Commercial Insurance 101: An Introduction to Insurance
(00:05): Today, we’re going to give a brief introduction to commercial insurance. What we’ve found over the years in working with so many different companies and being invited into their business was there’s usually somebody in the office who drew the short straw, who’s now delegated person to handle insurance and all the insurance policies. Yet they don’t have a background in insurance or understand at a macro level, you know at the 10,000 foot level where insurance fit, why it’s so important in the role that it plays. So the goal here or this presentation is to give your, your staff a basic idea of the importance of insurance, how it fits in and the role and function it plays inside your business. So insurance is a very complex financial contract and it’s not so simple. It’s not like going to the car dealer and buying a Honda civic where you know, all the Honda civics are the same.
(01:03): All the additions and accessories that you buy, it’s all fixed and no matter which Honda dealer you go to, it set every insurance policy and product is very custom tailored down to, you know, with a few words in set, a policy could make or break the difference of whether a claim gets paid or your customers will accept the insurance certificates and insurance policies that back the company that they work for. And you know, at the 10,000 level, the, the goal, the insurance policy is to finance your risk so your cash flows consistent for the business. The goal is to transfer as much risk as possible to the insurance carriers for the least amount of premium. What we’ve also found is because folks don’t have a general understanding of insurance policies and insurance contracts, they jump at the lowest premium, but they don’t understand there’s a difference between the price of the insurance policy and the cost of the policy and the cost usually doesn’t manifest itself until you have a claim and then you figure out that the policy that you bought that might’ve been $20,000 cheaper.
(02:27): Actually didn’t cover you for much. So now that cost is $1 million loss plus a $20,000 premium. So you didn’t save much, but you spent a whole lot of money pulling a risk. So the idea about insurance is if you get a thousand businesses and they all pay insurance premiums into a company, that particular insurance company knows that they’re going to take a hit or take a loss from a certain percentage of those thousand customers. And they used the premiums that they pulled together the pay for those losses and make a profit. If you look at the skyline of Manhattan without the ability to pull risk together and spread it around into the insurance marketplace, you’d never see buildings being built that high. You know, Manhattan. That skyline is a function of society’s ability to pull the risk, which allows individual companies to take risks or bets.
(03:34): And if something bad happens, the insurance marketplace will stand behind them and pay for that particular loss. Risk, SEG segmentation. So these, the insurance industry is set up within verticals called lines of insurance. You might recognize the names but you never understood how it fit. So anything property wise, properties, anything that you can touch or has intrinsic value, say like intellectual property. Music is intellectual property, movies are intellectual property, although you can’t touch it. It’s a, it’s an intrinsic thing of value. Liability is the things that you are responsible for. So let’s say you own an apartment building in a city and you have a defective sidewalk with holes in it, it’s your responsibility to keep that sidewalk in good working condition. And if a member of the public trips and falls, they can show you for that. So it’s liability is things that you’re responsible for.
(04:36): And remember, liability insurance doesn’t mean it’s going to cover your property. Excess liability and umbrella only sit over the top of liability. And you could also bake in other policies like directors and officers, commercial auto to broaden the coverage. But an excess liability or umbrella policy will not sit over the top of the property. So if you’ve got a property policy that only has one point $5 million a coverage and you’ve got $10 million of umbrella coverage, that doesn’t mean you’ve got now 11 points $5 million a property because this only sits over the top of liability. Commercial auto covers anything on wheels, both from a property standpoint and a liability standpoint. So these two coverage lines here are then combined into a commercial auto policy that covers things on wheels. Workers’ comp covers your employees, uh, for loss of wages if they’re injured, during work or in a work-related matter, if they’re hurt outside of work, that’s covered on our statutory disability policy, but workers’ comp covers medical and wages for workers injured on the job or for occupational hazard.
(06:00): There’s this thing called a business risk and not all business risk is insurable. As an example, if you committed, if the business owner commits fraud or steals money or bribes there, protect prospective customers or breaks the law, that’s never going to be covered on an insurance policy. So there’s, there’s a certain amount of business risk that all businesses take on that is not transferable to the insurance marketplace. The other point is that an and, and that’s where retained risk is. So your goal as the business owner is to buy as broad a contract as you can transfer as much risk as you can for the lowest amount of premium. The more risk you keep, the cheaper the insurance policy will be. And that’s, and that’s the mistake that we see a lot of companies make where they’ll jump at a low premium but don’t understand that they’re retained most if, if not three-quarters of the risk.
(07:05): So there’s a trade-off there and you gotta be careful about that because again, insurance policies are very complex financial instruments and you got to make sure that you understand the risks that you’re transferring to the carrier for a premium and the risk that you’re retaining and over here, a certain amount of risk is too big for you to take on. So we suggest that you abstain from actually doing that type of work because the risk is too great and it could have a severe impact on your business. So and this is uncovered. Usually, when you do the assessment you figure out what aspects of the business have a third rail component to it. This is how insurance works at a macro level. It’s about risk retained versus risk transferred to an insurance carrier for a premium.
