One way to save money on property insurance premiums is to raise your deductible. But increasing the deductible on your commercial property may not always be feasible.
Commercial property policies often have higher overall deductibles than residential property policies because of higher valuations and risk factors.
Here are some factors that go into creating a deductible:
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The location of the property (Properties in areas prone to disasters like wildfires or hurricanes are at increased risk of loss.)
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The type of business (Some business operations are riskier than others. Restaurants, for example, may have a higher risk of fires than small office buildings.)
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The overall value of the property and its contents (A luxury property, like a resort, will have a higher valuation for property and contents.)
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The insurance company’s risk appetite and solvency (An insurance company inexperienced in certain risks may not insure them. Or they might charge higher premiums for the risk.)
You’ll have some flexibility in how you structure your deductible. Increasing your deductible can lower your premiums, but it also means you’ll need to pay more out of pocket if you have a claim.
If you’re facing a high deductible, a “buyback deductible” can help. A buyback allows you to recover your high deductible without significantly increasing your premiums. Read on to learn about how deductibles work and whether a buyback may be right for you.
Types of deductibles
There are a few types of deductibles in commercial property insurance:
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Flat (aka “fixed” or “straight”) deductibles are a predetermined amount you pay before your insurance coverage begins. Let’s say you have a policy with a $2,000 flat deductible. If you have a claim for $10,000, you will pay the first $2,000, and your insurance company will pick up the remaining $8,000.
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Percentage deductibles are based on a percentage of the property’s insured value. If your building is insured for $500,000 with a 2% deductible, your deductible would be $10,000. You’d pay this upfront before the insurance company would pay for your claim.
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Per-occurrence deductibles are paid for every occurrence or claim made. For example, if your business has a $1,000 per-occurrence deductible and you file two claims in one year, you’d pay $1,000 for each claim.
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Aggregate deductibles are the maximum amount you’d pay in deductibles over your policy term. Once you meet the aggregate amount, you won’t have to pay deductibles for claims within the policy period.
Selecting a deductible that aligns with your business’s financial needs is essential.
If you have a larger liquid cash pool available, it could make sense to self-insure a portion of your property’s risk by trading a higher deductible for lower premiums. But if you don’t always have cash readily available, a larger deductible could put you in a financial bind when you have a claim.
How insurance appetite can affect premiums and deductibles
Insurance costs and coverages change to reflect real-life risk scenarios.
An insurance company’s ability or willingness to insure a business or industry is called a “risk appetite.” A low appetite means they’re not interested in underwriting a risk. A high appetite means they’ll take on a lot of risk.
For example, there’s a lower risk appetite for Florida property because of the severity of the weather claims and the number of lawsuits resulting from claims denials. Catastrophic payouts and litigation costs drive up the cost of insurance. Eventually, insurance companies stop offering policies.
Another scenario might be a low appetite for specific industries with increased risks. For example, a paint manufacturing plant might be unappealing to an insurance company because it uses flammable chemicals, increasing the risk of a fire. Insurance companies price policies higher to reflect the risk, or they pull out of the industry altogether.
Other risks are so unique there’s not enough data to appropriately price a premium, putting the insurance company at risk of bankruptcy. Insurance companies rely on data to run loss scenarios. This determines the likelihood that the risk will occur, and the cost to repair or replace the property if there’s a catastrophe. If they don’t have enough data, they could underprice a risk and go bankrupt when it’s time to pay out after a loss.
If an insurance company isn’t suited to the risks of your industry or location, they may offer you a higher rate. Or they might deny your policy application.
Property owners may have to accept higher rates to get a policy if insurance competition gets tough. Containing higher policy premiums can also mean accepting higher deductibles.
Percentage deductibles can be costly
Some higher-value properties with lower percentage deductibles can require millions of dollars in reserves just to meet the deductible to move forward with a claim.
For example, if your beachside resort is valued at $200 million and you have a 1% deductible, your out-of-pocket cost is $2 million. But suppose your property is in an area prone to annual hurricanes or other extreme weather. In that case, you might have to accept a policy with a 5% deductible to get coverage.
Percentage deductibles can range from 1% to 20%, so budgeting can be challenging. And you may have few options, depending on your property’s location. If you have lower cash reserves or highly valued property, you may need help offsetting the cost when a deductible comes due.
Enter buyback deductibles.
How do buyback deductibles work?
A buyback deductible, or buydown deductible, is an add-on or separate policy that allows you to recover your deductible cost. For an additional expense, it allows you to “buy back” a portion of the deductible to reduce your out-of-pocket expense after a covered loss.
Applying a buyback deductible to a commercial lines insurance policy can have strategic benefits for businesses, such as:
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Lowered expenses after a loss
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Increased cashflow predictability
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Cost containment for higher-probability risks
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More affordable insurance
A buyback can help you to secure lower policy premiums by choosing a higher deductible. If you’re in a hard market where insurance companies are losing their appetite for risk in your area, a buyback deductible policy can help when policy terms change.
Beach resort buyback example
Let’s say you own a beachside resort in an area that’s had increasing extreme weather events. You’re offered a policy renewal, but the deductible increased from 1% ($2 million) to 2% ($4 million) of your $200 million policy.
You decide to keep the coverage you’ve come to depend on. However, you ask your independent agent to obtain a separate buyback policy to cover $3 million of the $4 million deductible, leaving you with $1 million to pay upfront if you have a claim.
This insurance strategy allows you to maintain property coverage in a competitive market and reduces your revenue risk exposure by buying down the higher deductible.
You can purchase a buyback deductible to decrease your overall deductible or for specific perils, like wind or hail.
Specific perils buyback example
Let’s say you own a manufacturing plant valued at $10 million, with a percentage deductible of 5%, or $500,000. An upfront cost of $500,000 could negatively affect your business, especially if you’re caught with multiple claims in a year.
Your plant is in an area that gets a lot of wind damage, so you know the high risk. The 5% deductible keeps your premiums lower overall, but you know your most significant exposure is wind. You ask your agent to find a separate buyback deductible policy for wind coverage since you’re more likely to suffer a wind loss than any other type of loss.
You acquire a deductible buyback policy for wind damage to offset the out-of-pocket costs associated with your property policy. You get a buyback policy to cover $400,000 of the $500,000 deductible, reducing your out-of-pocket expenses to $100,000 for wind damage. You pay an extra premium for this buyback policy, but it still costs less than paying for a premium with a lower deductible on your overall property policy.
Later that year, extreme winds damage your plant, triggering a claim on your property policy and your buyback deductible policy that covers wind damage. Your underlying property and buyback deductible policies both cover you for wind damage. You only pay $100,000 out of pocket instead of $500,000.
In this situation, your buyback deductible helped you manage higher-probability risks.
Contact your agent and accountant to weigh your options
Buybacks aren’t right for every business. The added cost of a buyback premium might outweigh the financial advantages. A buyback probably doesn’t make sense if your risk exposures are low or rates are already favorable. Not every insurance carrier offers buyback options, so it’s important to work with an independent agent who can shop the market for you.
Give us a call today, Get a quote from your agent and run the numbers with your accountant to calculate the risks and benefits. We can help you decide if buyback coverage balances with the cost.
