Insurance: What You Can Do

(from Maine Townsman, January 2003)
by J. Alan Johnson, CPCU, ARM, AIS, owner The Johnson Agency, Madisonville, TN

In the foreseeable future we will continue to see many changes due to the Terrorist Attacks of September 11th.  All of us will have to adjust what we do and how we do them, and municipalities and other governmental entities will be subjected to major changes with regard to their insurance and risk management programs as a direct result of this threat.  There are things you can do to weather the storm.  This list is by no means all inclusive, but at least hits the major points I feel are important to consider. 

First and foremost, it is rare for a small to medium sized municipality to have the resources or staff with specialized knowledge of insurance and risk management.  Therefore my first recommendation is:

1.      FIND A KNOWLEDGEABLE INSURANCE PROFESSIONAL THAT YOU CAN TRUST 

Even though the Mayor’s brother-in-law got his insurance license last year and is selling life insurance at night, this is not the type insurance professional you need to be dealing with.  It is imperative that you find an insurance professional who knows how to read an insurance policy, who is knowledgeable in the workings of the insurance industry in general and governmental insurance specifically, who can assist you in determining what to insure and what not to insure, and who can explain in simple terms just what the heck you’re buying.

The insurance industry in general and the municipal and governmental insurance markets specifically, will be a virtual minefield for the next few years, with companies changing or deleting coverages entirely and with rates varying wildly while individual companies seek their level in a very unstable market.  Despite the general trend to standardize the insurance product over the past 20 years, insurance is not a commodity, where one product is the same as all others and your only choice is based on pricing.  An insurance policy is nothing more than a legal contract that promises to restore you financially if some covered event causes a loss.  Contracts can be changed, wording can be amended, and rates can be either too high or too low.  Yes, I did say too low.  If an insurance company does not charge enough to pay for losses that they are covering and for their expenses, they will not be able to pay your claim when it occurs.  And a policy that doesn’t pay claims it’s supposed to pay, is nothing more than a piece of paper.  In the foreseeable future, if you purchase insurance coverage based solely on price without making sure that all other factors are in line, you may as well buy your insurance from the local office supply house.  They can sell you pieces of paper much cheaper than you can get them from an insurance company. 

A knowledgeable insurance professional can be a very important team member during these uncertain times.  Look for experience, training and education.  Professional designations such as Chartered Property and Casualty Underwriter (CPCU), Certified Insurance Counselor (CIC), Associate in Risk Management (ARM) in the property & casualty lines and Chartered Life Underwriter (CLU) in the life & accident and health lines, indicate a dedication to the practice of insurance and a professional approach to the insurance business.  Some professional designations, CPCU, CIC and CLU in particular require several years of study and proof of a mastery of the subject matter to achieve.  They also require the holder to adhere to an a professional Code of Ethics—something that is especially important when you’re looking for someone to trust.   

One more thing that you may or may not know.  You don’t have to buy insurance in order to receive the services of a professional.  You can negotiate for an insurance professional’s services and advice for a fee, and then purchase your insurance coverage elsewhere.  If you do this, be sure to maintain your relationship with the professional for the term of the insurance contract so that he can follow-up and be sure you actually get what you’ve asked for. 

Simply put, you need to look for the best to guide you during this time. 

Hopefully, you have at least identified an insurance “guru” who will advise and guide you for the next few years.  Now it is time to turn to your specific exposures to see what you can do to help yourself.  First, take your current insurance policies and lock them in the top drawer of your desk.  You don’t want to trash these contracts, since (heaven forbid) you just might have a loss that may be covered while these policies are in effect, and you’d need the policies in that event.  But during the following process, put your current policies away so they won’t influence the decisions you need to make.  Get a clean legal pad and a couple of sharp pencils.  Set up a time to sit down with your trusted insurance professional so that together you can:

 

2.      DETERMINE YOUR RISK EXPOSURES 

This process is actually easier than most people think it is, if you are totally honest with yourself.   You will need to brainstorm on this one, so you might also want to call in your department heads, supervisors or managers, so you can bounce ideas around.  At this point, the more people you can get involved, the better.   

