A “sunk cost” is typically defined as money that once spent is never recovered. If you paint your house and decide you hate the color, you can paint over it with a color you like. Nevertheless, the cost for the old paint was a “sunk cost.” In many ways, commercial insurance is a “sunk cost.” Aside from providing peace of mind (which is a real benefit) and possibly meeting contract requirements (EG the state requires worker’s comp insurance and the bank requires property insurance), insurance premiums are never recovered unless the business has a loss and a claim. But… businesses don’t want to have a loss and a claim, because it results in higher insurance costs in the future. And for this reason, many CFOs and business owners tell me they hate insurance.
Don’t Hate It – Look For A “Both – And” Solution
Business owners, CFOs and advisors owe it to themselves and their companies to pursue strategies that will safeguard the viability and prosperity of the business. This can include rethinking business paradigms to look for ways to avoid sunk costs. This can also include identifying “both – and” versus “either – or” solutions. “Both – and” thinking seeks to avoid trade-offs (and sunk costs), equivalent to “having your cake and eating it too.”
For example, an old paradigm in the automobile market was the assumption that large, heavier cars were inherently safer. Hence, moves to improve fuel efficiency would likely come at the expense (or trade-off) of safety. The automobile industry has rejected “either-or” thinking and produced innovative vehicles that make great strides in both safety and fuel efficiency. The development of lower weight, energy absorbing auto bodies, aerodynamic designs, air bags, computer controlled engines and hybrid electric engines have combined to produce “both-and” results.
“Both-And” Thinking Applied To Insurance
A particular area where “both-and” thinking can address sunk costs is insurance. Insurance is often viewed through an “either-or” lens. A well- conceived risk management and insurance strategy is a necessity. However, insurance is almost always a sunk cost. It is certainly a necessity and often critical to the survival of a business, but it remains a sunk cost. Each year, precious dollars spent on insurance premiums are gone. It is a mere cost of doing business.
The paradigm shift required to overcome this “either-or” scenario is for business owners to make the choice to own their own insurance company. Specifically, a business can set-up and operate what is known as a captive insurance company. “Captive” may seem like an odd term. It is simply “captive” or “tethered” to the business or related entities it serves. Owning an insurance company can move a business from “either-or” to “both-and” thinking because the business can capture all or a portion of insurance profits and be positioned to control insurance costs. This effectively makes insurance a profit center and can turn sunk costs into sunk profits.
Isn’t This Risky?
Very few captive insurance companies stand completely on their own. Most have backstops to make sure large losses and claims don’t sink them. Three common approaches to backstop a captive insurance company are 1) to share risk with other companies, 2) to pool risk with other captives, or 3) to purchase commercial reinsurance. A well-structured backstop plan significantly minimizes the risk of a captive being sunk, and captives that play the long game almost always amass profit over time.
Captive insurance companies have the unique ability to write customizable insurance coverage. So, they can write policies that are specifically tailored for the specific needs and challenges faced by the parent company. It is often difficult and inefficient for third party commercial insurers to write customized policies. This reality often renders customizable coverage unaffordable or impossible to acquire. Another benefit of providing insurance coverage via a captive arrangement is that captive policies do not have to include the exclusions that characterize most commercial insurance policies. In this sense, policies issued by a captive can be “wide open,” which is particularly important when a business has a loss and needs the money. Also, claims approval and processing for captive claims are simpler, faster and more certain. For these reasons, a captive insurance company is a powerful vehicle to:
– Replace commercial insurance
– Insure Enterprise Risks
– Provide blended insurance coverage with existing third party insurance coverage
– Fill gaps in existing third party insurance policies including covering exclusions
– Insure risks that were previously uninsured
– Insure warranties
– Accomplish any combination of the above
Successful insurance companies accumulate profits year after year. It’s no secret that most insurance companies are very profitable. The skylines of most major cities in America are dominated by stadiums, banks, and… you guessed it, insurance buildings.
Stop Paying For Their Huge Buildings
The power of “both – and” thinking is the key to turn sunk costs into sunk profits and stop hating insurance.