Performance Based Insurance Program: Why it is time to consider

California contractors began the year with many challenges: increasing wages and qualified labor shortages, high inflation impacting availability of credit and a slowing economy.

However, while wages have been increasing, workers’ compensation rates are at a 25-year low per the Workers’ Compensation Insurance Rating Bureau. With rates so low, insurance carriers are under pressure to raise rates to balance the increase in healthcare costs.

Performance-based programs can lower clients’ insurance rates, drive risk management best practices, raise the level of cash flow – but also expose clients to more severe risks if not well prepared.

Lowering Future Insurance Rates

Performance-based programs can allow contractors to offset the future rate increases in the California workers’ comp market. Most contractors buy guaranteed-cost programs based on historical experience modification, base rates and payroll. However, performance-based programs reward contractors for lower losses in the current year, which can compound that benefit in future years. Performance-based programs range from 100% self-insurance, large deductibles, retros and group and single parent captives – all allow contractors to assume a larger portion of risk in return for lower premiums.

One advantage of performance-based programs is they can provide greater control over insurance costs, allowing clients to assume great risk, and also help mitigate big fluctuations in year-to-year premiums. This can be particularly beneficial for contractors that bid projects one-to-three years in advance of completion dates, enabling them to know their long-term insurance costs.

Economic Incentive

Performance-based insurance programs also provide a financial incentive to reduce risk exposure. Contractors with fewer claims are rewarded with lower premiums, incentivizing risk management strategies to reduce claims frequency and severity. As contractors scale, this becomes even more important. Clients that add a full-time safety director often yield 3 to 5 times that salary in lower ultimate losses. Before entering into these programs, contractors should do a thorough internal review of their human resources, field safety, claims management and contractual risk transfer controls – or work with broker to help drive best practices.

Cash is King

Beside possibly lowering insurance costs, performance-based plans provide cash flow benefits, charging less premium up front and adjusting as losses become known. The trade-off is a sacrifice of some stability, because actual losses may be reflected in future year operating results. Further, because losses take time to fully develop, the final cost for a given coverage period may not be fully known for years. With a commitment to safety and loss control and the enhanced accountability driven by implementing risk management best practices, the long-term impact on the overall cost of covering a firm’s exposures should be favorable.

Drawbacks

There are potential disadvantages of these programs: clients that assume a greater portion of the risk may be more vulnerable to large losses; adding risk management procedures and possibly personnel can be costly. But, having a proper risk management infrastructure, or working with a risk management partner, is key. This said, a transition from guaranteed-cost to performance-based insurance programs may not be suitable for all contractors, particularly those with a higher claims frequency or severity. Performance-based insurance programs can provide numerous advantages, but before taking on more risk, contractors should carefully consider all advantages and disadvantages of these programs.

Clients should work closely with a strategic risk management partner to complete an internal audit on risk management best practices and then determine what type of program is the right choice for their business.