Start by listing all assets which are owned or are controlled and for which your municipality is responsible.  These will include property you own, lease or otherwise control including buildings, contents, vehicles, equipment, tools, raw materials not yet processed (such as asphalt for street and road repairs), products held for emergencies (salt for icy roads, etc.), and any other item of value.  Don’t forget to include on your list your intellectual property, including specialized knowledge held by employees, and other intangibles which have some value.  Once you’ve exhausted the possibilities for your list of assets, you need to place a value on each and every one of them.  Be realistic at this point and don’t over value or under value these items.  [A copy of your latest financial statement, and your most recent inventory can be very helpful in making this list.] 

Next, you need to list every possible way you can be hurt by sources outside of your municipal operation, and also from inside your municipality.  This list will include your liability exposure for injury to persons or damage to property for which the city and/or it’s employees could be held responsible.  This list will contain all premises owned or controlled by the city, the services you provide, all municipal vehicles, the acts and actions of your employees and agents, the effect of weather and “Acts of God,” and any other way you can think of, no matter how obscure, that would cause the municipality to sustain a loss.  Don’t forget to include the loss of supply sources for goods and services needed to continue your current municipal operations.  [You can be greatly helped in the compilation of this list by using your insurance professional or risk manager’s knowledge.]   

On both lists, no item is too small or too outlandish to be included.  We’ll throw out and mark off items later.  The purpose in making these lists is to make sure that nothing of value and no exposure to loss is overlooked.  There are some municipal risk pools who will perform some of the services for you by compiling your lists of assets.  I still advise doing that part yourself, since no one knows your city like you do, and trusting totally in someone else to be sure you are properly protected is a dangerous practice.  

Now that you have an idea of what you have to lose, and how you could lose it, you can determine what to do about it.  Here is the point where you will have to make some executive decisions as to how to handle each exposure, if at all.  Your next step is to: 

3.      LOOK AT ALTERNATIVES TO INSURANCE  

In the discipline of Risk Management, there are actually five recognized methods to handle risk.  And from a risk management perspective, insurance is the final alternative, to be used when no other method of handling risk is available or is feasible.  The five accepted methods are:

a.                  Avoidance

b.                  Control 

c.                  Non-insurance Transfer

d.                  Retention

e.                  Insurance

A brief explanation of each of these follows with an example of situations where they are used. 

Avoidance means that you avoid the risk in its entirety.  In other words, you completely get rid of the risk exposure, or you don’t get involved with the exposure to start with.  An example of this might be your discovery that a older building you want to acquire for use as a city recreation center, has some asbestos insulation.  You determine that the cost to remove the asbestos is too high and the exposure is too great.  Therefore you decide not to purchase the building, and have effectively avoided the exposure. 

Control involves your taking steps to minimize or reduce the chance for loss from a particular exposure.  An example of this technique is having fire extinguishers mounted in strategic locations, or having a sprinkler system in municipal buildings.  Also, strict enforcement of employee safety practices is an excellent Control technique.  In this manner you have reduced the chance of loss by exercising control over the loss exposure.

Non-insurance Transfer is accomplished when you transfer the exposure to loss to another person or entity by contract other than an insurance contract.  This method of handling risk is done every day, and most likely if you examine contracts that have been signed in the normal course of municipal business, most of those contracts will contain some form of risk transfer, where the risk of loss has been transferred from one party to another.  An example of a common non-insurance transfer is the “Hold-Harmless Clause” found in most contracts.  This clause states that you agree that another party who may have caused some damage or injury will not be held responsible for that damage or injury.  They have transferred their liability to you without benefit of formal insurance.

