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A marriage made in heaven The advantages of a workers comp captive, and the strategies to make it work By Michael J. Moody, ARM, MBA Captive insurers companies have been used to address a wide variety of insurance exposures. One exposure that is frequently selected for inclusion in a captive is workers compensation. The frequency of losses in this line of coverage makes it relatively predictable even for smaller firms. This predictability eases the budgeting issues typically associated with captives. Additionally, workers compensation is usually considered “long tail” coverage, which means there is a substantial amount of time to pay out claims, thus providing ample opportunity for earning investment income from holding the reserves. While workers compensation is a natural for the captive approach, a number of relevant issues must be addressed. Going it alone A captive is typically defined as a closely held insurance company that primarily insures the risks of its owner(s). Captives have been used for workers compensation for years and can be structured in a variety of ways. The most obvious option and the easiest to implement is the single-parent captive. Single-parent captives, also referred to as “pure” captives, are established to address the risk financing needs of a single organization, including any subsidiary or affiliated companies. Single-parent captives make up the highest percentage of captives worldwide and are prevalent in workers compensation. A properly structured single-parent captive can provide a cost-effective way to handle many companies’ workers compensation exposures. However, since workers compensation is a state-mandated coverage, a fronting carrier must be used. Recently there has been a shortage of carriers available for fronting, and this can cause problems for start-up captives. One risk financing option that has attracted significant interest over the past 10 years is the high- deductible workers compensation program. The concept of the high deductible is quite simple, and it has gained favor rapidly in the risk management community. Conceptually, the program allows the employer to pay for its own losses, up to some predetermined attachment point. At that point, the insurance company is responsible for the remainder of the loss. The carrier pays the claim and then looks to the insured to reimburse it for its share of the loss. Under a high-deductible program, insureds are frequently responsible for significant amounts of retentions. Some programs have deductibles as high as $1 million, and the carrier typically will require some form of collateral to support the deductible amounts. Accordingly, many insureds have turned to deductible reimbursement captives. This captive is designed to provide funds for the deductible portion of the insured program, and since it is covering only the deductible portion, it is not required to have a fronting carrier. This eliminates one of the most difficult tasks for workers compensation captives: obtaining a fronting carrier to provide an insurance policy so that the captive can comply with state laws. Safety in numbers In addition to the single-parent captive, there are several popular group captive programs. In the past, many smaller organizations wanted to enjoy the benefits of using a captive but lacked sufficient size to justify this decision. However, they soon found that by combining their exposures with those of others, they became large enough to form a viable captive. Thus, group captives formed by two or more companies became a popular approach to insuring the workers compensation exposure. The group captive can take several different organizational forms. The traditional group captive can be made up of several companies that decide to join forces to establish a captive insurance subsidiary. These captives are usually established to cover only the workers compensation exposures of their owners. Group captives allow their owners to ease the burden of capitalization and administrative responsibilities and many of the other day-to-day issues involved in running a captive. For that reason, they have become popular with many smaller organizations. Associations have been frequent supporters of group captives. This is a good way for the executive director of an association to provide a value-added benefit for its members; and, if properly structured, it may offer the additional advantage of profit sharing from the captive. Typically, the association can provide some additional services such as loss control, sales assistance, and related services in order to obtain a source of non-dues revenue for the association. Group captives are used by a variety of associations, including the National Iron Workers Association and local Chambers of Commerce. Open or closed A group captive can be either homogeneous or heterogeneous. Each approach offers both advantages and disadvantages. For the most part, homogeneous group captives are made up of members of one specific industry group such as ironworkers or bricklayers. Typically, homogeneous groups allow for the provision of highly specific industry-related services such as claims management and loss control programs, which can greatly reduce the overall losses. Additionally, reinsurers prefer homogeneous groups. However, there are also some negative aspects. Growth of the captive is limited to the members of that industry segment and/or association. And in some instances, it may be difficult to persuade competitors to join a group program that may require the sharing of competitive information. In contrast, membership in heterogeneous captives is open to all industry segments, thus allowing for more rapid growth. These captives are favored by groups like the Chamber of Commerce or Lions Clubs. As a result, many of the critical insurance-related services such as loss control and claims management must be designed to cover a broader group of industries and will lack specific focus. There is typically less interest in these groups from the reinsurance community as well, which can adversely affect the overall pricing of the product. One form of heterogeneous captive that has seen significant growth over the last few years is the rent-a-captive. While the concept has been around for more than 20 years, it has just been in the past few years that rent-a-captives have become popular. These captives are developed by an entity that is unrelated to the captive participants—frequently a broker, insurer, or other third-party service provider. The captive is formed and capitalized by the third-party organization that is willing to “rent” its facility to others. The participants need not provide the capital and surplus that are required under a traditional captive arrangement. Obviously, this removes many of the barriers to entry that typically face companies that are considering the captive alternative. And while the companies that join a rent-a-captive forgo some of the benefits of a single-parent captive, they do have the opportunity to experience some of advantages of captive ownership without all the associated cost, time, and administrative commitment. Special issues Owing to its nature, workers compensation has several unique issues that should be addressed when considering the feasibility of a captive. On the positive side of the ledger is the trend toward including employee benefits in an employer’s captive insurance operation. Many experts agree that this trend will accelerate in the coming years and may offer a unique opportunity to captive owners. For years, employers have struggled to find a way to integrate all of their employee-related benefit programs. By consolidating all of these programs, including workers compensation, long- and short-term disability, and even employee health under the captive, employers now may be in a position to provide some type of “24-hour”coverage product. This overall integration of benefits has long been viewed as an appropriate method for a cost-effective delivery system. On the negative side is the pending sunset provision of the Terrorism Risk Insurance Extension Act (TRIEA). This act is the extension of the original TRIA legislation that requires the federal government to provide a backstop for terrorism coverage. While this is a vital concern for the entire insurance industry, the reason it is so important to a workers compensation discussion is that, unlike most other coverages, workers compensation can’t exclude terrorism. Accordingly, any captive that insures workers compensation exposures will need to offer terrorism protection as part of its coverage. With the sunset feature of TRIEA set to expire on December 31, 2007, there could be gaps in some captives’ coverage. Conclusion Workers compensation captives have become common, and there is little reason to believe that this trend will lessen. While workers compensation as a line of coverage has few trouble spots today, not so long ago it was categorized as being in crisis. Captive insurers can offer many employers a viable alternative to the traditional insurance market, and now may be the ideal time to consider a workers compensation captive. * |
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