Are Multi-Year Policies Really A Good Choice?

ARE MULTI-YEAR POLICIES REALLY A GOOD CHOICE?

by Gary Griffin

Although multi-year insurance contracts are not new, they seem to be garnering much interest lately. The renewed interest in these policies is generally as a means of locking in current beneficial terms, conditions, and pricing. Many insureds are considering such programs, believing that the very soft insurance market is about to end. But can you really be guaranteed that coverage or price will not change? Does committing to a multi-year deal really make sense? Here's what you should know before you decide.

Property, Package, D&O, and many other kinds of insurance can now be purchased on a multi-year basis. While such deals may benefit insureds who enter into them, some are merely marketing gimmicks designed to attract new business or retain existing business. Insureds are being enticed by the promise of administrative efficiency, reduced premiums, and more efficient use of limits. But there's more you should know.

Purported Advantages

Locks in favorable rates and coverages. By entering into long-term, non-cancelable contracts with your insurer, you may be able to lock in favorable rates and coverage features. Some insurers are reducing rates by as much as 25% to attract buyers. The potential for such savings over a number of years may look quite advantageous, particularly during a hard market when costs increase, high limits become scarce, and coverage terms and conditions become more restrictive.

Uses limits more efficiently. Over the course of several years, insureds may require lower aggregate limits than the amount they purchase under standard annual policies. For example, a company that historically carries $25 million in D&O liability limits on an annual policy basis would purchase $75 million in limits over the course of three years. That same insured might opt instead to purchase a multi-year policy that provides just $40 or $50 million in aggregate limits over the same period. Although a lower aggregate limit is purchased, the insured is able to carry greater single-occurrence catastrophe protection.

Lessens hassle. Some insureds complain that they're in what seems to be a constant renewal mode because they must start the renewal process several months in advance of policy expiration. Because multi-year policies' renewal dates are several years apart, risk managers get a reprieve from the time-consuming, costly process of annual policy renewals.

Builds relationships. Entering into a multi-year policy helps build long-term relationships between the insurer, broker, and insured because long-term commitments tend to be mutually beneficial. The insured hopes to receive better rates, terms, conditions, or claims-payment services than afforded by a single-year policy or a three-year cancelable policy.

Tracks the exposure better. In some situations, it may be desirable to know that insurance will be in place for the entire period of a particular exposure. For instance, when a company is involved in an initial public stock offering, the company may be subjected to Securities and Exchange Commission (SEC) liabilities for a specific period of time. Under a single-year policy, the insured could be left with little or no coverage if the insurance market suddenly tightens and the insurer cancels or fails to renew. A non-cancelable, multi-year policy can make sense because it assures the insured of coverage during the course of the exposure.

Potential Disadvantages

Market timing may be off. Perhaps the worst scenario for an insured who has purchased a multi-year contract would be to lock in competitive terms and conditions only to find that the cost of coverage continues to drop. Some insureds made this mistake a few years ago when many market analysts incorrectly predicted a tightening of the insurance market.

Policy may be cancelable. Many policies purported to be non-cancelable, multi-year contracts contain one or more clauses giving the insurer a way out of the contract. Such clauses make illusory the notion of locking in rates and coverage for a long time.

Rates may be adjustable. Even if a policy is non-cancelable by the insurer, it may still contain provisions that allow the rates to be adjusted based on loss history or other factors. In many instances, the insured is led to believe that insurance rates are guaranteed when they are not.

True non-cancelable coverage might not be available. Usually only very large accounts with a good loss history are eligible for truly non-cancelable, multi-year coverage.

There's no way out. Even if you're able to enter into a policy that is truly non-cancelable for both parties, insureds should consider that they may be stuck for the duration of the policy. Getting locked into a multi-year policy only to find that the insurer is fighting you on every claim can be a nightmare. Also, if you require additional coverage features not negotiated at the time of entering into the contract, the insurer might require onerous additional premiums, knowing that the insured has no recourse but to pay. Worse, the insurer may be unable or unwilling to provide needed enhancements at any price.

The up-front costs may be high. Although it's possible to save premium dollars through a long-term policy, many such policies require high up-front premium payments. Sometimes the entire premium is due at inception. Although many brokers offer attractive premium-financing terms, make sure that any premium savings are not offset by lost opportunity costs on the organization's internal rate of fund returns.

The relationship may be fragile. That entering into a multi-year policy helps to build a beneficial relationship with the insurer may be wishful thinking. Many insureds are able to continue long-term business relationships with their insurer that are indeed beneficial to both parties-and we encourage such arrangements. But if no relationship already exists, be careful when entering into a multi-year arrangement. Relationships are built on trust and experience over long periods of time, not on a single multi-year policy with an insurer you know little about.

More is less. Though multi-year policies allow for more efficient use of limits than traditional policies do, the limits they provide are spread over several years on an aggregate basis. Such limits might prove inadequate if a loss occurs over many years, such as losses involving pollution or asbestos liability.

Under a traditional program, such claims might trigger several years of insurance, resulting in a cumulation of limits. Under the multi-year policy, there's usually no such cumulation. The substantial discrepancy in available limits between these two kinds of policy could expose the insured to an unexpected uninsured loss.

Protection of the corporation against catastrophic loss is paramount. Whether it's obtained from a traditional or multi-year policy is irrelevant as long as it makes financial sense from the organization's perspective. Here are some pointers to follow when conducting your own analysis:

• Carefully read any multi-year policy to understand whether the policy is non-cancelable or whether one or both parties can sever the commitment should the relationship sour. Truly non-cancelable policies are rare and can be a double-edged sword if the insurer proves to be more of an enemy than an ally.
• If the premium is not written on a flat-rate basis, make sure you understand how and when premium adjustments are to be made. Keep in mind that even guaranteed-cost policies are usually adjustable, depending on loss ratio or other criteria.
• Make sure you have some experience with the insurer and broker with whom you're considering the long-term relationship. Nothing is worse than getting locked into a commitment you later wish you had avoided.
• Factor in cash-flow considerations against your organization's own internal rate of return. Lost opportunity costs associated with a large up-front or deposit premium may offset apparent savings.
• Consider the nature of your risks. Have they been steady over time or subject to much change? If your organization experiences numerous and rapid changes, you may find yourself hamstrung if new coverages or features are needed and your insurer is unable or unwilling to provide them. Even organizations with a stable risk profile can be affected by sudden changes in the law necessitating enhanced coverage features.

Deciding if multi-year policies make sense for your organization requires careful consideration of all these points. True guaranteed-rate, multi-year polices that are non-cancelable may provide many benefits over traditional annual policies-but keep in mind that in some instances, so-called multi-year policies may be little more than marketing gimmicks designed to lure insureds with the possibility of substantial savings.