A large contractor that specializes in excavating, removing, and hauling contaminated soil runs into an insurance problem while bidding on a multi-million dollar three-year project. The contractor has Liability insurance that covers pollution-related incidents for up to $1 million each and up to $10 million per year. However, that is not enough for the project’s owner and general contractor. They plan to build a new school on the site after the soil is cleaned up, and they want the excavation contractor to carry at least $40 million limits in case students fall ill and their families sue. The excavation contractor’s insurance broker gets quotes from four companies for the extra $30 million and reports back that the premiums will be astronomical. The companies are assuming that any claims involving sickness in children will get sympathetic hearings from juries, leading to potentially large judgments and defense costs.
The excavation contractor has more than a decade’s experience in this type of work and has never had liability losses in any one year that exceeded $5 million. Its management is confident in its ability to do this project correctly, and it wants the lucrative contract. However, the high premiums for the excess $30 million coverage will take a major bite out of its profit margin. The solution might lie in something known as the “corridor self-insured retention.”
Corridor self-insured retention is an insurance program where the insured organization carries one layer of insurance (known as the primary layer) and an excess layer, but insures losses that fall between the two with its own funds. To illustrate, our excavation contractor buys the primary insurance that pays for up to $10 million per year in liability losses. It then self-insures (pays on its own) for losses that exceed $10 million per year but that are less than $20 million. Finally, it carries the excess $30 million coverage (the excess layer) that applies when losses exceed $20 million.
Here’s how it would work under three loss scenarios:
- The contractor has a typical year, incurring around $4 million in losses. Since the primary insurance will cover up to $10 million in losses in one year, it will pay all $4 million, less any applicable deductible or self-insured retention specified in the policy.
- The contractor has $17million in losses. This time, the primary insurance pays $10million (again, less self-insured retentions or deductibles). The contractor pays the remaining $7 million out of pocket.
- The contractor has $30 million in losses. The primary insurance pays $10 million, the contractor pays $10million out of pocket, and the excess insurance pays the remaining $10 million.
Under the last two scenarios, the contractor has to pay some very large sums out of its own funds. Why would an organization agree to such an arrangement? First, it might be the only way it can obtain Excess insurance. If the organization is in a highly hazardous line of work, insurance companies might not want to pick up coverage at the point where the $10 million primary insurance is used up (also known as the “attachment point”). Second, if Excess insurance is available, a corridor self-insured retention can make the premiums more affordable. Instead of kicking in when losses exceed $10,000,000, the Excess insurance begins to pay when they exceed $20 million. Because the chances of having to pay are reduced, the insurance company reduces the premium. Finally, it allows the contractor to meet the general contractor’s insurance requirements at a more reasonable cost and relieves it of having to pay for expected losses out of pocket.
A corridor self-insured retention program is complex and should be developed with care. Our professional insurance agents experienced in alternative risk transfer techniques can provide valuable assistance with such an arrangement. Large organizations with strong balance sheets can benefit from a program like this, but they must build it on a thorough analysis and understanding of the risks.