Deductible reduction clauses are clauses sometimes included in professional liability policy forms that, under certain conditions, reduce the deductible of the policy, typically by 50 percent, if certain conditions are met. Typical criteria the insured must meet are: (1) report the “incident” to the insurer before the incident becomes a formal claim; (2) use a standard letter of commitment for all client projects; (3) agree to settle the claim on the recommendation of the insurer within 1 year of the claim being made to the policyholder; or (4) obtain a written agreement from all clients whereby clients agree to mediation or arbitration rather than litigation of claims against the insured professional. Insurers offer these conditions because when the insured takes action, both indemnification and protection costs are usually much lower than otherwise.
Insurance is a contractual relationship that arises when one party (the insurer), for a fee (premium), agrees to compensate the other party (the insured) for losses caused to a certain subject (risk) caused by certain unforeseen circumstances (hazards or dangers). The term ‘guarantee’, commonly used in England, is considered synonymous with ‘insurance’.
The 10/10 Rule is a matter of analyzing and demonstrating the transfer of risk as a precondition for the use of reinsurance accounting, which was codified in the early 1990s with the adoption of Financial Accounting Standard (FAS) 113 (and its statutory counterpart, SSAP 62). FAS 113 itself was a response to alleged abuses and set the standard for testing whether something should be called an insurance contract. FAS 113 required that the transfer of risk be demonstrated by comparing the present value of the cash flows associated with the contract and, in particular, by exceeding certain thresholds of “significance” of risk. The thresholds, often referred to as the 9a and 9b tests, are: 9a. The reinsurer assumes significant insurance risk under the reinsured parts of the underlying insurance contracts. 9b. It is possible that the reinsurer could suffer a significant loss from the transaction. While neither “significant” nor “reasonably possible” was defined in this context, standard rules of thumb quickly emerged in the implementation of FAS 113. The most commonly cited is the “10/10 Rule”. This rule states that a contract reaches a threshold if there is at least a 10 percent chance that it will suffer a loss of 10 percent or more in present value (expressed as a percentage of the contract premium ceded).