What Is Performance Based Insurance?

What is Performance Based Insurance? Let’s begin with some simple definitions. Subsidy Based Insurance (SBI) is traditional insurance, conventional insurance coverage where the carrier keeps about 35% of the premiums companies pay. Traditional insurance blends various types of businesses together into a risk pool. Companies with superior track records (favorable loss histories), subsidize those companies with a problematic loss history. Insurance rates are influenced by external factors including highly variable loss histories, safety programs of the companies mixed into the loss pool, and industry market variability (soft and hard market swings).

Performance Based insurance (PBI) provides greater control over these exogenous factors and guarantees that the participating companies will know the other companies included in their risk pool. It focuses on a long term strategy as opposed to short term, reactive approach. For example, a short term approach to insurance can result in thrashing, quoting insurance policies and changing carriers every year. A short term approach focuses on achieving the best rate available at that moment in time. A long term strategy includes a comprehensive safety strategy and a plan for the return of premiums in the form of dividends for unused claims. In other words, companies using performance based programs will be rewarded with reduced premiums instead of subsidizing companies with weak loss histories and unsafe practices,. A simple way of thinking about his is as follows:

  • Subsidy Based (SBI): Premium determined by market rates and other companies loss history.
  • Performance Based (PBI): Premium determined by the participating company’s loss history – “Pay By Performance”.

What is guaranteed cost insurance? Subsidy based or conventional insurance can be described as “guaranteed cost insurance.” Companies pay a fixed premium regardless of their claim levels. This means that companies also pay for carrier overhead and profit. Performance Based Insurance offers companies innovative alternatives, allowing businesses an opportunity to significantly reduce costs. Safe, well-managed companies can reasonably save 25% on average. Companies with superior loss histories can save over 50% of their typical premiums.

What happens in the event of a catastrophic loss? Performance Based Insurance plans include a catastrophic loss policy with a major carrier. This risk transfer is an important element in all performance based plans. This insures the participating companies against large and unpredictable losses.

Is Performance Based Insurance a captive insurance plan? Captives are one of the better known types of Performance Based Insurance, and they are becoming increasingly popular as an insurance vehicle. Approximately 30 US states have passed laws allowing captives to be formed in their jurisdictions. Vermont, which allowed the first on shore captive to be formed, now boasts approximately 600 captives. A few of the other types of this plan include:

  • Risk Retention Group
  • Retention Plan
  • Self-Insured Retention Plan
  • Participating Dividend Plan
  • 831(b)

Is this type of program appropriate for all types of companies? Typically companies with premiums of $125,000 or more are the best candidates for this type of plan. Companies can and should evaluate Performance Based Insurance plans as part of their overall insurance strategy.

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