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Builders advised to find risk retention sweet spot

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Builders advised to find risk retention sweet spot

SAN DIEGO – Analyses that construction contractors use to set appropriate parameters for their risk retention strategies should be equal parts quantitative and qualitative, said Michael O'Neill, president and CEO of the Dallas-based American Contractors Insurance Group Ltd.

During a presentation Wednesday at the International Risk Management Institute Inc.'s annual conference, Mr. O'Neill outlined several methodologies contractors can use to determine the types and dollar amounts of liability losses for which they choose to retain sole financial responsibility, as opposed to financing those losses through traditional insurance products or alternative risk transfer agreements.

“Every company has a 'sweet spot' in terms of their level of acceptable risk retention,” Mr. O'Neill said during the presentation. “You find that sweet spot by figuring out where your liability claims are occurring and at what level those losses are occurring, and then analyzing the options for financing those losses.”

In most cases, Mr. O'Neill said contractors' risk retention strategies should focus on losses that are easily forecast and limited in severity, such as workers compensation, inventory and supply-related risks and certain types of general liability claims.

“You don't want to be in a dollar-swapping exercise with an insurer on predictable, low-level losses,” Mr. O'Neill said, adding that low-frequency, high-severity risks such as data breaches, intellectual property disputes and environmental liability claims should be excluded from retention.

When setting a dollar limit on their retention appetite, Mr. O'Neill said contractors' review of their financial capacity should be as expansive as possible and include multiyear analyses of their working capital, total assets, pretax earnings, annual sales and operating cash flow.

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Small and midsize contractors in particular, whose operations often rely significantly on external sources of capital, also should be aware of any restrictions their financing partners may impose, he said.

“If you're depending on banks or surety companies to leverage your operations, they may have some limits as to what levels of risk they'll allow under your covenants,” Mr. O'Neill said.

In addition to the recommended quantitative methodologies, Mr. O'Neill said contractors should conduct an honest, qualitative review of their company's current and historical attitudes when it comes to the assumption of financial risk.

“Companies go through different cultures, as we know. You may have a first- or second-generation family-owned company that was less risk-averse in the past vs. a culture under the current generation that is now turning away from risk,” Mr. O'Neill said. “Contractors will land on the spectrum of risk retention appetite based on their culture, their business model and the types of contracts they undertake.”

Business Insurance's digital coverage of the 2013 IRMI Construction Risk Conference is sponsored by Ace. To view all the Digital Daily news and related content in its ideal form, use a nonmobile browser to visit www.businessinsurance.com/IRMI2013.