Builders risk. Workers comp. Insurance abounds in the construction industry. But what about keeping it in-house?

The construction industry is grappling with an abundance of risks like supply and labor shortages and high costs of money, materials and wages, even as spending on commercial projects has defied expectations to slip this spring.

The insurance industry’s lingering hard-market conditions continue to test the industry’s resilience. That’s further complicated by a drastically changing insurance marketplace, where adequate coverage of many essential lines is costly and hard to get. It’s past the stage of simply adjusting deductibles to wring out savings on insurance premiums.

A high-level strategy in response to today’s conditions might be for construction firms to affect a shift from being buyers of insurance to sellers of risk—requiring a more holistic and proactive risk management strategy. One way to achieve this is through a self-insurance strategy. But the construction firm must be large enough to justify the risk/reward tradeoffs. And since these programs are complex to structure, a broker partner with deep experience in both construction and insurance is vital.

Even more important, contractors must consider the tradeoffs before embarking on this strategy. For example, certain jurisdictions—think Florida, New York, Colorado or South Carolina—have a high-risk legal environment, making self-insurance more risky. In states with better legal risk climates, it’s a better option. Yet because insurance is cheaper as a result, firms may be less interested. 

UNDERSTANDING SELF-INSURANCE

Broadly defined, self-insurance is a way to retain risk in-house, versus transferring it to a third party, like an insurance company. The self-insuring company allocates funds on its balance sheet to pay claims rather than paying premiums to insurers.

To qualify, a company should have sufficient financial resources to cover all forecast losses, plus some level of traditional insurance to protect against catastrophic claims. Also necessary is a solid, proven risk-management program and a detailed understanding of the company’s claims history. This approach is a viable option for many large firms; smaller ones typically don’t have the financial resources, loss credibility or risk appetite to qualify.

Outside creditors also play an important role in approving this risk management strategy for construction clients since collateral is often required, impacting existing credit lines and active loans. Also worth noting is that project owners may not accept self-insurance to satisfy contractually required coverages. In fact, since the bulk of a contractor’s insurance program is acquired for contractual purposes, self-insurance in its purest form in this sector is unusual.

SINGLE PARENT CAPTIVES

The typical way that construction firms structure self-insurance programs is through a single parent (versus group) captive. This is owned and controlled by one construction firm and insures its risks. 

While, in theory, any line of insurance can be put into a single parent captive, higher frequency risks like workers’ compensation and auto liability are more common. To ensure contract compliance—ensuring the firm has the adequate funds and credit to pay claims—a fronting carrier can be utilized, issuing a policy even though the risk is retained by the captive through an indemnity or reinsurance agreement.

Large homebuilders often use single parent captives for lines like casualty, property and subcontractor default, when coverage is too expensive or unavailable through standard or excess markets.

DUE DILIGENCE

Here’s what to think about when considering self-insurance:

1. Will self-insurance actually save money? It doesn’t always. A thorough financial evaluation is essential.

2. Is this a short- or long-term solution? Self-insurance is often a better long-term solution, given the required diligence and upfront investment requirements. Organizations looking to solve short-term problems should consult with their brokers for other possible solutions.

3. Are your lenders on board? Lenders may need to approve this solution and often specify the amount of risk to be covered.

4. Is there time to plan this? Structuring a self-insurance program takes time, requiring considerable advance planning. It’s not a quick fix to get coverage or cut costs over the short term.

5. Can your technology adequately manage this solution? Self-insurance programs are complex, requiring a robust process for identifying, evaluating and managing risks, ensuring compliance and enabling strong data and analytics capabilities.

6. Are your risk management strategies sound—and strong? This is essential for making a self-insurance program work. Your data and analytics are key to this evaluation since you’re effectively betting on yourself.

7. Can your broker do the job? It’s complicated and cumbersome to evaluate a self-insurance program. Experienced brokers will help manage the complexities for maximum impact. 

Self-insurance may be a viable option for construction firms seeking to better manage the impacts of today’s volatile economic environment. But it’s not a strategy to be embarked upon without first weighing the benefits and risks, beginning with a thorough risk assessment. 

SEE ALSO: FOUR WAYS BUILDERS RISK COVERAGE IS RESHAPING CONSTRUCTION RISK MANAGEMENT