Retention is the act of keeping the possibility of loss with no attempt to control or transfer that loss to another party.  This method is used when the risk of loss or the loss exposure is either too small, or too great.  Each of us practices loss retention every day to some extent.  The mere act of getting up out of bed is an example of loss retention.  We accept the possibility that we may trip over the dirty clothes strewn about the floor and injure ourselves (risk too small to do anything about) and we start the day with the expectation that the world won’t end (risk too great to do anything about).  Retention is actually what people are doing when they say they are “Self Insuring.”  There are formal retention programs which can be either “funded” or “unfunded” and involves a strong commitment to the Risk Management process.  [However for our purposes here, this type program is much too complicated to go into.  If interested in true “self insurance” your insurance and risk management professional can provide you with additional information.]

The final method for handling risk is Insurance.  Formal insurance is a method whereby the financial consequence of loss is transferred by means of a legal contract to a company which is specifically set up to accept risk from others, and which charges a fee (premium) for doing so.  Assessing and accepting risk is the business of insurance.  The higher the risk of loss, the higher the premium charged. 

With knowledge of the methods by which exposures to the risk of loss may be handled, you now can go through your lists and make your decisions as to how you should handle each exposure you have.  Some may be too hot to handle and you may want to Avoid.  Some risks you may be able to Control so as to lessen the possibility of loss.  Some you may be able to Transfer to others by contractual means.  Some may be too small to do anything with, or too large to do anything about, but involve an act you don’t want to give up, therefore you decide to Retain the exposure.  And with some exposures your only alternative will be to handle them with Insurance.  During this process, you will find that most exposures will involve some combination of two or more of these risk management techniques. 

The point here is that in many instances, there are alternatives to buying insurance, and you need to look at each of the other alternatives before you turn to the purchase of insurance to handle your exposure to loss.  Because of the cost of insurance, and the limitations which the insurance product sometimes imposes, formal insurance should be the risk handling method of last resort.

At this point, you now have your insurance professional to guide you, your lists of loss exposures, and some knowledge of the means by which each exposure can be handled.  Now you need to refine your list.  Exposures which can be handled by methods other than insurance need to be looked at closely to determine their costs and how to go about implementing those methods.  Set in motion the processes needed to amend contracts, put in place loss control measures and whatever else you can do to handle loss and the possibility of loss.  As for those exposures which you have determined have to be handled by formal insurance, you need to take the insurance section of your list and proceed to:

4.      PRIORITIZE YOUR INSURANCE EXPOSURES 

Most insurance can be broken down into three categories:  (1) Insurance that is required—either by law or by other entities, such as loan requirements, contractual requirements, or required by agreement; (2) Insurance that is needed—this is insurance that you need to assure the continued financial viability of your city in the event of a loss; and (3) Insurance that you want—coverage on assets that you would find difficult to replace but whose loss would not significantly impair the city financially. 

Here again, an insurance professional can assist you in identifying and classifying your loss exposures into these categories.  Unless you systematically organize your business in this manner, you may find that you’ve left out some vital coverage, or that you’ve insured something that essentially will be a waste of the tax payers money.  Now you can categorize the loss exposures to be insured as those that are REQUIRED, those that are NEEDED, and those that are WANTED.

When you’ve finished putting all your insurable loss exposures in their categories, you now have the basis for drawing up a set of specifications for your insurance program that can be taken to the insurance marketplace for premium quotes.  Here you will need the guidance and advise from your insurance professional to set up account specifications that can be marketed.  When doing this, you need to keep in mind that traditionally insurance was never meant to be used as a maintenance contract.  Insurance should be purchased in order to provide a financial safety net to assure the continuation of your municipality in the event of a large, devastating loss from which would seriously impact the financial stability of the city if you didn’t have insurance.  To this end, you should: 

5.      EXERCISE CONTROL OVER YOUR INSURANCE PROGRAM

 There are several ways you can exercise control over your insurance costs.  Again this list is not all inclusive, and there may be other ways which will be specific to your particular city.

