Every dealer knows there is a relationship between the losses printed on your loss runs and the premiums you pay. If premiums continue to rise as predicted by industry professionals, the first dealers to feel the pain will be those with higher losses.
Many insurers use a loss ratio approach to determining premiums. That means they shoot for a certain loss to premium ratio. As of this writing we are seeing most insurers writing to a 40% – 50% loss ratio for medium to large dealership groups. Smaller dealers are being written at 25%-35% loss ratios. If premiums rise, the loss ratio they are looking for will fall. During the hard markets right after the 9/11 crisis, we saw loss ratio pricing fall to 25%-30% even for bigger dealers. To be clear, when I speak of loss ratios, I am referring to your total losses (plus reserves) divided by your total premium. Most insurers look at a three to four year average of losses.
To give you an idea of the real effect loss ratio underwriting has on premiums, look at this example. Let’s assume for the last four years your dealership has had an average of $75,000 in losses each year. At a 50% loss ratio, you could expect to pay $150,000. But at a 30% loss ratio, those same losses will generate a premium of $250,000. Regardless of how low your losses go, insurers will have a minimum premium they are willing to accept, based on the size and location of the dealership.
Just to complicate matters a bit more, insurers will often have different target loss ratios in different parts of the country. If you are located where that insurer wants market share, the loss ratios go up, premiums go down and they get market share. If you are in an area the insurer is not excited about, the opposite can happen.
Some insurers look at a loss as a loss, they don’t care how or where it came from. Others are smart enough to give your loss run a little analysis. Assuming your bidders do look closely at your experience, here is what they are looking for.
Severity vs. Frequency
In insurance-ese, “frequency” is a four-letter word. Insurers would much rather see one large loss than ten smaller ones. Why? Often insurers perceive a high loss frequency as a sign of lackadaisical management that could ultimately result in many larger claims. The dealership with five small fender benders or a higher than normal frequency across all lines of insurance, concerns the insurer much more than the dealership with one big claim two years ago, and rightfully so. There’s a good chance the dealer with one big claim just got unlucky, where the dealer with ten claims got lucky that five weren’t big ones.
How much is too much? This is a tough question, because so many factors come into play such as severity, frequency, acts of God and the general state of the insurance market. There are some general rules, however. Insurers break even at about a 60% loss ratio (losses/premiums). This does not mean insurers are dying to write 60% loss ratio accounts. The chances of this account’s losses getting worse are greater than the chances they will get better, unless specific steps have been taken by the dealer to reduce losses. As a rule, insurers like accounts with lower than average loss ratios and love accounts with less than 25% loss ratios. Loss ratios are usually reviewed over a three or four year period to see if the loss ratios have been consistent and predictable.
Loss run management
Take a very good look at your loss runs, preferably three or four times a year. Not just this year’s loss runs, but go back to all runs the insurers will be requesting. In the older runs, look for changes, like the claim from two years ago whose reserve has jumped from $10,000 to $75,000 and ask why. In the current experience period, look for any trends that point toward loss control steps you need to take. If you see three workers’ compensation claims for “metal in eye” you know your shop folks are not wearing their goggles.
Check your loss runs for accuracy. With the current level of automation, we don’t see the number of mistakes we did in years past. However, we do see insurers occasionally classifying a garage keeper’s (damage to a customer’s car) claim as an auto inventory physical damage claim, inadvertently skewing your inventory claims higher than they really are. Subrogation (when your insurer sues someone else to pay the loss, when it’s not your fault) should be included to reduce the amount of your paid claim, but is occasionally left off.
What to do when you have “bad losses”
Communicate and advocate! – Find out where your losses have come from, take steps to correct them (possibly with your insurer’s help) then communicate your efforts and results. Don’t wait to be asked. To communicate and advocate is particularly important if you are bidding your coverage. Those bidders only have your loss runs to look at, and if you don’t communicate they will assume your bad losses will continue. You must also be an advocate when your losses result from unusual circumstances or have been mishandled by an insurer. Remember that insurance is not a constitutional right. Insurers do not have to provide insurance to the dealership that disregards their losses. On the other hand, even if your losses have been poor, insurers often embrace the dealership that takes the necessary steps to correct their loss problems.