HOW SAVING IN INSURANCE PAYS THE COST OF SPRINKLERS
Roger W. Babson, Well Known Financial Authority, Points Out Advantages of Insurance Premium Savings Plan—Emphasizes Need for More Sprinklers
HOW the installation of automatic sprinklers in mercantile and manufacturing establishments will reduce the fire loss and the advantages of the so-called “Insurance Savings Premium Plan,” which allows the immediate cost of installation to be spread over a period of years is emphasized by Roger W. Babson, well known financial and business authority, in a letter to the Grinnell Company. Mr. Babson points out that this places the installation of sprinklers within the reach of those who heretofore might have been deterred from using them on account of the high initial cost incident to their adoption.
Mr. Babson continues: I realize very clearly that fire insurance indemnity does not add anything to the country’s wealth since it simply replaces destroyed values. The important thing, therefore, is to stop the loss itself. Just how important this is becomes clear when one realizes that the fire waste of this country with all of its contingent losses of insurance company expense, fire department expense, interrupted business operations and the loss of steady employment by workmen, probably amounts to over the billion dollars a year.
No thinking man could study fire protection experience and not realize that the automatic sprinkler system is at present the country’s chief hope of reducing this drain on our prosperity. A few brief facts will illustrate why such a conclusion is inevitable. In the Factory Mutual Fire Insurance Companies, there are insured some $7,000,000,000 of industrial values. The business men whose plants are thus insured practically make their own fire insurance rates through the superior nature of their fire protection, automatic sprinklers being the fundamental requirement. The average net cost of insurance among this group of manufacturers for 1922. was 4c per $100. Practically the same results were obtained by those reciprocal insurance companies which write largely department stores and other mercantile values invariably sprinklered. The Factory Insurance Association of the Stock Fire Insurance Companies shows a rate very nearly identical. In fact, I have before me figures to show that with insurable values of over $2,500,000,000 mostly in stock companies. a certain group of completely sprinklered risks in 1923 showed a fire loss of only $1,600,000. Such a fire ratio should presage a very low insurance rate.
Table Showing How the Installation Automatic Sprinklers Reduces Insurance Rates
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Cost of Sprinklers Paid by Insurance Saving
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In all of these cases automatic sprinkler protection is the paramount cause of low fire losses and consequent low insurance expense. An idea of how automatic sprinkler systemreduce insurance rates may be obtained from the table, on page 366, which one of your own men has prepared, covering investigation among 843 firms in the various industries mentioned:
If any doubt remains as to the ability of sprinkler protection to reduce the fire losses of the country to a minimum, it is to be found in the following tables supplied by the Actuarial Bureau of the National Board of Fire Underwriters:
UNSPRINKLERED MISCELLANEOUS MERCANTILE CLASSES
SPRINKLERED MISCELLANEOUS MERCANTILE RISKS
Briefly, these figures mean that in the unsprinklered class, with about 50 per cent, increase in the values at risk, the actual fire losses incurred were more than twenty-two times as great as they were in the sprinklered class. In other words, there was a useless loss of practically a quarter of a billion dollars in this one class of risk during a six year period chiefly because automatic sprinkler protection had not been extended to these mercantile properties.
The problem contained in these fire loss figures and the reduction in fire losses and fire insurance expense made by automatic sprinklers is pre-eminently a problem for business men because it is in business properties that the great bulk of such losses occur. Therefore, business men occupying unsprinklered properties pay the major part of the insurance premiums which partially indemnify these sufferers from fire. Sometimes it is said that the cost of fire insurance is spread over the whole population in the price of goods. There was a time when this was true. But today it is a fallacy. The reason is this. Whenever a large group of leaders in an industry find the same way to cut overhead costs the resultant savings are hound sooner or later, to be utilized in a competitive way.
So many of the leaders among American business firms today have complete sprinklered plants and very low insurance costs that only the unescapable minimum of insurance expense can be charged into the price of goods. Everything above this minimum must and does come out of the profits of the firm paying above the minimum. One example will suffice to show this. Manufacturer A is a competitor of Manufacturer B. A’s plant is sprinklered and his insurance costs him 15 cents per $100. B’s plant is unsprinklered and his insurance costs him $1.50 per $100. A’s overhead is lower by the total amount of money so saved. Since he is competing with B, he can either take this amount of money off the total selling price of his goods or add it on to his net profit. Manufacturer B can do nothing to get himself this additional profit, except effect the same savings in insurance cost by installing automatic sprinklers.
The above facts are especially important now fliat automatic sprinkler equipments can be obtained on an insurance premium savings plan which allows their immediate cost to he spread over a period of years. This renders large initial cash investment on the part of the purchaser unnecessary. Ihe situation as explained by the sprinkler companies is as follows and I agree therewith:
- Insurance premium payments are an unescapable annual expense. On such payments depend to a very large extent the stability of the whole credit structure of business.
- The installation of Automatic Sprinklers immediately reduces this annual payment 50 to 90 per cent, depending on various considerations of hazard, location, etc.
- Without the protection of Automatic Sprinklers this possible saving cannot be made, or in other words, a useless waste goes on continuously.
- The plan referred to contemplates the gradual building up of a tangible property asset out of this unescapable insurance expense.
- The plan further provides accomplishing this desirable result without disturbing working capital position. In fact, it improves that position by making the property a better credit risk as is evidenced by the fact that Dun’s Reports always ask if a plant is sprinklered.
- The same immunity from fire, effective immediately, that would result from a cash purchase of a sprinkler equipment.
- The same reduction in premiums as a permanent cut in overhead expense, that would result from a cash purchase of a sprinkler equipment.
