Self-Insurance Options for Small Businesses
You Can Save Premium Dollars By Retaining More Risk
All businesses face risks that can generate losses. A common way to manage risk is to purchase insurance coverage. The business pays a premium and in exchange, the insurer assumes the risks outlined in the policy. by retaining some of those risks, the business can save money on insurance premiums. Risk retention is also called self-insurance.
All businesses retain some risks. When a business buys an insurance policy, it retains risks that are excluded by the contract. This type of risk retention is involuntary. Businesses may also retain some risks by choice. Large companies have a broader range of options for self-insuring risks, but small businesses can enjoy many of the benefits of risk retention, albeit on a smaller scale.
The term self-insurance means funds set aside to pay for future losses. The money may be held in a loss fund or savings account or employed in a more sophisticated financial arrangement such as a captive insurance company.
The primary reason to retain risk is to lower your cost of insurance. Generally, the more risk you assume, the less you will pay in insurance premiums. Another benefit is the ability to handle losses in the manner you choose.
For example, suppose you decide to forego collision insurance on two pickup trucks that are insured under a business auto policy. You save $1,000 in premium. A few months later, you accidentally back one of the pickups into a wall, damaging a rear fender. A local body shop will repair the vehicle for $1,500. Instead of using the body shop, you hire a friend who's handy with cars to hammer out the dent for $100. Your decision to self-insure collision damage has given you the flexibility to bypass the body shop and hire your friend. It has also saved you $1,400.
Self-insurance can motivate you to practice good risk management. You will try harder to prevent accidents if you know you'll have to pay for the resulting losses out of pocket.
Risk retention has some disadvantages. One is that your out-of-pocket costs may be larger than you anticipate. In the previous example, suppose that the damage to your vehicle is too extensive for your friend to fix and the body shop charges $2,500. You have saved $1,000 in premium by foregoing collisions insurance but your out-of-pocket cost is $2,500.
Options For Small Businesses
Here are some ways a small business can retain risk.
Deductibles can be an effective tool for lowering your premium if you have the financial resources to pay some losses out of pocket.
Deductibles are often used in first-party coverages like commercial property and auto physical damage. They typically represent a specified dollar amount you must pay for each loss. If a loss exceeds the deductible, your insurer will pay the difference between the deductible and the loss amount.
For example, suppose your business property is insured under a commercial property policy that includes a $1,000 deductible. If vandals cause $2,500 in damage to your building, your insurer will pay $1,500 for the loss. The insurer subtracts the deductible from the amount of loss and pays you the difference.
General Liability or Auto Liability Coverages
One way to save money on auto liability or general liability insurance is via a property damage deductible. This type of deductible is appropriate if your business is likely to generate small property damage claims. For example, suppose you own a cleaning company that serves businesses and homeowners. Because your cleaning staff works at customers' premises, they could accidentally damage customers' property. Your insurer offers to lower your premium in exchange for a $1,000 property damage deductible.
Liability policies covering small business owners rarely include a deductible for bodily injury since small BI claims can quickly become large ones if not managed properly.
Liability policies covering small business owners rarely include a bodily injury deductible. Small bodily injury claims can quickly become large ones if not managed properly.
Workers' Compensation Coverage
Many states allow insurers to offer all workers' compensation policyholders a small deductible plan. Plan details and eligibility requirements vary from state to state. Depending on the jurisdiction, a "small" deductible may range from $100 to $75,000. The deductible typically applies to both medical benefits and indemnity (disability).
A small business owner that wishes to purchase workers' compensation coverage with a small deductible may be required to provide evidence of financial security such as an irrevocable letter of credit. The deductible is typically added to a standard workers' compensation policy via an endorsement.
A self-insured retention (SIR) is used in liability insurance. A SIR is a specified dollar amount that you agree to pay for each claim or occurrence. Unlike a deductible, a SIR may apply to claim expenses as well as damages. Another difference is that you may be responsible for handling claims that fall below the SIR. Claims that fall within a deductible are usually administered by the insurer.
While most policies purchased by small businesses don't include a SIR, an exception applies to umbrella policies. Some umbrellas contain a SIR that applies to claims covered by the umbrella but not by underlying insurance. An example is a claim alleging mental anguish that is covered by your umbrella but not by your general liability policy. An umbrella SIR typically applies to damages only (not claims expenses).
Some states permit small and mid-sized employers to self-insure their workers compensation obligations on a group basis. To form a self-insured group, the members must belong to the same industry and operate similar types of businesses. Group members contribute premiums into a fund, which is used to pay claims and expenses. If premiums exceed losses and expenses, members share the surplus as dividends. To learn whether group self-insurance is an option in your state, consult your insurance agent or state insurance department.