PERFORMANCE BASED INSURANCE: SMART SOLUTION FOR MID-SIZED COMPANIES
A seasoned expert explains how PBI works and why it’s a great choice for middle market businesses
By Elisabeth Boone, CPCU
Performance Based Insurance? What’s that? How does it work? For whom is it designed? How do I get started with it?
These are just a few of the questions agents and brokers ask about what to many is an unfamiliar concept.
Fear not! Industry veteran Bob Phelan will explain it all to you. Phelan, chief executive officer of TriPoint, is an authority on captive insurance and a published author with several books to his credit, and he’s also the creator of the Performance Based Insurance (PBI) concept. Tripoint was formerly known as Litchfield Insurance Group, an insurance agency Phelan led as chairman and CEO.
Let’s tackle our first question. What is Performance Based Insurance?
PBI is an umbrella term for all of the products that insurance practitioners refer to as alternative risk transfer (ART) or loss sensitive plans. Phelan thought “performance based” was more descriptive of how these products work. Conventional or guaranteed cost insurance has a fixed cost. PBI has a variable cost based on “performance,” where performance is measured by loss levels. In the simplest sense, the lower your claims or the better your performance, the lower your cost.
PBI gives middle market businesses the opportunity to earn money back in the form of a dividend on their premium or an up-front discount for a large deductible. The amount of the dividend/discount is based on the “performance” or claims level of the insured company. Companies that perform well can earn a dividend or up-front discount of 40% to 50%.
“I have been providing performance-based solutions for over 40 years, and my company manages more than $20 million in PBI premium for clients,” Phelan says. “In the beginning we offered conventional insurance company programs, dividend plans, retrospectively rated plans, and large deductibles. The plans were confusing, and a lot of clients didn’t accept them because of the complexity or the penalties charged in a bad year. Then in the late 1990s we learned about group captives, and I got active in the captive business and learned about other kinds of performance-based solutions.
“I realized that all of these plans have a common characteristic: Instead of paying a fixed cost as with conventional insurance, the insured pays a variable cost depending on loss levels. You don’t need to look at actuarial tables or retrospective rating factors. All you need to know is that the better you perform, the lower your premium will be.
“When I came to this realization, I wrote a book called The Cost of Ignorance, an insurance novella about two companies. One company used Performance Based Insurance and saw how it enhanced their financial performance. The other company didn’t adopt PBI and struggled because its insurance costs were too high.
“Even though some forms of PBI have been around for 40 years or more, there still is very little penetration in the middle market,” Phelan says. “Producers are used to guaranteed cost and are intimidated by the apparent complexity of PBI. The key is to align yourself with top-tier strategic partners who will do the heavy lifting.
“All you have to do as a producer is offer the idea of a performance-based program with the potential for a 40% to 50% dividend. I know producers who are very successful in the Performance Based Insurance space but don’t really know much about the concept,” Phelan remarks.
“Many producers label the value they add as expertise,” he continues. “They know a lot about coverage, or they know a lot about markets. The expertise we provide in the PBI space is putting all of the strategic partners together on a team and coordinating that team, like an orchestra conductor. Depending on the situation, we can have a nurse case management company, a third-party administrator, a captive consultant, a captive manager, and an investment advisor. Our role is to bring together all of those strategic partners so they can create the best solution for the client—and then let each one of them step up and show their expertise. That’s how we add value to our clients,” he explains.
“Fortune 1000 companies all have professional risk management teams that buy insurance, manage claims, and devise strategies to prevent losses. Almost without exception, those companies implement some form of Performance Based Insurance,” Phelan says.
What kinds of coverage and what kinds of risks are more amenable to Performance Based Insurance vs. conventional insurance? Where does Performance Based Insurance work best?
“PBI works best for the frequency lines of coverage—workers comp, general liability, automobile—where there are enough claims that you can look at your experience, figure out where the problems are, and resolve them to enhance your performance. This is particularly true in the area of workers comp; that’s where Performance Based Insurance has the most leverage and works the best,” Phelan says.
“In workers comp, PBI is all about risk management, which is really about providing a safe workplace,” he explains. “That is the most important element of all, because it shows that companies care about their workers. Investing in a safe workplace has a lot of benefits, and the financial rewards of a performance-based program are good for everyone.”
Obviously the best candidates for PBI are risk management-oriented, safety-conscious companies with favorable claims histories. “Any company that has a strong safety culture and maintains low levels of losses should automatically consider some form of Performance Based Insurance because otherwise it’s leaving money on the table,” Phelan declares.
Eye on group captives
“If a company has low loss frequency and between $150,000 and $1 million in premium for workers comp, general liability, and auto, then the best solution is a member-owned group captive,” he asserts. “That’s the sweet spot for Captive Resources, Inc., an Itasca, Illinois-based captive consultant that controls about 90% of the group captive market. The group captive model expands the possibilities for a much broader swath of the middle market.
“Group captives can be an option for companies that pay as much as $10 million in premium, but once you get past the million-dollar premium threshold, two additional options are large-deductible programs provided by all of the major national carriers and single parent or cell captives, where instead of being in a group, the client company is the sole participant,” Phelan says.
“We’ve been very successful with a captive manager and consultant in Philadelphia called Keystone Risk Partners,” he notes. “They’re a great strategic partner; they can put all of the elements together, bring in the client who’s paying a million or more, and put him or her in a captive of their own.
“When you form your own insurance company, you’re making a long-term commitment,” Phelan observes. “I’m personally agnostic about which solution is chosen; I think that’s up to the broker and the client. We can make a recommendation based on the client’s risk profile and what might work best, but ultimately it’s always going to be up to the buyer to make a choice. Some prefer the independence of owning their own insurance company, and others like the flexibility of having many national carriers competing for their business. Some might want the immediate cash benefit of a large-deductible credit, whereas others might like the net cost ad-vantage of dividends paid out over time.”
Options are now available even for companies that aren’t quite ready for PBI, Phelan remarks.
“Let’s say you’re a company that’s looking at Performance Based Insurance, but you don’t have a safety culture yet. You still have some claims problems; you still have a lot of accidents and injuries that are costing you a lot of money, and no group captive is willing to accept you into its risk pool. I call these companies ‘aspirational.’ Some of them are my clients,” Phelan says. “They want to be in a performance-based program, but they don’t qualify yet. We need to beef up their safety program and improve their performance before they’ll be ready for a group captive.”
Phelan mentions a company with which he has done business: Strategic Comp, a division of Great American. “It was formed by an agent who had the idea that the entity could work with ‘aspirational’ companies and help them qualify for Performance Based Insurance.”
Strategic Comp, he explains, offers an aggregate deductible credit and incentive-based safety program. Typically the firm can turn a company’s safety record around in two to four months. The company also has an extreme focus on injury management once a claim occurs. “Their claims adjusters have considerably fewer files on their desk than a typical insurance company adjuster might have; they get the claim resolved quickly and economically,” he comments.
“Strategic Comp is highly selective, and it’s not for everybody,” says Phelan. “It’s another option, and it’s an example of how our industry continues to evolve. There’s a lot of entrepreneurial energy out there, and people like me are always trying to find the next generation of Performance Based Insurance.”
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Elisabeth Boone, CPCU, is a freelance journalist based in St. Louis, Missouri.