 First, you need to be sure that what you insure is properly valued.  Purchasing insurance in an amount less than what it will cost to replace an item or for less than it’s worth is pretty useless.  If you have to make up the difference between the cost to replace and what your insurance pays, out of the tax payers pocket, you probably don’t need to insure the item at all.  This is especially true with Municipal Property insurance that contains a Co-insurance clause.  [Note that some municipal property contracts require that property be insured to its replacement cost value, and do not contain a co-insurance clause.]  This contractual provision states that so long as you insure your property at least 80% or more to the replacement value (or in some cases the Actual Cash Value), if you suffer a loss to that property, the insurance contract will pay the cost to repair the loss or replace the property, up to the limit of insurance, less your deductible (which will be discussed below).  If you insure your property for less than the percentage amount and have a loss, you will only receive partial payment as calculated by the co-insurance formula.  In other words, if you don’t insure your property to the proper value, you become a “co-insurer” with the company in the event of a loss.  [Here’s a tip on choosing a qualified insurance professional.  If he or she doesn’t know and understand co-insurance and can’t explain it so you can understand it-- look for somebody else!!]

 While I’m on the subject of co-insurance, your option to set the percentage amount is another way to exercise control over your costs.  A credit to your property rates is built into the calculations for co-insurance based on the percentage to value you set.  Most standard property forms require you to insure your property at least 80% to the value established.  You can, however, set that percentage higher, to 90% or even 100%, and the higher the percentage you set, the higher the credit you receive on your rate.  You must, however, be careful here, because you have to be sure that you maintain your property insurance to the percentage you set.   

Another way to exercise control over the costs is by use of deductibles.  Actually a deductible is a form of retention (See Alternatives to Insurance in 3. Above), and again, the higher your deductible, the more credit you get on your rates.  Your deductible amount should be set at a level that you can comfortably take out of current operating funds without seriously impacting municipal operations.  Most insurance companies look favorably on clients who choose higher deductibles, feeling that the client is demonstrating their desire to take care of the small, day to day loss, and are not using their insurance for a maintenance policy.  Deductibles for the most part are used in the property lines of insurance, but small deductible amounts ($250 or $500) are increasingly being used in liability to promote safety and force clients to think about what they’re doing before they do it.  Some companies are starting to use large deductibles ($10,000 and higher) in workers compensation programs where the clients have a funded reserve that complies with their operating state’s statutes.

 Your use of loss control techniques can also effect the cost of insurance.  If you have a security system which discourages theft, or a sprinkler system that can put out a fire before it can do major damage, you will receive credits on your rates.  Also, on new construction, the type of building you build is important.  A masonry building is less damageable than a frame building, and a non-combustible (metal) building is less damageable than either, and these factors figure heavily in your rates.  The amount and type of training and protection that Police forces and Firefighters have also have a great impact on insurance costs.  A properly trained, certified Police Officer who is required to wear a bullet proof vest while on duty, is much less likely to injure someone else, or be injured than the alternative, and likewise a Firefighter with the proper training and turnout gear.

 Here again, the knowledge and advice from your insurance professional can save you money.  Before undertaking any major expansion, large purchase or new project, most city managers or Mayors and Board of Aldermen will consult their attorney and their accountant.  You should now include your insurance professional in that group, since sound risk management advise can save you money far into the future.

 Over time, the immunity from legal action once enjoyed by municipalities and the power to tax with impunity in order to pay for governmental operations, has been eroded by the legal system and by the activist citizen.   It is incumbent for public officials to maintain the public trust in their elected positions, and the prudent use of taxpayer money is one way of doing this.  With the changes in today’s insurance and risk management marketplace, it is more important now than ever before to prudently plan and protect the public’s assets.  It is the purpose of this report to attempt to give some guidance with regard to insurance matters, so that changes we experience will be more understood and to provide some ways to retain some semblance of normalcy.