One of the least understood things about product liability audits is the perceived unfairness of why there is no refund of premium at the end of the policy period from the insurance carrier, if actual sales fall short of projected sales.
An important point with product liability insurance is – the more sales you have the lower rate per $1000 of sales you deserve. In other words, if you have two distributors that sold the exact same products and one distributor had $1M in sales and the other distributor had $10M in sales, the distributor with $10M in sales should receive a lower rate per $1000 of sales than the distributor with $1M in sales.
The primary reason product liability insurance carriers do not offer full refunds, if actual sales fall short of projected sales, is it opens up to much of an opportunity for abuse by the policy holder by over estimating their projected sales and therefore, causing the insurance carriers to not earn a fair rate of return for the overall risk.
To better understand this point, see the two hypothetical illustrations below:
Illustration 1 – Based on current system in which no refund is provided if actual sales are less than projected sales.
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Projected sales are $15M
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Based on this projection, the insurance company provide you with a $8.00 per $1,000 of sales
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Annual premium or Minimum and Deposit Premium is $120,000
Illustration 2 – Insurance Carrier provides a full refund if actual sales are less than projected sales.
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Projected sales are $35M.
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Based on this projected sales, your insurance carrier provided you with a $6.00 rate per $1,000 of sales.
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Annual premium is $210,000
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At the end of policy period your actual audited sales are $15M.
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Because you receive $120,000 refund from the insurance carrier, actual paid premium is $90,000.
If the insurance carriers would offer full refunds when actual sales fall short of projected sales, there is not a business person alive today that would not invest $90,000, if they could guarantee a return of $30,000 at the end of twelve months.
Of course, the information above is an oversimplification and applies almost exclusively to Excess/Surplus product liability policies. Excess/Surplus insurance carriers are responsible for providing product liability policies for most of the high risk products on the market and those products that may be unique or new to the market and not insurable by the admitted market insurance carriers.