One more use case before I really get down to business. Underneath my Fort Pedro uniform, I am wearing a Custom Insurance Services T-shirt. A tool like Ancho could be extraordinarily useful in my profession.
I've been working at the agency for over 10 years now, and I like to think that I've got more on the ball than your typical car insurance guy. I obtained my Certified Insurance Counselor (CIC) designation in 2004 -- a designation held by only about 7% of insurance sales agents in the U.S. Now I'm working on my Certified Risk Manager (CRM) designation, and I expect to finish it later this year. That designation is held by less than 1% of insurance salespeople.
In the CRM program, the focus is on managing risk and its costs, not just on the technicalities of "insurance" per se. You might say that a risk manager has done their job when they tell you how you can buy less insurance. They do this by identifying risks that you face in your business and helping you either prevent them, control them, or learn to predict them. Predictable expenses can often be directly paid, at lower cost than buying insurance for them.
That Sounds Crazy!
Actually, it is quite typical for large companies, or groups of smaller companies, to self-finance more predictable risks such as employee medical coverage, workers' compensation benefits, general liability risks, auto liability risks, property losses due to storms or fires, and so on.
The variables involved in choosing to establish a program of self-insurance, and in managing one once it's set up, are numerous.
- How much of a reserve should you set for this loss? Maybe they've turned in a bill for $5,000 but your data says this type of loss typically costs you $15,000.
- How many losses have you already incurred, but haven't been reported yet as of a certain date, perhaps because the person who fell in your parking lot is just hoping that the pain will go away? (The technical term for this is "IBNR," for "incurred, but not reported."
- How much are you going to have to pay an adjuster or an attorney to determine how much you owe, or whether you should be responsible for paying for something? ("Loss adjustment expenses")
- Can you rely on your own loss data, which shows very few claims, or should you go by industry data, which suggests that your loss rates could be much higher? Maybe you've just been getting lucky.
- What are future interest rates and investment returns going to be like? This makes a difference if you're responsible to pay for something, but not for some period of time.
- What kind of deductible or retention amount should you choose, so that you can fund whatever losses you'll have at the lowest possible cost?
- What is the likelihood that your tax-advantaged self-funded insurance arrangement will lose its favorable tax treatment next year?
- Is your business going to have the cash flow to finance your self-funded program?
- If you have to post bonds or letters of credit to a regulatory agency in order to get your arrangement approved, what is the loss of that operating capital going to cost you in terms of other lost opportunities?
- How much "excess" insurance (limits in excess of expected losses) do you need to purchase? How much is that going to cost?
Hopefully, this next paragraph will astound you.
On average, I am told, these self-insurance arrangements last around five to seven years. Only rarely do they survive longer than that. They typically end in a royal clusterf**k of missed estimates, worse-than-expected claims, higher-than-expected legal bills, bankruptcies, and litigation that goes on for years. The industry term is that they "blow up."
What's going on here? I honestly don't know. The people that set these things up aren't dumb. They have advanced degrees; they wear bow ties. But I have to assume that they're boiling down their data to "point" estimates for every variable, rather than accepting the probabilistic nature of the problem. The second you start projecting a single outcome for a system as complex as this, the one thing you do know with certainty is that it's not right.
If a system like Ancho could make it possible for these risk financing vehicles, which are good ideas in theory, to avoid these blow-ups... well, you do the math.