Insurance and Risk Management
Risk management and insurance decisions begin with risk assessment. Risk assessment should lead to determining what is needed to protect the carrier from risks. It should also lead to operational changes that reduce risks through a strategy of continual risk assessment, risk avoidance, risk reduction, and risk allocation or transfer.
Risk assessment is an in-depth study of the risks the carrier is exposing itself to. Common risks at carriers are vehicle accidents, cargo claims, driver injuries, theft of equipment or cargo, breech of contract claims, and non-compliance punishment (fines). Risk assessment also involves determining the level of risk, both in terms of frequency and severity (potential loss).
The two types of risk that will require immediate attention after the assessment are risks that are either recurring (greatest probability) or have the chance for the greatest loss.
When assessing risk, it is possible to quantify the level of risk. Take the expected number of occurrences, and multiply them by the anticipated loss per occurrence. This establishes the “level of risk.”
The most often occurring and largest risks faced by all carriers are vehicle accident claims and litigation. To protect against these risks carriers routinely purchase insurance. While this is a form of risk management, it is actually risk allocation.
Risk allocation (sometimes referred to as risk transfer, which is a similar concept) involves sharing risk with, or transferring risks to, other parties that agree to accept the risk such as insurance companies, customers, or captive groups. For many risks a carrier can allocate the full value of the potential loss to an insurance company, but this may lead to extremely high premiums.
Risk reduction is the systematic reduction of risks, and the potential losses they carry, through the use of internal management controls. Examples of risk reduction activities are hiring standards, training programs, company safety policies, and verifying driver qualifications. Generally, risk management initiatives undertaken by carriers will result in a reduction in losses over time. This reduction in loss is the goal of a risk reduction initiative.
Risk avoidance is a practice of structuring the operation to eliminate, or avoid, a risk. However, not all risks can be avoided or eliminated. Some cannot be avoided because they are intangible risks, not necessarily tied to controllable events. An example of this would be damage to a carrier’s reputation.
Other risks cannot be avoided because they are inherent to the activity. An example of this would be the risk that comes with every newly hired driver. It is a known fact that newly hired drivers have a higher incidence of accidents in fleet operations. Carriers try to reduce this risk by establishing hiring standards, but the risk cannot be avoided or eliminated.
Risk acceptance is the deliberate acceptance of risk based on a determination that the company can (legally and financially) accept the risk. An extreme example of this would be a company in Wisconsin deciding to accept any risks associated with hurricanes that may damage the home terminal.
In the transportation industry a certain amount of risk acceptance is unavoidable. Take the earlier example of hiring drivers. The carrier can do everything possible to reduce the risks associated with hiring drivers, but there must be a level of risk acceptance. This is because the carrier cannot eliminate all risks associated with hiring. The questions become, what steps is the carrier willing to use to reduce the risk, and how much risk is the carrier willing to accept. The more risk you accept, the higher your incidence of loss may become.
Another form of risk acceptance that is more dangerous is the accidental or unintentional acceptance of risk. This occurs when a company is not aware that it is taking a risk, or does not have the correct protections in place against loss, but believes it does.
Single source or package policies. This is a strategy of using the carrier’s full buying power to attempt to leverage a better premium package. There are several advantages to this. First, the cost of insurance can be lower because the insurance carrier is carrying the company’s good risks, as well as the bad risks. Single sourcing can also simplify the carrier’s notification, reporting, and filing requirements. As well as having all of the carrier’s liability insurance with the same insurance company, the carrier can also bring in their cargo insurance, property insurance, general business insurance, errors and omissions coverage, and workers’ compensation coverage for negotiating.
Layering and separating. Layering coverage involves negotiating insurance coverage in “layers,” attempting to get the best premium for each layer. The carrier may secure one policy for the first million dollars in loss, then negotiate another policy to provide additional insurance for large losses. As carriers have been successfully sued for amounts well into the 20 million dollar range, this practice is becoming more common. Layering allows the carrier to pay a higher premium in the loss ranges that are more common, and a lower premium for protection against an extreme loss.
Separating coverage's involves using different insurance companies to cover different risks. This can be done for several reasons. The primary one is to lower the overall cost of insurance by lowering the cost of the low risk or high retention policies.
Another reason for separating coverage's is to secure skilled protection against a specific risk. An example would be a company that wants to work with a specific workers’ compensation insurance carrier that does not provide any other insurance services to the transportation industry.
Self retention of risk (self insurance) can mean two different things. First, as discussed earlier, it can be an accidental or deliberate acceptance of risk by not having insurance coverage to protect the carrier from a specific type of risk. This can be referred to as being “self-insured.” The decision to not purchase insurance for a specific risk should be based on a risk assessment and a risk/benefit assessment.
A risk assessment is done by taking the expected number of occurrences, and multiplying that by the anticipated loss per occurrence to determine the level of risk. When this is being done it is important to use factually correct numbers, not optimistic projections. The next step is to compare the cost of insurance to the possible loss as determined in the risk assessment. At this point the company can make an informed, reasonable, decision.
