Insurance Mic

Minimum and Deposit in The Free Trade Zone

I recently had a very interesting case come across my desk for an opinion. The situation was this; a construction company bound their renewal quote with a Licensed & Admitted Insurance Carrier in the State of New York. The carrier Sirius America was operating in the "Free Trade Zone" , which is to say they did not have to use the rates filed with the NY State Insurance Department, however they still needed to meet the minimum standards set forth by the department for both forms and rates. The policy contained a Minimum & Deposit endorsement which is unusual for a Licensed & Admitted New York State Carrier, however because they were operating in the free trade zone, apparently the State let them use the endorsement.

One month into the Sirius America policy the Construction Company was notified of a delay in a project they were awarded. This delay would significantly impact their numbers for the policy period. They allegedly contacted Sirius America and tried to adjust their exposure basis downward. The carrier Sirius America, allegedly denied their request. Eight months into the policy , the Construction Company cancelled their insurance policy and moved to another carrier. Sirius came in promptly and conducted their audit. The result of the audit revealed what the client already knew, their numbers were down significantly from what they initially projected when they bound the policy.

Under normal circumstances with in the friendly confines of the NEW YORK STATE INSURANCE DEPARTMENT, this insured could expect a refund consistent with the actual, not projected exposure base, which in this case was sub contract cost, and payroll. The amount of money due back to this Construction Company was north of $200,000. However instead of a check, they received an audit statement that revealed the insurance company, Sirius America was allegedly keeping the premium. The apparent reason, although it was not specifically stated, was the Minimum & Deposit endorsement on the policy stating unequivocally in endorsement IL 12 01 11 85, " It is understood and agreed that this policy is written on an adjustable basis subject to an annual minimum and deposit premium of _____ . For purposes of this policy, the term minimum and deposit premium shall be defined as follows:

Deposit Premium: That premium which is stated in the policy declarations and payable in full by the insured at inception of the policy.
Minimum Premium: Is the lowest amount for which this insurance will be written for an annual period, (applicable to such classification(s) as indicated on schedule.)

There are a lot of issues we can address here, however for purposes of this discussion I will focus on two. First, please be very careful of the minimum & deposit endorsement. If not managed properly it can cost you plenty. To brush up on the fundamentals of the endorsement, and on how to manage it please click on this link: Managing the Minimum & Deposit Endorsement. The second issue which I will touch on further which is even more interesting, is the endorsement being legally applied?

In an informal opinion issued by the Office of General Counsel on March 27, 2002 representing the position of the New York State Insurance Department regarding the Minimum & Deposit Question " The Department has approved minimum earned premium endorsement filings (which may include an annual minimum and deposit premium endorsement) where the insurer has provided supportable evidence that the minimum earned premium equals the cost associated with issuing the policy. The purpose of allowing minimum earned premium is to permit the insurer to recover the expenses of writing the business should the policy be canceled prior to expiration, or, in the case of an auditable policy, where the audit results in a premium lower than the amount needed to cover the cost of writing the policy. "

As a footnote the Insurance Department for the State of New York understands an " annual minimum & deposit premium to be the premium an insured has to pay as a deposit on the policy, which is also the minimum dollar amount that the insured will be charged as a premium regardless as to whether the policy is written on an auditable basis, or cancelled prior to the expiration date of the policy.

The question at the heart of the matter as I understand it is the following; can Sirius America, a licensed and admitted carrier in the State of New York, operating in the free trade zone, retain more premium, than the auditable exposure permits?

The simple answer may be yes they can, however it cannot be more than the cost of issuing the policy. My initial thought was the company was not properly applying the sprit and intent of the department. By retaining in excess of $200,000 in premium for exposure they didn't have seemed to me excessive. They appear to be broadly applying the endorsement well beyond it's intended use. How can Sirius America assert and justify that it cost them in excess of $200,000 in administrative expenses to issue this policy? As I write this article the strict application of this endorsement is being argued to the State Insurance Department, and perhaps Civil Court. I have to believe wisdom and common sense will prevail, however I have seen it fall both ways.

