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Enterprise Risk Management Self-insurance An “old standby” deserves consideration By Michael J. Moody The alternative risk transfer (ART) market has taken over the commercial insurance marketplace. Recent projections suggest that more than 50% of the commercial market is now using ART products to transfer risk, and now a new crop of ART solutions has been making a name for itself due to the recent capacity issues with regard to property coverage. Among the more successful, innovative product introductions in recent years are CAT bonds, weather derivatives, sidecars, and industrial loss warranties. All of these new products are designed to tap into the capital market in an attempt to expand available capacity. Despite these innovations, it is sometimes the old standbys that have consistently helped the ART market gain favor. One of the “old standbys” is self-insurance. While organizations can easily self-insure some types of coverage, such as auto physical damage or various forms of property coverage, the ART market typically looks at two key coverages with regard to self-insurance. One of these is employee health coverage. For years, employers have found that self-insuring employee health care costs can be a cost effective way to control this expense. Self-insuring comp The other major area for self-insurance is workers compensation. The concept of workers comp is not new. In fact, the first-state mandated workers comp law was passed in Wisconsin in 1911. By 1934, the remaining states had also passed similar compulsory workers compensation laws, which were designed to provide benefits to employees who are injured at work. While workers comp laws differ in all 50 states, they do share a basic no-fault approach to coverage. At the core of the concept is, regardless who is negligent, the employer will pay for job-related injuries that are suffered by their employees. For the most part, employers have chosen to comply with the law by purchasing a workers compensation policy. Over the years, however, some employers have moved toward self-insuring the workers comp exposure. Employers have generally found three broad advantages to self-insuring workers comp. • Reduced costs—While cost savings are frequently available from many ART products, self-insuring the workers compensation exposure can be one of the most cost-effective approaches to handling this risk. In addition to the normal expense reductions for things such as commissions and insurer’s profit, self-insuring also reduces or eliminates some assessments levied by the state. These would include second injury funds, assigned risk pool charges and guarantee fund charges. Additionally, premium taxes are also reduced. • Investment income—There are usually cash flow advantages that are associated with holding reserves. This is also true for workers compensation, since the claims can take years to pay out, thus providing a major investment income opportunity for employers who decide to self-insure. • Control of their own destiny—In order to implement any ART product or strategy, management must be willing to control its losses. This willingness to control their own destiny leads to many advantages for employers. And since manage-ment attention is focused on reducing workers compensation expenses, many times the employees also gain due to the keener interest by management. Food for thought When an employer is considering self-insuring workers comp, several key factors should enter into the decision. The first factor to take into consideration is the state regulations. As noted earlier, every state has specific laws that require an employer to compensate employees for injuries on the job. While the majority of employers comply with these laws by purchasing workers comp insurance, most states also allow employers, subject to certain requirements, to self-insure this obligation as well. Obviously, each state has its own set of rules and regulations, but some points are consistent among the states. First and foremost, the state is most concerned about the financial ability of the employer to continue to meet its obligations to employees. Accordingly, the state must ascertain the continued viability of the employer. Key to this determination is the audited financial statements and financial projections of the employer. Over the past 10 to 15 years, state regulators have watched a continual flow of self-insured employers go bankrupt, leaving the state to pay remaining worker comp claims on the employer’s behalf. As a result, this financial analysis has become one of the most critical parts of the self-insuring process. Questionable financials almost always will result in a denial of the self-insurance privilege. Other concerns of the regulators include: the quality of the safety and loss control programs; who will be handling claims management function; and the commitment of management to a long-term strategy like self-insurance. Most state applications also will require details regarding the employer’s operations and past workers compensation loss experience, as well as details regarding the excess worker compensation coverage and security requirements. Assuming all of these points are favorable, the state will then grant the employer the privilege of self-insuring its workers comp obligation. Additional factors As noted above, one of the key considerations for the state regulator will be the excess workers comp policy details. In essence, there are two essential excess coverages required, specific coverage and aggregate coverage. Specific excess workers comp coverage is designed to protect the employer from claims arising from a single occurrence. The employer is responsible for an amount known as the self-insured retention or SIR. The SIR amount will vary by employer and is based on the individual loss experience. The specific excess insurance will reimburse the employer when a claim from one occurrence exceeds the SIR. Aggregate excess coverage on the other hand, reimburses the employer in the event that the total paid losses in any one policy year exceed a pre-determined amount which is known as the loss fund. The major difference is that the specific coverage is written on a per-occurrence basis while the aggregate protection is based on the accumulation of individual losses. Basically, the specific coverage serves to protect against the one large, catastrophic claim, while the aggregate policy is there to protect against an unusually heavy year of claims. Another factor that will need to be addressed is the state’s security requirement. As mentioned previously, many self-insured employers have gone bankrupt and have left the state holding the bag for future payments to their employees. To help limit this potential problem, all states now require a surety bond or letter of credit from the employer that guarantees payment of claims in the event that the employer is unable to pay. Obtaining the surety bond has been quite difficult in recent years, due in large part to the fact that the bond company has concerns similar to those of the state regarding the ability of the employer to maintain an ongoing business. Many times this aspect of the self-insurance process is the most challenging. The final factor to consider is the selection of the claims administrator or TPA. This choice will typically become one of the most important decisions that the employer will make, since the success of the self-insurance endeavor depends heavily on the work provided by the TPA. The claims administrator will, in fact, become an extension of the employer and as such plays a key role in the managing of claims dollars. It is important for the employer to do its homework with regard to this important element. It is critical to understand the TPA’s philosophy with regard to claims management, as well as the background of the staff that will be handling the employer’s account. Information should be requested regarding the TPA’s reporting procedures, how to obtain access to their data system, and the management reports that are available to the employer. It is usually suggested that the employer interview a minimum of three claims administrators and get a minimum of two bids for their business. For the most part, the selection of the TPA will rest in the hands of the employer; however, any of the other parties—the state regulator, the bond underwriter or the excess coverage underwriter—may require a final approval of the selection. Final analysis Obviously, any feasibility study for self-insuring workers comp will include significantly more detail than has been addressed in this article. The study should also identify any shortcomings of moving to a self-insured program as well any additional administrative and/or operational considerations. But assuming the study comes back with a favorable response, self-insurance can provide a very cost-effective ART approach for some employers. While self-insuring is not typically considered as part of the “cutting edge” of the ART market, it still represents a very effective approach to fulfilling the state obligation to compensate employees for on-the-job injuries. And, as such, it warrants careful deliberation when considering ART solutions for an employer’s workers comp requirements. * The author |
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