Take Pittsburgh-based Nova Chemicals. When other chemical commodities companies reduced or dissolved their SIRs as insurance prices bottomed out in the mid-1990s, $3.9 billion Nova did the opposite, quadrupling its property insurance SIR to $70 million for claims from fire, explosions, and the resultant loss of income. Nova's peer companies were more likely to have SIRs in the $1 million range. "We felt then and continue to feel that it makes no sense to spend all this money on insurance when we could be spending it instead on loss prevention," says Nova risk manager Brad Silver, who notes that the company hasn't submitted a claim to its insurer for the past decade. "It was a radical decision," he says, "but it has paid off for us over time."
Following a recent merger with Trans-Canada Pipelines and a subsequent reorganization that spun off its energy business, Nova reduced the SIR on its property insurance program to $50 million, still very high compared with its peers. However, that deductible, says Silver, will have to be reevaluated during the next renewal cycle, in June 2002, in light of current economic and insurance conditions. SIRs, he says, "are influenced by the financial position of the company, which can change from year to year."
Accepting higher deductibles — whether by choice or not — comes with a downside. "Obviously, you subject your corporation to more earnings instability when you take on more risk," explains Hartwig. "If you take a $50 million SIR instead of a $25 million SIR and there's a loss, that will wind up in your quarterly earnings, not an insurer's. If there's no loss, then you've won the gamble."
Some companies have been unwilling to take that gamble. Epix Holdings, for example, a Tampa-based professional employer organization with $1.3 billion in annual revenues, balked at absorbing a high SIR. Prior to September 2000, the company had a no-deductible workers' compensation insurance program, similar to the one at Scholastic. That fall, however, Epix president and CEO Thomas Taylor found the market had changed — considerably. The company's insurer no longer would write workers' compensation without an SIR, an outcome that did not sit well with Taylor. "I wanted the same attributes I had with my former program — earnings stability, cash flow, tax deductibility, and so on," he explains.
So Taylor turned to his broker for help. "Marsh put together a program with two insurers: The Hartford, which would provide the coverage above the $250,000-per-claim SIR, and Scandinavian Re, which would absorb the SIR in full," he says. "The upshot is we now have full coverage, as before, although it is through two insurers and the cost is 50 percent more than what we paid for our previous single policy."
Taking Captives
Costco Wholesale's response to its higher SIR was to take matters into its own hands. Instead of transferring the SIR to a commercial insurance company — as Epix did — the wholesale-retail company set up its own corporate-owned captive insurance company to insure it. "We wanted to be in charge of our own destiny," says Janice Chamberlain, risk manager at the Issaquah, Washington-based company with $34.1 billion in 2001 revenues. Adds Chamberlain: "We're very glad we did what we did, when we did."
Costco's $1 million SIR for general liability, $500,000 SIR for workers' compensation, and $250,000 SIR for auto liability are insured by its brand-new Bermuda-based captive, which provides similar tax treatment accorded to premiums paid to a conventional insurance company. The difference is that Costco gets to keep the investment income drawn on the premium paid to the captive, rather than the insurer having it. Above the SIR, Costco buys insurance from Kemper Insurance in Chicago.
"This is a much better, lower-cost way to insure ourselves," says Costco executive vice president and CFO Richard Galanti. "We don't get hit with the overhead and profit charged by the insurer to take these low-value risks," he adds. "We're also not subject to the vagaries of the [insurance] marketplace, we get far more financial predictability on an annual basis, and hopefully we can garner significant investment income on the premiums paid the captive."
Other companies are pursuing the same course. According to executives in Marsh's Bermuda office, the number of new captives is up in all domiciles, from Guernsey to Vermont. "The hard market is driving corporations to increase their SIRs, which is encouraging them to put that risk in a captive," says Andrew Carr, a managing director in Marsh's captive management practice. Carr notes that as of August 31, 64 Bermuda captives have been set up this year; Marsh has formed 14 of them, and expects to form a total of 30 by the end of the year. Carr adds that several companies that were undecided about the approach have been prodded into action by the disasters. "After all, it is the best defensive action one can take," he says.
Risky Business
Lowe of Tillinghast-Towers Perrin estimates that it will take six months to a year before the insurance industry has a firm handle on the business-interruption costs stemming from the September 11 incidents, and several more years for total liability claims to be known. But in the meantime, many companies are reevaluating just how high an SIR they can handle without jeopardizing earnings stability.
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