Archive for August, 2009

If you are moving product from one location to another with a freight company do you know the amount of risk  associated with this movement?  In most cases the freight is protected from loss or damage to some extent, but the amount of protection can be dependent on how you negotiate the transportation contract or the freight classification that is assigned to the shipment.

In nearly all shipments a standard release rate is provided that establishes a reimbursement to the owner of the goods based on the weight of the shipment, or a standard amount per shipment.  In the case of UPS, the standard release rate is $100.00 per shipment.  In standard tariff the amount can be $50.00 per shipment or $0.50 per lb per article up to the cost of the product. 

Carriers are required to provide an option to allow for greater coverage up to the cost of the goods.  They can do this several different ways including:

  • Establishing a full valuation tariff, typically at a higher cost per cwt. 
  • Provide “additional valuation” at a set rate for every $100 of declared value. 
  • Provide a one time insurance policy through an insurance company (not the carrier) for the value of the shipment. 

Needless to say these and other options will all have specific exclusions on what does and doesn’t constitute a claim.  You should read your contract carefully to fully understand your duties and rights for coverage.

So, what options are best?  It depends on several factors but primarily the cost of the goods, the loss ratio, and your appetite for risk.

Let’s work through an easy example to identify on how these three items work together:

You are a furniture e-tailer that ships a bedroom set of furniture from the distributor to your customer.  You have negotiated a good contract with the carrier with a standard release rate of $0.60 per lb per article.  You have shipped a 5 piece shipment to your customer with a total weight of 400 lbs (2 items at 60 lbs, 1 item at 80 lbs. and 2 items at 100 lbs.) with a wholesale cost of the goods shipped at $1500.00.  Unfortunately, the shipment is not delivered and after a short time, the carrier declares it lost and indicates you should file a claim for the missing product.   The wholesale cost of the shipment is $1500.00. 

The carrier provides an option to ship the product with full coverage at an additional cost of $1.25 for every $100.00 of declared value.  The cost of this shipment would be $18.75.

Now we look at the company’s tolerance for risk:

  • If you are have a very low tolerance for risk, you would probably choose to include full coverage on every shipment.  It will assure payment in full on any loss or damage that is related to improper handling by the carrier. 
  • If you have a high tolerance for risk, you would not even consider choosing the full valuation option. 
  • If you are somewhere in the middle, then you will want to review historical data and determine what the “tipping point” is where the cost of risk is greater than the actual cost of protection.  Once this is determined, you may take several different steps such as purchasing the additional coverage from the carrier, or establishing an accrual account based on estimated costs and debit against this account.

The loss ratio with the carrier is 0.5% or 1 shipment lost for every 200 shipments.  When we compare the cost for full replacement coverage against the retained loss for the shipment, we see that 67 shipments at $18.75 per shipment would need to be covered to equal the retained loss, or the equivalent of a lost shipment ratio of 1.49%.

  Rate Extended Amt
Cost of product   $1500.00
Maximum allowance on std release rate $0.60 per 100 lb $ 240.00
Retained $ Loss   $1260.00
Cost of Additional coverage $1.25 per $100 $  18.75
Number of shipments to equal $ loss* $1260.00 / $18.75 67
Loss incident ratio to equal cost of coverage   1.49%
Current loss incident ratio   0.50%
* based on similar declared value

With a lost incident ratio of 0.50%, the retained loss amount is $6.30 per shipment (based on all shipments being $1500.00 value) or $0.42 per $100 of your cost. 

Naturally this is a very simple example and does not factor into consideration all the shipments and claims processed and looks only at a lost shipment, not a damaged shipment which could have a lower retained expense, but it does provide you with some thoughts on how to look at the potential claim costs associated with your products while in transit.

In what I considered a surprise move, Illinois Attorney General Lisa Madigan provided a green light to resume collecting “contingent commissions” to Arthur Gallagher & Company.  Considered to be the fourth largest broker they are headquartered in Illinois and regulated by the state of Illinois. It’s surprising as they along with Marsh and McLennan, and AON had agreed to a settlement several years ago brought about when former NY State Attorney General Eliot Spitzer forced the major insurance brokers to stop this practice.

In case you are not familiar with contingent commissions, these are commissions paid by insurance companies to the insurance broker to push their products to companies, and in many cases the company is paying the insurance broker to negotiate and secure insurance coverage.

I should point out that the agreement between Spitzer and some insurance brokers did not put a halt to contingent commissions.  Many smaller insurance brokers continued to collect these types of commission either as a contingent or a “supplemental” commission.  

As a buyer of insurance programs it is important to understand your relationship with your insurance broker or agent as well as the their relationship with the insurance company.  Is your agreement with them fee based, where you are providing a payment to them for the services they are providing?  Or, is the agreement based on a commission they are receiving from the insurance company for the policy?  Or, is it a combination of the two, where there are some payments provided by you and some commission provided by the carrier.  This should be spelled out in your agreement with the broker, or outlined in the proposal itself. 

Review and understand the proposal that is presented to you at the time of renewal.  Make sure there is a disclosure statement included by your broker which indicates if they are receiving a commission for the placement of the insurance and if they are participating in a contingent or supplemental commission program with the carrier.  If there is no clear documentation, ask your sales rep.

It is important to clearly define your relationship with your insurance broker or agent.  It is also important to understand the breakdown in the cost of the program, if commission is added to the premium, or if there is a portion of the premium dollars that is being earmarked for commission. 

The fact that a contingent commission is associated with an insurance policy should not be a deal breaker, each organization must review the policy and determine if the coverage, and service meet their requirements.  Understanding what makes up the costs help to make an informed decision.

For additional information and another thought on the contingent commission, please review the BNet posting discussing this and the potential pitfalls by Ed Leefeldt.   His posting is a great perspective on the situation.

Business Insurance has reported that the International Organization for Standardization has endorsed a proposal for international standards on risk management.   This is the first global document focused on establishing standards for risk management.  The balloting showed overwhelming support of the members of the international standards organization with only one country reported to have voted against this measure. 

The proposed standard draws heavily on the Australian and New Zealand standard  AS/NZS 4360:2004 but with a wider ranging scope designed to help multi-national organizations an approach rather than the regional focus of the AS/NZS standard.

While no certification will be available for this standard, I feel the ability to effectively establish broad based guidelines will advance the process and the risk management profession.  The new standard will be published in approximately 6 weeks. 

For complete details please refer to the Business Insurance article or the posting from the New Zealand Society for Risk Management .