The fact that this transaction had taken place in the "Free Trade Zone" apparently has no consequence according to this same opinion written by Sally Geisel, Office of General Counsel. " Although the rates and policy forms for insurance written in the "Free Trade Zone" are exempt from filing, an insurer is still bound by the same standards of fairness that are applied to rates that are required to be filed. Comp. Codes R & Regs. tit.11§ 16.5 (1995) states:

The rates applies (SIC) to policies issued pursuant to section 6301 of the Insurance Law shall not be excessive, inadequate, unfairly discriminatory, destructive of competition, detrimental to insurer solvency, or otherwise unreasonable. Each insurer shall maintain in it's files the premium charged for each special risk and the basis of for the rate or premium.

She further states, "Thus, such an insurer may not charge a minimum earned premium that exceeds the cost associated with issuing the policy. Additionally, such insurer may not charge a percentage based (rather than a flat charge) minimum earned premium unless the percentage actually measures the cost associated with issuing the policy. "

In Conclusion :

It is my personal opinion that companies who seek to charge more than the cost of issuing the policy are in direct violation of New York State Insurance Law, when they seek to retain premium instead of issuing proper audit refunds to their construction clients. The impact of the "Free Trade Zone" on the application of the Minimum & Deposit endorsement appears to be negligible. It will take a few cases like this one, and perhaps the Attorney General's Office stepping in to enforce fair and equitable practices, before you see carriers like Sirius America act responsibly. This is why it's so important that the insurance buyer be as informed as they possibly can. Your best strategy is avoidance when at all possible.

For a copy of the Office of General Counsel informal opinion, please email me : mstoop@bncagency.com

The Minimum and Deposit Trap

Imagine guaranteeing the IRS that you will pay at the very least the same taxes you paid last year. If you make more money this year, the IRS will invoice you the additional taxes owed. If you make less money this year, too bad, no tax refund forthcoming. You know the IRS would love that situation, thankfully however that would be illegal, unless of course you are an insurance company.

Since most contractor liability policies are audit-able, the premium you pay in any given year is an estimate, and not a firm number like for example your auto or home insurance policies. Since they are audit-able the "basis" ( i.e. payroll or gross sales) pricing factors are just an estimate for what you think your actual numbers may be in the upcoming policy year. Your true "insurance cost" is determined upon audit, which is conducted typically 3 months after the policy expires. The company sends out an auditor to look at your records, they file a report to your insurance carrier confirming both the class codes used, and the final "basis" numbers. For example if your policy premium was based on an estimated gross sales of $ 1 million dollars, upon audit it is revealed that your actual gross sales came in at $ 1.2 million, the auditor would let the insurance company know that, and they in turn would invoice additional premium to cover the additional "exposure". Anyone involved in Construction knows this drill, it works the same way with Workers Compensation. I thought I would define the audit process to assist in understanding the next and most important point.

In the last several years more and more contractor's liability policies have been written outside the friendly confines of the New York State Insurance Department. If you have one of these policies there are several clues that give it away. First, it should be on the written proposal from your current broker. It should say, "Carrier Not Licensed Nor Admitted In the State of NY". Secondly, you will have signed several acknowledgment forms which state such, one being a "Total Cost Form" which shows all of the taxes and fees charged when doing business with such a carrier. Lastly, and probably the most obvious, there will be a big red stamp on the front of the policy that states "this insurer is not licensed nor admitted in the State of New York". You can also go to this site NY State Authorized Insurance Carriers , and do a search to see if your insurance company is licensed.

