospectively rated programs
• Captive reinsurance
• S
elf-insurance (more common for general and
product liability; less common for workers’
compensation and auto liability)
When to consider a loss-sensitive program
While there is no specific rule of thumb for determining
the right kind of program for your company, it might be
wise to consider a loss-sensitive structure if one or more of
the following applies:
• Your guaranteed-cost premium is high relative to the
expected losses.
• Your aggregate loss experience at various retention
levels by coverage line is fairly predictable year over
year and can be actuarially measured. Review of prior
losses is usually a good gauge of the future.
• You understand the potential severity for aggregate and
large losses.
• Your company has the financial capacity to assume the
maximum amount of retained losses within a given
policy year and over a period of years.
• There are no contractual requirements that prohibit
your company from assuming a certain level of risk.
• Your company wants a financial incentive to control
losses and manage claims.
• Your company can post collateral in the form of a letter
of credit, cash, or other vehicle.
• A guaranteed-cost program is not available.
In addition, consider how peer companies are structuring
their casualty insurance programs, and work with your
broker to analyze the suitability of a loss-sensitive
program. Wells Fargo Insurance, for example, can help you
in your decision by offering:
• Loss forecasts and variability studies
• Risk-retention analysis to help you determine the
optimum per-occurrence retention levels, maximum
premiums, and the impact that accruals for retained
losses will have on your balance sheet
• Calculations of the compounded savings expected over
a multi-year period in varying loss scenarios
• Evaluation of pre-loss efforts, such as safety initiatives
and other loss-control programs
• Evaluation of post-loss efforts, such as claims handling,
managed care programs, and return-to-work initiatives
Wells Fargo Insurance white paper: When to consider a loss-sensitive casualty program structure | April 2015
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• Analysis of additional administration needs
• Evaluation of different loss-sensitive program structures
• Assessment of insurance companies, claims handling
companies, and loss control specialists
How can we help?
For more information on this topic, please contact your
Wells Fargo Insurance sales executive, or:
Douglas O’Brien
212-209-0253 office | doug.obrien@wellsfargo.com
Conclusion
As companies see higher insurance premiums and
reduced capacity from carriers, loss-sensitive programs
are becoming an important alternative to guaranteed-cost
structures. While loss-sensitive programs can result in a
higher cost than first-dollar programs in any given year,
loss-sensitive programs tend to be more cost effective over
time, especially for companies that remain proactive with
respect to controlling losses and managing claims.
Wells Fargo Insurance white paper: When to consider a loss-sensitive casualty program structure | April 2015
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Exhibit
Loss-sensitive program
Guaranteed-cost
Guaranteed cost program
Individual claims or occurrences
Individual claims or occurrences
Losses paid by carrier
Losses retained by ABC
Losses paid by carrier
Limited or
unlimited
Primary
limits
Primary
limits
$250,000
$250K
$250,000
$250K
retention
level
level
Losses
collateralized
Losses within policy year
Losses include defense costs and
claims handling
Losses within policy year
Need to negotiate inclusion of defense costs in losses.
Claims handling costs usually in addition
Loss
amount
negotiated
separately
Optional
aggregate
protection
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Wells Fargo Insurance white paper: When to consider a loss-sensitive casualty program structure | April 2015
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