“What the f*@k is up with my insurance premiums?!”
We’ve seen our fair share of companies go from their “friends and family” round of financing up through their Series A, B, C, and D rounds. As the years (or mere months!) go by, more investors and employees are onboarded, revenues grow and the battle to scale layers in more and more complexity to the operation.
And with this increased complexity comes a spike in risk exposure. Venture-backed companies are unique in the eyes of underwriters in that they tend to shatter growth expectations that are pegged to more traditional companies. In short: with risk comes reward…and an increased cost of doing business. Here are some major factors that affect the behavior of your insurance costs as you grow and scale.
All insurance policies have a “rating basis” and “rate” at which the policy is priced. The most common way to price a policy is using revenues with a rate of “x” per $1,000 in revenue, with the revenue as the rating basis. Let’s say an underwriter is pricing an E&O policy, for example:
Rate = $10 per $1,000 of revenue
Rating basis: total revenue projected for the policy period = $500,000
E&O premium = : $10 * ($500,000/1,000) = $5,000
In the above example, we have been offered a premium of $5,000 with a rate of $10 per $1000 in revenues. Once we’ve found an underwriter with the best rate in relation to the quality of coverage, we move forward with placing the policy.
So how does this equation affect your insurance costs as your company grows? It’s obvious that as revenues increase, premium increases: the larger the rating basis, the larger the resulting premium. Companies that are growing can expect their insurance premiums to grow as well.
But is is a 1 to 1 relationship? That question leads us to our next factor.
Losses and claims can have a major effect on your insurance premiums as your company grows. A history of claims will clearly drive premiums up, but a clean loss history can work in your favor to drive your rate down over time. So as your rating basis (revenues) increase, your premium will increase, but not in direct correlation. Let’s say the policy from the previous example is renewing. This year, revenues are up to $2M and the new premium quoted is $11,500. How did we get here? Let’s back into the rate for this policy:
Rating basis: total revenue projected for the policy period = $2,000,000
E&O Premium = : $11,500
E&O Premium = : [rate] * (2,000,000/1,000) = $11,500, rate = $5.75 per $1000 of revenue
In the above example you can see that the overall cost of the policy has more doubled, but the rate has almost been cut in half. So even though the risk exposure has increased 4x, the premium isn’t keeping pace.
This is not an uncommon characteristic of renewals for growing VC-backed companies with clean loss histories. The reason for the cut rate is because with each year that passes, the underwriter has more data to go off of. And, somewhat counterintuitively, the more revenue earned, the more the company is brought in line with the statistical models used to project losses.
It’s a different story when there are either multiple claims or one or two very large claims on the loss history. Rates are less likely to decrease and premiums can be higher. In these situations, it’s best to showcase what adjustments have been made to prevent similar claims in the future. This will help soften the blow and show some good faith with the underwriter.
In short, more experience is better, and more loss-free experience is best when it comes to pricing out insurance policies as you grow.
There are 2 types of insurance policy “forms,” or templates, out on the market: “occurrence” and “claims made.” Occurrence forms will kick in and cover your company as long as the occurrence has taken place within the policy period. On a claims made form, however, a claim needs to be made against your company and reported within the policy period.
They both cover snapshots in time, just with different triggers. With occurrence, even if the claim is made after the policy has expired, you could still get coverage as long as the policy was in force at the time of the occurrence. With a claims made form, the policy must be in force at the time of the claim being made to get coverage. But since “continuity of coverage” in claims made forms means that acts that occur after the retroactive date would be covered, that “snapshot” in time actually grows with each policy year.
So what does this mean for your insurance costs as your company grows? All things being equal, claims made forms have a higher likelihood of increasing in price each year (even if just incrementally) because the period of coverage is extending each year. This is not the case with occurrence-based forms because you’re paying for that fresh 1-year snapshot in time at each renewal.
Most general liability policies are on occurrence forms, but essentially all E&O, cyber, D&O and EPL policies are on claims made forms. It’s not uncommon for companies to see their GL costs remain flat where the other policies see slight increases.
Market Forces / Carrier Rating Guidelines
At the end of the day, insurance is a financial product. And like any financial product, pricing can be influenced by market forces and macroeconomic trends…particularly losses. For example, Superstorm Sandy devastated the east coast in 2012, causing massive property losses for many insurance carriers. In 2013, we saw the market harden and rates rise across commercial insurance product lines, including even D&O…a risk exposure totally unrelated to the property damage caused by Sandy.
A similar situation can happen when a carrier is too bullish on a particular market sector or product line, or products are priced too aggressively in a particular state. The losses can permeate across the company and increase the premiums of other lines of coverage. When this is the case, we go to work to re-market your coverage to be placed with another carrier.
There are many factors that will play into your insurance costs as your company grows, but think of it just like homeowners insurance: if you build an addition on your house, it’s reasonable to assume premiums will increase. You might see rates go up if your house (or neighborhood) has been battered by storms throughout the year as well. It’s important to remember that these are simply growing pains. For each storm weathered, new addition build or extra family member, your overall output increases to outweigh the costs of insuring the potential downturn.
With the right outlook, these costs are really an investment in your company’s future, cutting out unnecessary risks and adding bumper rails on your path to success.