(08:04): Why should you care if you have a loss or a large claim? There are only four ways to fund the loss you funded at current cash flow. So let’s say you own a store and the window broke and you decided to self-insure for your store windows and that window costs $3,000 to fix rather than a hand that claim did each Durance carry, you decided that you’re going to pay that $3,000 out of your pocket out of your current cash flow. For larger companies, they figured out that they could pay the losses editor’s current cash reserve. It’s cheaper than buying insurance. So they’ll, they’ll self-insure or self-fund the losses because it’s more efficient for them from a cost standpoint. Other companies get hit with losses and they don’t have the cash flow or the cash. And if insurance doesn’t pick up for the loss, then they’re going to have to go into debt to finance that loss.
(09:02): And you saw that a lot with the hurricanes and flood where a lot of businesses didn’t buy flood insurance. So they went to the federal government and took out SBA loans to help them recover and put their businesses back together. So they borrowed money from the government the fourth way and usually the most cost-efficient way to buy insurance. So you Shay, you Liz, jeez. You know, um, you know, think about your own home. If your home ever burned down, that’s a pretty significant loss. Let’s call it $1 million. Plus you’re going to have to live somewhere until the home gets repaired and replaced. That that would put a pretty significant hurt on a lot of folks. So instead of absorbing that or knowing that that’s out there, what most folks do is for a few bucks, they hand it over to an insurance company. (09:57): And if that house ever burns down to the ground, that million dollars gets that. That loss gets funded by the insurance company. It only cost you $5,000 plus whatever your deductible was. So insurance for a lot of businesses, especially small businesses, it’s the most cost-efficient way to fund a loss. What’s the best option? Well, it depends. Um, it depends on the size of your business and the size of your balance sheet. How much cash reserves do you have, what’s your risk tolerance? Are you a cowboy and you know, do you wheel and deal or um, are you the type of person who likes to sleep well at night and know that you’ve got cashflow certainty? How much free cash flow do you have inside your business. If your business has a pretty high-profit margin and you’ve got a of free cash flow, then it makes sense for you to self insure an up to a certain dollar amount and any of the losses you come in, you, you pay him out of pocket, the larger your business gets.
(11:00): What you do is you, you, you, you go through and you hire an actuary and they’ll figure out what your future probability losses are based on your current financials and your loss histories. And that, you know, there are folks, mathematicians that this is exactly what they do. At the end of the day, you know, insurance is the pooling of risk and, and sharing the cost through thousands of other businesses in case you have a loss, the insurance carriers use the premiums paid by those thousands of businesses to make you hope. Not all risks should be funded by insurance, by the way, you know, the larger you get. Um, what you’ll find is that you know, through process and protocols, through loss control engineering, which is, you know, resources geared towards preventing claims from happening in the first place when they want claims do happen if you could manage them so they don’t go sideways and escalate. It saves your company a lot of money relative to going out and buying insurance. The larger you get, the higher the rate of return on these mechanisms. Contractual risk transfer. Sometimes especially like in certain industries like general contracting, the higher up the food chain you are, the more your risk you can push downstream to your vendors. So when a loss does occur, you’ve got the contractual ability to pass it downstream and your vendors will actually pay for the loss,
(12:46): keep more risk, buy less insurance. That’s when you start to get cost-efficient management best practices. So a good broker should put you through a risk assessment to first understand what your true risk profile is. Understand insurance as a trailer. It’s never a leader, it’s, Oh, you know, it, it, it’s the end of the process. It’s never the beginning. Too often we see insurance brokers just come in, they copy the policies, they ask you to fill out a couple questionnaire, you know, a supplemental application. Um, they look at your loss runs and then they, they run out to the insurance marketplace and they slap applications everywhere. But nobody sat down with the business owners, the CFOs and the HR folks to understand, um, how they’re conducting their business, what the org chart looks like, what resources they’re actually applying now, what resources are they missing? Maybe there’s risk inside the business that we can transfer. There’s risk inside the business that we should never even be doing. There are risks that you know what, it doesn’t make sense to buy insurance for all this. We could sell funds for a lot of this and, and, and book the profits inside the company.
(14:14): But most companies don’t know this because they’ve never really gone through a risk assessment. They’re just copying policies in and fling it out into the insurance marketplace and they’re skipping. Bree are four very important processes and essentially they’re just buying insurance instead of managing risk. So contingent on what the risk assessment reveals. The next step is to separate each risk component of three buckets, keep risk risk that you can potentially transfer and then other risks that you’ll either avoid or we can mitigate them tweaking our processes and protocols. You know once you separate and you filter through risk tolerance and you take a look at the financials of the company at that point you overlay a strategy that incorporates the first three steps so you can divide resources consistent with the strategy. You still find that you’re buying insurance the same way, the same painful process and are frustrated by the time it takes to get the quote to deal with four different brokers by the confusion and the noise and by the outcome and you’ve never had a full risk assessment performed and you’re unsure what risk you’re retaining at what consequence.
(15:36): And you don’t have a full risk management program that you can use as your template moving forward and you have a brokerage relationship. It reacts, reactionary, not proactive. Then we encourage you to speak to one our risk advisors. So you can compare and contrast our strategy versus the transaction of buying insurance as your company grows and as you become more cost-efficient and as you start taking on claims, we suggest that you need to stop buying insurance and start managing risk. Thank you. Have a great day
