This is part two of our series "Why insurers ask so many question". If you have not done so already, please read Part 1 before continuing.
WoodCo instructed you to offer insurance terms in order to transfer the financial risk, which brings you to the process of determining the size of the financial risks that needs to be transferred. It follows that you need to understand the valuation used by WoodCo to determine these amounts. This basis of valuation needs to be compared to the Basis of valuation of the various policy sections that you want to offer WoodCo, but we are running ahead of the process.
The high level offers that you have to consider are the following:
- Self Funding, On-Balance Sheet
- Self Funding, Off-Balance Sheet
- Conventional Insurance
1. On- Balance Sheet Funding
In this instance we refer you to the Risk Management decision of Woodco, who decided to NOT to buy insurance cover for Burglary Exposures. Their RM analysis required them to allocate resources to manage this risk, and thus you as their advisor can suggest an On-Balance sheet solution, where Woodco allocate an amount, say N$ 100,000.00, on their balance sheet to be used to pay for any losses suffered should a burglary occur.
The benefits for WoodCo are the following:
- The cash will be available to pay for any machinery that may be stolen, damages to buildings, or operational expenses that may need to be paid for.
- The events that will activate the use of the funds will be listed and noted, also with the expert input from you!
- The steps needed to reduce this risk will be analysed and implemented as part of the process.
- Inexpensive way of financing the risk.
The disadvantages for WoodCo are the following:
- No “contract” determining the use funds, thus Woodco may be tempted to dip into the funds for events not part of the “burglary” risk.
- WoodCo may have cash flow constraints and as such may battle to allocate the required amount of money.
- The financing cost is NOT considered a business expense and as such may not deducted from the taxable income of the firm.
By doing this with WoodCo, it will allow you to demonstrate your involvement and expertise and help you build up an intimate knowledge of your clients business.
2. Off-Balance Sheet
This transfer mechanism was designed to mitigate the disadvantages of the On-Balance solution, by moving the funds Off the WoodCo balance sheet and placing it with an insurer, like Quanta.
The Benefits for WoodCo are:
- An Insurance contract will be negotiated between Woodco and Quanta, making sure that the funds is reserved for the intended event.
- The expense to fund the insurance contract is a business expense and as such may be deducted from the taxable income of Woodco.
- The cash will be available in the event that the burglary occurs.
The disadvantages for Woodco will be:
- Quanta will charge a fee for the cost to issue the insurance contract.
- Woodco will have to pay VAT on the funds.
You as the broker will again have been an active part in the Risk Management process of WoodCo, enabling them to focus on their business of producing quality wood products.
3. Conventional Insurance
In this instance it is your opportunity to Rock & Roll, since the art of designing a tailor made insurance solution for your client is exactly the reason why you are a Quanta Accredited Broker. As always, the Catastrophe covers needs to be dealt with first and foremost. These are the risks that can ruin a business and its owners, if not properly insured.
Key concepts to keep in mind, Replacement Value and its associated pain sword Average. Remember that the standard insurance contract has various costs that forms part of the value calculation, like Professional Fees, and as such needs to be calculated and added to the building cost. Since catastrophe covers are cheap covers we suggest that you make sure of the sums insured and also add at least 10% on top of the calculated amount to be safe. The following example may help to convince you:
New Cell Phone N$ 12,000.00 Premium N$ 2,400/year = Additional Fire Cover of N$ 960,000.00
In terms of this topic, you can advise your client to ACCEPT the risk of a lost/damage cell phone, to CONTROL that loss by buying a cover and screen protector and to FINANCE the replacement cost, ON-BALALNCE SHEET, while TRANSFERRING the business closure risk to the insurer, and AVOIDING the FINANCING shortfall of Average if a fire occurs.
In terms of Liability covers, it is important to remember that a Limit of Liability is purchased and your client will reply heavily on your advices. All liability policies requires WoodCo to be held legally liable and as such any action against the company has to be defended. The legal costs to defend the action forms part of the eventual settlement should WoodCo be found guilty and as such it is important to select a high enough Limit of Indemnity to firstly fund the legal expenses and secondly to pay for any award made against WoodCo.
These two amounts together are the claim amount and should the Limit of Indemnity be too low, your client will be required to pay the difference, another event that may close the business.
The last section of the conventional insurance that we need to address are the operational risks. These risks presents their own unique set of considerations, however in most instances they are fairly straightforward to determine, insure and explain to WoodCo. Care needs to be taken to explain the concepts of First Loss, Market Value and the insurer’s rights to repair, replace or make a cash payment, but that you are more than capable of doing.
We hope that you have enjoyed this Quanta Talk about the extremely important role that the insurance industry play in the economy and how you the broker forms a vital cog in the risk management process of your client. We hope you will bear with us when we ask the questions and we trust will have the answers ready!
Thank you and enjoy your next client interview!