I plan on doing a whole article just on the difference between doing business with an "Licensed & Admitted Carrier" , and "Non Licensed and Non Admitted Carrier" , until then suffice it to say be very careful when you are playing with a "Non Licensed and Non Admitted Carrier" , for the simple reason a lot of the consumer protection laws set up by the insurance department to protect you the insurance buyer do not apply. "Caveat Emptor" "let the buyer beware is the rule when you purchase a policy from a "Non-Licesened and Non Admitted Carrier". Minimum & Deposit" is one such example of why you must be very careful.

Minimum & Deposit basically states that irrespective of what your audit reveals, the minimum premium you the insured will be pay is (x), which is usually 100% of the annual quoted premium. Remember my prior example that states if you make less money the IRS doesn't care you still need to pay taxes on the previous years earnings because they were higher? Similar logic with minimum & deposit. If your audit reveal that your gross sales where only $500,000 as opposed to the $ 1 million you projected, you have guaranteed the insurance company that you will pay at the very least insurance premium on $ 1 million of gross sales. In this example not only will you not get a refund, but your insurance cost came in double as a percentage of sales, thus eating into a significant portion of your profit. In this example the percentage of liability insurance cost to gross sales went from 10% to 20% , if the annual premium is assumed to be $100,000.

Managing the Minimum & Deposit Endorsement

It's imperative that you the Construction client are aware of the effects this endorsement can have, and figure out a way to manage it. You can't manage what you don't know.

1) Don't commit to an unrealistic basis. If the policy is based upon gross sales, use only work 80% of work on hand as your basis. Apply the same rule of thumb to sub-contract costs, and or payroll if that is your basis. I offer 80% to give you a 20% spread for margin of error. What happens if you aren't paid timely from one of your owners, and the large check hit's your books after the policy period ended? You will pay for the insurance twice. Once in the prior period where calculated it in your estimate because it's a guaranteed number, and the other in the current period, because it will now be picked up on audit as current revenue, so you will pay premium again.

2) Estimate in your exposure basis only those signed and executed contracts that are guaranteeing a certain revenue flow. One contractor I consulted with used an upcoming job they expected to get in their "estimated exposure basis" or gross sales/sub contractor costs, only to find one month into the new policy the $13 million award did not come thru. The company, Sirius America, refused to lower their "basis" down , thus they were forced to pay premium on revenue they didn't have. Don't count your chickens before they hatch.

3) Try to negotiate the percentage of the "minimum & deposit" down from 100% of estimated exposure, to at the very least 80 %. i find that most carriers will give this concession if you ask for it You don't ask, you don't get.

4) Do a mock 6 month or 8 month audit of your exposure basis to see where you may end the policy year. If you are a head of projections see if it makes sense to hold revenue back. If you are behind projections, to the point you won't hit your minimum& deposit projections, see if you can escalate some of your payments from your owners. Talk to your accountant on some other strategies for hitting your threshold. Some of our clients are working on razor thin margins. A few points here or there can make an enormous difference.

The real goal of this piece is to make Contractor's , and Developers aware of how this endorsement can affect their profitability and results. If it's not managed, it becomes a huge tax!

The Difference Between Additional Insured and Certificate Holder

It’s amazing how few business owners know the distinction between being a Certificate Holder on a vendor or sub contractor’s policy, and being an Additional Insured. There is a clear, and measurable difference between these two Certificate of Insurance functions. I will try and keep it as simple as possible.

Certificate of Insurance simple shows you proof that the “Named Insured” actually has insurance. Think of it as your sub-contractor gets pulled over, you ask him for his insurance I.D. card, (certificate of insurance) proving that he does in fact maintain insurance. That’s all a Certificate Holder really is, someone who is provided proof the sub has insurance.

Additional Insured is a whole different matter. As an “additional insured” you are actually given coverage, and have rights under the sub-contractor’s policy in the event of a future claim. Some carriers will charge the sub-contractor a premium for this privilege because they are actually conferring coverage.

Bottom line Certificate Holder is simply proof of insurance, where as Additional Insured status gives you coverage and rights under your sub-contractors policy.

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