What is performance-based insurance? Let’s start with some simple definitions. Subsidy-Based Insurance (SBI) is traditional insurance, conventional insurance coverage where the insurer keeps about 35% of the premiums paid by companies. Traditional insurance combines various types of businesses into one risk pool. Companies with superior track records (favorable loss histories) subsidize those companies with a problematic loss history. Insurance rates are influenced by external factors including highly variable loss histories, company security programs mixed in with the loss pool, and industry market variability (soft and strong market swings).
Performance-Based Insurance (PBI) provides greater control over these exogenous factors and ensures that participating companies will be aware of the other companies in their risk pool. It focuses on a long-term strategy rather than a short-term, reactive approach. For example, a short-term approach to insurance can lead to problems, quote insurance policies and change companies every year. A short-term approach focuses on achieving the best rate available at the time. A long-term strategy includes a comprehensive security strategy and a plan for returning premiums in the form of dividends on unused claims. In other words, companies using performance-based programs will be rewarded with reduced premiums instead of subsidizing companies with weak loss records and unsafe practices. A simple way to think of it is as follows:
- Subsidy Based (SBI): Premium determined by market rates and the loss history of other companies.
- Performance Based (PBI): Premium determined by the history of losses of the participating company – “Pay By Performance”.
What is guaranteed cost insurance? Subsidy-based or conventional insurance can be described as “guaranteed cost insurance”. Companies pay a fixed premium regardless of their claim levels. This means that the companies also pay the carrier’s overhead and profit. Performance-based insurance offers companies innovative alternatives, allowing companies the opportunity to significantly reduce costs. Secure, well-run businesses can save a reasonable 25% on average. Companies with superior claims histories can save more than 50% of their typical premiums.
What happens in the event of a catastrophic loss? Performance-based insurance plans include a catastrophic loss policy with a major carrier. This risk transfer is an important element in all performance-based plans. This insures participating companies against large and unpredictable losses.
Is performance-based insurance a captive insurance plan? Captives are one of the best known types of performance-based insurance and are becoming increasingly popular as insurance vehicles. Approximately 30 US states have passed laws allowing captive formation in their jurisdictions. Vermont, which allowed the first captive to form on land, now has approximately 600 captives. Some of the other types of this plan include:
- Risk Retention Group
- retention plan
- Self-Insured Retention Plan
- Participatory Dividend Plan
- 831(b)
Is this type of program appropriate for all types of companies? Generally, companies with premiums of $125,000 or more are the best candidates for this type of plan. Companies can and should evaluate performance-based insurance plans as part of their overall insurance strategy.