A company that has the financial reserves may even provide self-insurance to comply with mandatory insurance requirements. As far as motor carrier and cargo insurance, there are processes provided in the regulations for a carrier to secure authorization to operate as a self-insured motor carrier (see Part 387 in the Reference Tab). In cases of self-insurement, the carrier is retaining 100 percent of the risk. Carriers that operate as self-insured carriers will many times secure insurance against catastrophic losses (i.e. in excess of $1,000,000). This is similar to the insurance industry practice of re-insuring discussed earlier.
The second strategy is the self retention of a portion of a risk normally covered by insurance. An easy explanation of this type of risk retention is to equate it to the deductible on a standard insurance policy. If the carrier is willing to accept responsibility for the first $50,000 of any loss, then the carrier can negotiate a lower insurance premium. Much like the deductible on a standard auto insurance policy, the more of the risk the carrier is willing to accept, the lower the premiums become.
Captive insurance is another alternative to traditional insurance. Captive insurance companies are private, self funded, limited purpose insurance companies, specifically constructed to provide insurance to a select group. In some cases captives can offer coverage at a more attractive rate, or provide insurance to a carrier that is having difficulty locating an insurance program that fits their needs.
The business model of the captive is identical to the business model of a traditional insurance company (profit = premium + investment income - losses - underwriting and operating costs), with the companies operating the captive keeping any profits.
Typically, the company or companies involved in the captive will need to “fund the start up” or “buy” their way into the captive if they are not involved in the start up. These initial funds establish the investment pool, and premiums paid by the captive members (who are also the owners) replenish it. If the captive is profitable, then all participants in the captive are given a dividend, which they can keep or use to reduce the next premium. Just like a regular insurance company, if the captive is not profitable premium adjustments are made to establish profitability.
Captives typically will only insure a portion of the total risk the captive is exposed to and will typically reinsure the risk. Reinsurement is the insurance industry practice of purchasing additional insurance from another insurance company to protect the original insurance company from having to absorb too large of a loss. Because the captive is for all practical purposes an insurance company, it has direct access to the reinsurance market.
Captive insurance may hold certain advantages. The advantage that is most popular with some companies is captives may be able to lower the cost of insurance. This is because profits are either returned to the captive reducing the need for future premium increases, or paid out as dividends. Captives can also be more responsive and responsible in the settlement of claims. As the captive is owned by the members, claim handling can be streamlined and provided with specific guidelines to be followed.
Captives can also be flexible with their risk management. If the commercial or reinsurance market rates are low, the captive can choose to use outside insurance or reinsure a larger amount of the risk, allowing for larger returns from the captive’s investment pool (less money leaving to cover claims). If insurance rates climb, the captive can adjust by reducing the amount of risk covered by outside insurance, reducing the amount leaving the captive to pay outside premiums.
Finally, because captives are operated by companies with common goals, and do not have traditional shareholders that insist on a profit, the captives may be able to absorb short-term profit losses to ease sudden insurance rate increases.
Be a “low risk” carrier. The best insurance strategy is to appear to insurance companies as a “good risk.” Insurance companies operate under a business model of:
Profit = Premiums + Investment Income - Losses - Underwriting and Operating Expenses.
The insurance company has direct control over only one of the factors in their business model; premiums. While they can control what they invest in (within the scope of their regulations), they do not have direct control over that portion of their business model. Their investment income can vary, no matter what steps they take.
If a carrier is generating losses (or showing the potential to generate losses) the insurance company may have no choice but to increase premiums to maintain their profitability. If the carrier’s performance or potential is “bad” enough, the insurance company may cancel the policy in an attempt to maintain its profitability.
Insurance companies assess risk through a process known as underwriting. Underwriters are very specific and scientific when establishing the level of risk a carrier will expose the insurance company to. During the underwriting process the underwriter uses “actuarial science” to quantify the risk of a company.
The underwriter will consider statistics and probabilities based on present and past performance in the areas of violations, citations, accidents, losses to claims, company policies and practices, driver driving records, driver turnover, equipment value, property value, and other factors. This allows the underwriter to determine the potential “exposure,” or potential for loss, that a carrier will represent to an insurance company.
Many times the insurance carrier may not have the ability to fully protect a carrier, in which case they will re insure the risk. During the underwriting process, the underwriter may recommend that the policy be re-insured, due to the size of potential losses. In such cases the re-insuring insurance company may accept the underwriter’s judgment, or may insist on having their own underwriter or loss control specialist (or consultant) assess the company.
A carrier can have a good safety history, and still see high premiums based on an underwriter’s work. This can occur if the underwriter sees “gaps” in the carrier’s operations, making the carrier a bad risk. Poor hiring standards and practices, high incidence of turnover, lack of adequate safety policies and/or staffing, poor equipment condition, and too many miles for too few drivers are all examples of gaps, or reasons why an underwriter may set a higher premium against a carrier that has a good safety history. This is because underwriters are aware that carriers that demonstrate certain behaviors (or do not demonstrate certain behaviors) are involved in a disproportionate number of high loss incidents.