Most Cost-Effective Insurer Might Be You

If you buy liability insurance as protection in case the public is injured on the premises of your business, it would probably pay you to take a close look at the way your insurer settles such claims.

Why?

* Your policy probably gives the insurer complete freedom to settle any claim at any time, with or without your consent.

* Most insurers settle claims under a certain limit--the insurer’s threshold of pain, as it were--without contesting them, and if your insurer has a high threshold of pain, its practices can cost you money.

You can, however, seize control by acting as your own insurer, substituting your own threshold of pain for your insurer’s. The solution is simple, and it can pay dividends.

The language of most small-business general liability policies closely follows that of model policy “forms” developed by the Insurance Service Office, an organization headquartered in New York and run by property/casualty insurers to gather statistics, develop policy language, and promulgate rates. In plain English, this means that the ISO writes the cookie-cutter provisions found in most standard insurance policies, including most general liability policies sold to small business.

To be sure, insurers often change the ISO’s language to suit the needs of their own markets. And not all insurers use ISO forms in the first place; for example, insurers selling professional liability coverage, as distinct from general liability coverage, often write their own policies, some of which give the policyholder a say in settling claims.

But most general liability policies leave the disposition of claims, including the decision to settle, solely in the hands of the insurer.

“Under our policy forms, in the vast majority of cases, the insurer selects the defense against all claims and determines at what point escalating defense costs trigger a settlement,” says Chris Guidette, a spokesman for ISO in New York.

“This means that under the policy forms produced by ISO, the destiny of any claim is entirely up to the insurer, and the policyholder does not have the option to veto a settlement.”

Some insurers show more backbone in fighting unjust and meritless claims than others, but yours may settle claims that you would contest, were it your decision. Worse, because you pay for the costs of just and unjust claims alike in the form of higher premiums, an insurer with a high threshold of pain costs you money. In the worst-case scenario, you may end up “trading dollars” with your insurer--a very expensive way to buy insurance.

You trade dollars with an insurer when your claims equal your premium, more or less. For example, if your liability insurance costs $50,000 a year and your claims come nearly to the same number, every premium dollar you send your insurer flows right back out again as a claim dollar, less a certain amount for your insurer’s overhead and profit. In essence, when this happens, you become your own insurer without knowing it--with the added expense of your insurer’s overhead and profit. You cease transferring risk to your insurer and instead use it merely as an expensive conduit through which you pay claims.

Insurers settle a given claim when they expect the costs of contesting it--mainly staff time and legal counsel--to outstrip the costs of the claim itself. If, for example, a customer slips and falls on your premises and runs up $2,500 in medical expenses, most insurers simply write a check, even when they suspect that your customer exaggerates his or her injuries. Many insurers don’t contest claims until they reach $5,000 or even $10,000.

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Insurers do not, of course, advertise their thresholds of pain, and few boast of their backbone in contesting claims--on the theory that people won’t buy insurance from a company that turns stingy just when they need help. But your insurer’s threshold of pain is your key to seizing control, and the place to look for it is in your own claims history. Does your insurer pay claims of, say, $5,000 or even $10,000 without much of a fight? Do you know enough about such claims to believe some of them meritless? Put another way, do you suspect that some of your claims come from people who, knowing how insurers work, judge a windfall to be an amount just short of your insurer’s threshold of pain?

If so, check your policy deductible--the point at which your insurance coverage kicks in. Below your deductible, you essentially act as your own insurer, absorbing all losses. You transfer the risk of any losses above the deductible to your insurer.

If your deductible is low and your own threshold of pain doesn’t match your insurer’s--that is, if your insurer doesn’t contest most of your claims--and if you suspect the merit of some of those claims, the solution is simple: raise your deductible, bear the risk yourself, and fight some of those claims that your insurer would pay as a matter of course.

“It may well be cost effective to assume the costs of claims below a relatively high deductible yourself--because you know what they’re going to be,” says Jim Strang of Strang & Associates, a Simi Valley risk-management consulting firm. “What you can’t handle is the unknown--the $10-million claim.”

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If, for example, every year you get 120 claims of which 100 come in under $10,000, renegotiate your insurance premium with a $10,000 deductible, maybe even more, Strang says.

“If your claims cost $100,000 and you pay $300,000 for insurance, by taking the $10,000 deductible and fighting some of those claims, your cost may drop to $150,000 a year,” Strang says. “Even if it costs you $100,000 to handle those claims, you’re still $50,000 ahead.”

The key, Strang says, is to look at insurance for what it really is-- a financial decision to transfer risk to an insurer.

“In my practice I try to get managers to look not at insurance but at risk, and to make a financial decision to handle that risk depending on what best fits the company,” Strang says. “A small business may be better off with a higher deductible if it suits its own financial needs--because it allows the business to control costs.”

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For the Record: A recent column incorrectly characterized CalCAP, a state-subsidized bank lending program, as open to almost any small business in California. The state finances the program with fees levied on “private-activity” bonds issued by business to finance pollution-control work in the state, and the program seeks to benefit firms whose business activities affect the environment. That includes manufacturers, warehouse operations, most agribusiness, contractors, wholesalers of durable and nondurable goods, printers, and even pottery makers. But it does not include most retail operations, even those involving hazardous materials--for example, hardware stores selling paint and solvents.

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Freelance writer Juan Hovey may be reached at (805) 492-7909 or via e-mail at jhovey@compuserve.com