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Insurance Premiums Versus the Total Cost of Risk

Author: Chris Boggs

When was the last time your client said, “That premium seems fair; the insurance company is getting adequate premium to cover its exposure and I'm getting the protection I need"?

I doubt ever. More than likely you have heard them say – maybe even today - “I can't believe I have to pay out all this money. The insurance company is killing me. Can't we get this premium down?"

Carriers advertising low, low auto rates on TV are play to the belief that insurance is all the same and all about the visible premium – the “price." But is it the price or the cost of protection the insured needs to calculate?

Insureds must understand – or be taught by us – that premium (the price) is only part (sometimes a small part) of their “Total Cost of Risk."

Six “costs" in addition to the premium combine to develop the insured's true total cost of risk: 1) Deductibles or Self-Insured Retentions; 2) The cost of uninsured or self-insured losses (intentional or unintentional); 3) Legal costs; 4) Loss control and safety costs; 5) Claims management costs; and 6) Opportunity costs.

Let's talk first about Deductibles and Self-Insured Retentions. Premium savings is often accomplished by increasing a deductible or using a self-insured retention (SIR). But any visible premium savings must be weighed against the initially invisible “out-of-pocket" cost directly related to the deductible or SIR. The Price:Cost comparison is easy with smaller clients that have relatively few losses. A small commercial client, for example, may enjoy a premium savings of $2,000 by increasing its property deductible to $5,000 from $1,000; but one loss could “cost" the insured $2,000 more than staying with the lower deductible.

$1,000 Deductible$5,000 Deductible




Property Loss:



Amount Paid by carrier:

(Loss – Deductible)



Total Cost of Risk following loss:

(Premium + Deductible)



And this is if there is only one loss during the year; what if there are multiple losses during the year?

Larger corporations are major proponents of high deductible programs because there is the immediate premium savings (as seen on the balance sheet). But when compared to the actual cost of loss experience such a plan may ultimately be more expensive.

Basically, visible premium savings are eaten away by the “invisible" costs of deductibles and self-insured retentions following a loss.

Now let's add in the costs associated with uninsured and self-insured Losses. In an effort to cut insurance costs, insureds may intentionally or, worse, unintentionally self-insure certain risks. Before implementing intentional self-insurance there must be careful study of loss frequency and, more importantly, loss severity. (Frequency is how often the loss occurs; severity is how expensive the loss is.)

Unintentional self- insurance is generally the result of coverages being cut from a program in an effort to lower the premium.

Any out-of-pocket expense related to self-insurance is part of the insured's total cost of risk. Like the use of deductibles or SIR's, these may push the cost of risk beyond the pre-change price of insurance. Two prime examples of these expenses are claims management costs and legal costs.

Internal Claims Management Costs are most often associated with self-insured losses or uninsured losses. These losses and claims must be managed by someone. This “someone" may be an internal employee designated as the claims administrator or it may be an outside third-party administrator (TPA).

Although the expense of the internal employee may be captured under a separate line item – payroll expense – the cost is still a part of the total cost of risk. Any TPA expense is also a part of the cost of claims management and the total cost of risk.

Legal Costs flow out of the claims management of uninsured and self-insured losses. Defending uninsured or self-insured events or losses can be expensive. The cost of defense counsel will devour any premium savings enjoyed by self-insuring.

However, there are legal costs that may be required – regardless of the program. These are legal costs incurred to avoid a financial loss, such as the costs to develop proper contractual risk transfer mechanisms or employee manuals (just two examples). These are necessary to properly run any business operation and are costs that occur regardless of the insurance protection purchased.

Loss Control and Safety cost, like unavoidable legal costs, apply almost regardless of the underlying protection. In an effort to avoid or reduce loss, insureds may invest in loss control and safety. This includes sprinkler systems and safety equipment like safety glasses and fall protection. Granted, some of these are required by regulation, but such costs arise out of the inherent risk of the operation and are thus part of the “total cost of risk."

Opportunity Costs are the last piece of the total cost of risk picture. This is a somewhat subjective factor in the total cost of risk, but to manage a non-traditional (or even traditional) insurance program requires resources be taken from other areas of the operation. These are monetary and time resources.

The insured can choose to pay a higher premium and allow the insurance company's personnel to do the work; or they can choose to do some parts of it themselves. This comes back to a price:cost analysis.

Payroll and time costs are a factor in the total cost of the insured's risk.

To ask the question again, is it the Price or the Cost? Insureds can ALWAYS find a lower PRICE, but at what COST? Understanding the Total Cost of Risk concept is important to both insureds and agents. Being able to distinguish between the two can save insureds in the long run.

Don't misunderstand, there is a place for alternative protection programs and even some price comparison among the less sophisticated coverages; but don't ever let the insured, or yourself, be fooled into believing that insurance is all about the price.

Last Updated:
November 22, 2019

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Alexandria VA 22314
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fax: 703.683.7556

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