It will, therefore, be seen that the firm which cannot immediately see its way clear to purchase an automatic sprinkler equipment for cash would do well to thoroughly investigate this plan of securing a sprinkler system. By this plan a necessary, unescapable and constantly recurring expense (insurance premiums) purchases fire insurance indemnity and at the same time and more important, it also purchases immunity from fire in the shape of an automatic sprinkler equipment. I. therefore, advocate this plan of sprinkler installation because it immediately safeguards business from fire by capitalizing what otherwise will continue to be a useless expense.
The following hypothetical case has been prepared by someone and is worth repeating:
“The X. Y. Z. Mercantile Company is carrying $75,000 of fire insurance. This amount represents 80 per cent, of their physical property values. In case of total loss by fire, they lose 20 per cent, of their net physical value in spite of insurance. They lose also profits, good-will and expected trade, and consequently, a part of their advertising expenditure, possibly valuable parts of their personnel, etc. For this insurance indemnity against perhaps half of the total cost of a fire, the X. Y. Z. Mercantile Company is paying $1,125 per year. They have been paying that $1,125 for a good many years. They will go on paying it just so long as their fire hazard and lack of fire protection remains what it is. But let them install an automatic sprinkler squipment and their $1,125 insurance payment shrinks to say $375, a net saving per year of $750. ‘But,’ said the X. Y. Z. Mercantile Company, ‘a sprinkler equipment will cost us $6,000 and the savings therefore, per year would be only 12 per cent, on our investment. Our business is one of rapid turnover and we make 2 per cent, on each turnover, so that we can make vastly more money out of keeping this $6,000 turning over as capital in our business than we can by tying it up in a sprinkler equipment.’ ”
The insurance premium savings plan is designed to meet just this situation. By adopting that plan, the X. Y. Z. Mercantile Company would get the immediate fire protection it needs without disturbing working capital position because the annual payments would be only a little more than the insurance savings which otherwise could not be made. In a few years, the X. Y. Z. Mercantile Company would receive full and clear title to the sprinkler equipment.
Most concerns considering a proposition of this kind would be inclined to view their yearly payments to the installing company as deferred charges against the cost of the sprinkler equipment. As a matter of fact, it seems to me that these should be regarded as a fire protection premium just as whatever is now being paid to the insurance companies is regarded as a fire insurance premium. Look at it this way. Today a man is paying an annual fire insurance premium. This premium payment buys for him partial indemnity in case of fire. This fire insurance premium is an expense pure and simple. The plan mentioned above contemplates the payment of a yearly fire protection premium which immediately reduces the present fire insurance premium to a mere fraction of what it is now. But—as the sprinkler companies, say—it accomplishes vastly more than that.
A—It purchases immunity from fire, which is vastly more important than indemnity from fire.
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Cost of Sprinklers Paid by Insurance Saving
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B—It is not an expense but an investment, since it eventually secures you a valuable piece of plant equipment—an Automatic Sprinkler System.
C—The fire protection premium is further distinguished from the fire insurance premium in that it is paid for only a definite and limited number of years and not forever. It is like a paid up insurance policy in that its benefits continue indefinitely.
How much does this fire protection premium amount to? In many cases it will be found on investigation to be no larger than the present fire insurance premium. In other cases, the fire protection premium is from 25 to 75 per cent, higher than the present fire insurance premium. After the payment of the fire protection premium ceases, the proprty owner gets all the advantage of low cost insurance. The savings over what is now being paid show an investment return of from 20 to 100 per cent, on the total amount of the fire protection premiums paid in.
A careful examination of statistics should show that the majority of business firms who are not now enjoying the many benefits of sprinkler protection would find in an insurance premium saving plan, a proposition which at worst would be about like this:
This table shows that the spending of $650 the first year makes a saving of $750 that year and gives immediate fire protection besides. Unless the $650 is paid out as a fire protection premium, the $750 saving will not be made, unless the sprinkler system be bought for cash. At the end of the five year period the total fire proection premium paid is $3,250. The savings made by that expenditure are $3,750. These savings plus the fire protection premiums paid have bought a sprinkler system which will continue to make insurance savings of $750 a year, netting the owner 23 per cent, on this total fire protection premium payments.
The amount saved annually, of course, varies depending on the values involved, but I am told that the savings of one year are usually sufficient to take care of all the carrying charges necessary on this plan of installation and pay for all the service involved. Therefore, the business man who simply postpones sprinkler installation until his cash position warrants outright purchase is actually losing money if such postponement extends over a year. More important than this, he is doing without adequate fire protection in the meantime and possibly may, therefore, lose all his business in a disastrous fire with losses that no insurance will compensate him for.
The whole question thus becomes one of fact finding and analysis. The facts you want to find out are these:
- —Cost of Sprinkler protection.
- —Insurance premium savings by reason of sprinkler protection.
- —Possible cost of a serious fire in your property.
All of these facts are easy to get but a word of caution is necessary because I have found some cases where shortsighted insurance agents fearing the loss of commissions, which sprinklers necessarily impose through reduced rates, have not fairly indicated the savings which the equipment would make.
With the facts as above indicated in hand, all that remains for the business man to consider and analyze is his working capital position. If he has a surplus of extra cash which he cannot find use for in the ordinary course of his business, then he will want to buy a sprinkler system out of that cash. But if his business requires all the working capital he can get his hands on, then he would not wish to divert working capital to the purchase of a sprinkler system and should allow the system to pay for itself on this insurance premium savings plan. Banks do not like to loan money for plant improvements and the cost and trouble of raising new money by the flotation of preferred stocks, notes or bonds (the only other alternative), is often quite heavy.
It is for all of these reasons that I am glad to urge business men. who are not now enjoying the fire protection benefits and the low insurance cost of a sprinkler equipped plant, to thoroughly and painstakingly investigate the matter and act promptly on their investigations. Moreover. I have no direct or indirect interest in the matter except to help reduce needless fire losses.