Clients who want to better manage the costs of their property programs often look to higher deductibles as an attractive option, but their lenders may not allow it. Higher deductibles can bring significant cost savings on property insurance programs, particularly for higher hazard risks or accounts with unfavorable loss histories. Taking higher deductibles provides access to more competitive markets and can lead to the most cost-effective property program. Clients willing to take a $100,000 deductible, for instance, will draw far more interest from more markets than those insisting on a $10,000 deductible.
Lenders, however, may be unwilling or unable to accept higher deductibles. Insureds can still obtain the advantages while remaining compliant with their loan terms. These three strategies can enable your clients to meet lender underwriting requirements while still controlling their insurance costs.
DEDUCTIBLE BUYDOWN POLICY
A stand-alone deductible buydown policy enables an insured to make up the difference between the lender’s requirements and the most cost-effective deductible. Depending on market conditions, a deductible buydown policy may cover “All Risk” perils or specific named perils such as windstorm and earthquake. For example, if an insured’s property program has a $100,000 deductible, but the mortgagee requires a deductible of no more than $25,000, a policy would be issued with a limit of $75,000 excess of $25,000 to cover the difference.
DEDUCTIBLE INDEMNITY AGREEMENTS
The most cost-effective option may be a deductible indemnity agreement. Rather than buying a separate policy, the insured’s property carriers endorse their existing policy to treat a loss as if the lender-required lower deductible were in effect. Typically, the loss is adjusted and paid in accordance with the policy’s normal deductible. Should the carrier be required to pay the loss from the lower deductible, the insured would indemnify the carrier for the difference in deductibles. Carriers may require a letter of credit to provide a financial guarantee.
DEDUCTIBLE REIMBURSEMENT POLICY
A stand-alone deductible reimbursement policy (DRP) presents another cost-effective option. Similar to a savings account, the insured funds the deductible difference up front with a letter of credit to the carrier and may earn investment income on the funds. The structure resembles a captive, and like a captive, the insured will pay a fee to set up the policy. Any funds not used to pay losses would be refunded by the carrier to the insured when the program is ended. Funds spent to cover losses would have to be replenished by the insured. This policy satisfies lender requirements for the lower deductible. This structure is more attractive as a longer-term strategy, particularly for insureds with adverse loss histories that are confident enough that they have effectively addressed the cause of their losses to put their own funds at risk. Such a structure, which is more common for casualty risks, can generate enough savings over time to cover the deductible difference, provided there are no losses.
Higher deductibles bring savings on property premiums, but lenders often require lower deductibles. Deductible buydown policies, deductible indemnity agreements and deductible reimbursement policies offer a way for clients willing to risk more of their own money to enjoy the benefits of higher deductibles while still meeting their loan terms. Make sure your clients know all of their options when it comes to cost-effectively structuring their property programs.
- David Pagoumian is the president of CRC’s Shrewsbury, New Jersey office and a member of the property practice advisory group.