CAPTIVES FOR COMP
An expert weighs the pros and cons of this strategy and discusses the pandemic’s impact on comp coverage
By Elisabeth Boone, CPCU
Amid the turmoil brought on by the COVID-19 pandemic, high unemployment, and the murder of George Floyd, businesses continue to seek ways to deal with ongoing and new challenges. One of these is workers comp insurance, and an expert in that field is Frank Pennachio, principal of the consulting firm Oceanus Partners. Rough Notes recently had a chance to talk with him about using group captives for comp, and also how the COVID-19 pandemic is affecting the workers compensation line.
Historically, workers compensation has been a volatile line that in some years has posted combined ratios approaching 120%. In more recent years, the figure has settled comfort-ably in the low to mid 80s. Pennachio knows why: “Fewer people are getting injured.” He says that, particularly in the manufacturing sector, robots are becoming more common and are playing a significant role in the reduction of workplace injuries.
Analysts at A.M. Best attribute favorable underwriting results in work comp to factors like low reported claim frequency, legislative reforms, more effective use of data and predictive analytics, and enhanced workplace safety measures.
At the same time, the Best’s analysts caution that work comp profitability may decline because of low rates for the coverage. (Best’s Market Segment Report, “Declining Rates Could Threaten Profitability of U.S. Workers’ Compensation Line,” published on December 23, 2019.)
Given this mixed scenario of good results and expert warning, we asked Pennachio what group captive managers are telling employers about the advantages of their approach. He cites a number of points:
- Reduced insurance costs
- Less impact of market volatility
- Direct access to reinsurance markets
- Enhanced risk control capabilities
- Improved cash flow
- Investment income
- Greater transparency and control
With workers compensation per-forming so well, having posted a 2019 combined ratio of 83%, the obvious question is: “Why use a captive?”
According to Pennachio, group captive managers acknowledge that the combined ratio for comp is low, but at the same time, they assert that they can drive it down even more. “They say, ‘We’re going to bring together a group of best-in-class employers, and our claim costs are going to be even lower than they are in the broader employer population.’”
“Maybe they will; maybe they won’t,” he adds. “I’m a ‘trust but verify’ guy; I’ll trust the assertion, but I want to verify it. Are you beating the traditional market? If not, why not? Let’s compare your numbers with those of the traditional market for the past five years and see how you’re doing.”
What about alternatives?
Pennachio acknowledges that agents are becoming educated about group captives. “But,” he adds, “they’re not getting educated on the alternatives, such as retrospective rating plans or deductible programs. Nothing is good or bad except by comparison.
“Thanks to the strong marketing efforts of group captive managers, group captives may be the only alter-native loss-sensitive risk financing arrangements agents know about,” he observes. “Sadly, many agents are not aware of alternatives, and they’re not technically savvy about them.”
For employers who choose not to join a group captive, Pennachio observes, a number of options are available. Some employers opt for a large deductible or a self-insured retention, whereas others choose first dollar coverage with an excess layer or opt for a loss-sensitive policy.
“Retrospective rating is a loss-sensitive plan,” he explains. “The carrier calculates the insured’s maxi-mum premium by adding losses and expenses to the minimum premium. It’s a neat and tidy plan that’s designed for one individual company.”
As for deductibles, Pennachio says, “Intermediate deductibles start at about $25,000 per claim, and large deductibles start at $100,000, $250,000, or $500,000 per claim. They can go as high as $10 million if the employer can afford it.
“Agents should be agnostic with respect to the particular rating plan the client chooses,” he continues. “Their role should not be pitching captives. Their role should be to educate employers and help them make informed choices among the plans that are available to them.”
Pennachio raises another issue for agents to consider. “Typically, captive managers will not allow an agent to use a broker of record letter to transfer a client out of the captive,” he points out. In this scenario, the employer literally is in a captive situation.
For employers that are considering joining a group captive, Pennachio recommends asking whose interests are being served: those of employees, the employer, or the group captive?
“Group captives promise greater transparency,” he says. “If so, let’s challenge the captive managers to share all the contracts that are involved in the administration of the captive. First and foremost is the contract with the third-party administrator to adjudicate claims. Next are all the contracts that the third-party administrator signs with its downstream medical providers and cost containment services.
“Lacking transparency, we don’t know if there are misaligned incentives or if a significant amount of money is coming back to the captive through revenue-sharing arrangements with medical providers and cost containment services,” Pennachio explains. “Group captives promise greater transparency on their websites, but if we ask for transparency, we’re often told: ‘Those are proprietary trade secrets, and we can’t share them with you.’”
Group work comp captives, he notes, are only too happy to share the benefits they provide employers, and Google searches turn up page after page of their websites with glowing descriptions of their offerings. “If you want to hear about the drawbacks of joining a group captive, you have to rely on your trusted contacts who have first-hand experience,” Pennachio asserts.
Group captives are ideal for employers who want to be part of a pool and share in both the profits and the losses, he remarks. What’s more, he adds with a chuckle, “A lot of people like to go to the Cayman Islands.”
Thoughts on COVID-19
Most Americans were caught short when COVID-19 became a pandemic, and they quickly found their super-market shelves stripped of necessities like flour, yeast, toilet paper, and hand sanitizer. Employees were forced to set up makeshift home offices and master the intricacies of Zoom, while parents tried to juggle working from home with keeping their kids engaged in the new world of online education.
The recent resurgence of COVID-19is cause for grave concern, as states that chose to open early now confront the possibility of having to reimpose lock-downs on individuals and businesses.
How is COVID-19 affecting the insurance industry and the workers compensation line in particular?
“The pandemic is transforming the insurance business,” Pennachio asserts. “Greater emphasis is being placed on careful risk assessment and underwriting. The bid/quote approach will land on the scrap heap of history.”
A key issue related to COVID-19 is whether workers compensation policies should pay claims to employees who contract the virus, not just at work but anywhere. “Are state legislators or judges going to rewrite workers comp policies?” Pennachio asks. “Business income policies all exclude pandemics, but the situation is less certain in workers comp where in some states policies exclude ‘ordinary diseases of life.’”
Of paramount importance, he remarks, is the development of an effective vaccine for COVID-19. “Until this happens, the economy will shrink; this means that claims also should shrink,” he remarks.
Pennachio asserts that, amid the pandemic, the recession, high unemployment, social turmoil, and uncertainty about whether COVID-19 is compensable, agents and brokers can educate employers and help them make informed risk management decisions.
His parting advice: “Stay positive; test negative.”
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