If your organization is strictly focused only on premium savings, you are chasing the wrong rabbit.
Any prudent business person should know the cost of their insurance. But to strictly focus on the lowest premiums without understanding the real cost is a problem—and a costly one at that. Allow me to explain.
Recently, I had a discussion with a local business. They had been working with a consultant who they hired to get multiple bids on their Workers’ Compensation insurance.
The low bidder won the business and in exchange the buyer got the lowest premium.
Win-win, right? On the surface, yes. In reality, it was the most expensive way by hundreds of thousands of dollars!
How can that be? Keep reading.
Any CFO knows that—even though the insurance carrier pays the claim—there is an internal loss cost absorbed by the business. They just don’t know what that cost is as it is not a separate line item on their financial statement.
We call this financial leakage, which is a controllable expense. A conservative ratio is somewhere between 1 and 1.5 times the amount of the losses.
We all know losses drive premiums. The more losses, the higher the premiums and vice-versa.
To illustrate, let’s assume the losses had no impact at all on their premiums. In addition, let’s also assume their yearly competitive bid strategy achieved a 10 percent premium savings over a five year period. Both are unlikely, but for the sake of this illustration let’s run with it.
The losses are the controllable part of this equation. In their case, they did not place enough value working with a broker who could provide them with the resources needed to make significant reductions.
We estimate that with the right strategy and resources in place they could have reduced their losses by 50 percent. For this illustration, let’s use a 1.25 indirect loss cost factor.
Now let’s take a look back and see what did occur.
Premiums: $2,500,000
Losses: $1,100,000 (Paid by the carrier)
Indirect Loss Costs: $1,375,000
Total Cost: $3,875,000 (Premiums + Indirect Loss Costs)
Now let’s look at what could have occurred with a 10 percent increase in premiums and 50 percent reduction in losses.
Premiums: $2,750,000
Losses: $550,000 (Paid by the carrier)
Indirect Loss Costs: $687,500
Total Cost: $3,437,500 (Premiums + Indirect Loss Costs)
The local business thought they were saving $250,000 by competitive bidding. In reality it cost them $437,500 more do it this way. Ouch!
They had the right intentions, but they were chasing the wrong rabbit. Which one do you want to chase?
