SIGs in peril?

New York's actions to rescue failing self-insurance groups could imperil healthy ones

By Michael J. Moody, MBA, ARM

Workers compensation is a coverage that is common to most employers. It is also one of the insurance coverages that is susceptible to the widest pricing swings. As a result, employers have looked for viable alternative risk-financing methods to reduce the cost of workers comp. For many years, self-insurance has proven to be one of the most cost-effective methods available. Initially, large employers began to self-insure their workers comp exposures in states that allowed it. But soon, smaller employers also were banding together to self-insure their workers comp exposures.

State regulators view self-insurance as a privilege and, as such, they allow it only when certain conditions are met. There are typically a number of financial requirements and other key terms and conditions such as the joint and several liability issue. Recently, the joint and several issue has received significant attention in an effort to address and post-fund the underfunded liabilities of a number of SIG [self-insured group] Trusts. In response, New York has adopted legislation that, among other provisions, expands the traditional scope of joint and several liability to include related and unrelated SIG members.

This legislation seemingly conflicts with a recent New York court decision that rolled back 2008 regulatory assessments against healthy SIGs and individual self-insured employers to make up for the insolvencies of other unrelated SIGs. While the parties continue to contest these positions, the real issue is that state regulations are sorely out of date. This is particularly true regarding the financial requirements that are placed on group self-insured employers. Most of the regulations reflect financial requirements that simply could not be envisioned in today’s economic environment. As a result, states must turn their regulatory attention to updating the financial aspects of the self-insured workers comp regulations, particularly those that deal with SIGs.

California—while keeping a watchful eye on New York develop-ments—is one state that has been quick to address this important issue. Nationwide, workers comp pricing and availability has been relatively stable over the past few years. Such was not the case in California just five or six years ago. The California workers compensation insurance market of the late 1990s and early 2000s was hotly contested with “open competition” among insurers vying for a share of the voluntary market. Carriers competed on the basis of price, driving premiums well below actual loss costs, thereby depleting reserves and forcing some aggressive insurance underwriters into bankruptcy or rating downgrades. Early in the new millennium, the surviving insurers rolled out significant premium increases forcing employers to explore alternatives for workers compensation such as self-insurance.

And while the state has had group self-insurance regulations on the books for a number of years, it only approved its first SIG on January 1, 2002. Since that time, 25 SIGs have been approved to do business in California. However, the regulations that applied to the group programs had been on the books since the mid-1990s and were outdated for the current financial situation. Nationwide, SIGs in several states have been experiencing significant problems retaining their effectiveness as a viable alternative for smaller employers. In addition to New York, Kentucky has experienced some self-insured group failures due to poor management and aggressive marketing. Bottom line, the financials of these pools deteriorated to the point that they were forced to go out of business.

Mindful of these recent incidents, California’s Office of Self-Insurance Plans (OSIP) has been working with a group of interested stakeholders to update the state’s regulations. A task force of interested parties, which included SIG members, service providers, and workers comp experts was asked to provide guidance in recommending needed changes to the group self-insurance regulations. Reflecting task force input, the revised OSIP Regulations have been approved by the state’s Office of Administrative Law and, after a 30-day comment period, was to have been filed for formal adoption with the Secretary of State with a targeted effective date of mid-March.

Among the most notable revisions are the changes in the financial requirements. According to David Bramwell, a member of the task force that advanced the recommendations and managing director of Monument Administrators, one of the state’s leading program administrators, “These changes were needed to eliminate ambiguity in the regulations and place the SIGs on solid financial ground.” One of the key concerns surrounded the issue of surplus or insufficient funding. In both instances, Bramwell notes, “Prudence and conservative timing were introduced so that profits cannot be distributed prematurely nor can deficits be ignored because of short-term market goals.”

Additionally, the state will mandate that actuarial projections be performed both on a pre-funding and post-funding basis equal to an 80% confidence level. Minimum financial requirements for new members were also addressed in the new regulations. Bramwell points out that this section “adds a number of new methods that can be used to document net worth and financial standards necessary for determining a new member’s financial condition.”

The regulations clearly spell out, for the first time, the limits required for excess workers comp coverage and address acceptable investments that can be utilized by the SIG. Another very important financial related feature of the new regulations places greater oversight tools at the disposal of the Office of Self-Insurance Plans that will allow it to take timely corrective action to mitigate and manage financial workouts for SIGs that fail to comply with continuing financial standards.

Other major improvements that are incorporated in the new regulations include a material change in the determination of group homogeneity. Previously, only the first two digits of the employers’ Standard Industrial Code (SIC) were used to determine homogeneity. However, the revised regulations require that employers use the more stringent North American Industry Classification System. Several other parts of the new regulations address the potential conflict of interest issue that can occur between the SIG and some of its service providers. Bramwell says that these changes were addressed “to assure the possibility or appearance of conflicts are eliminated”—believed to be a contributing factor to the financial problems experienced in New York.

While all of this is viewed as a positive change in self-insured regulations, one can speculate about whether the proposed California regulations are timely or not. Whether or not it is just coincidence, several California SIGs have already begun to wind down their operations. One of the SIGs has indicated that it is having difficulty securing the renewal of its surety bond. The SIG, the Preferred Auto Dealers Self-Insured Program, pointed out that the surety bond issue occurred as a result of the current credit crunch. The lack of a surety bond, coupled with the ongoing drop in consumer spending in the auto industry, has led the SIG to disband. As a result, the SIG’s 70 members will be forced back into the conventional workers comp market.

A second SIG has indicated that it will be winding down its operation as well. The Vintner and Independent Producers Self-Insurance Program of California has decided to disband. As is the case with the auto dealer’s program noted above, the Vintner program’s 30 members also will be forced back into the conventional workers comp market. We trust the proposed changes, while oriented towards the future, will not be too little or too late to remedy possible retroactive issues that may be a direct result of recent economic disruptions.

California has always been viewed as a bellwether state; actions that start there frequently migrate to other states. It is hoped that this will be the case with updating a state’s financial requirements for self-insured employers. It is extremely important that state regulators who deal with workers comp self-insurance look realistically at the current financial situation and enact regulations that will assure the continued availability and viability of self-insurance. This is particularly true for smaller employers that serve as the backbone of today’s economic landscape and depend on SIGs to provide a cost-effective means to obtain workers comp. As Bramwell notes, “The proper management of these plans and adequate regulatory oversight is paramount to this alternative’s viability and credibility in the marketplace.”

Other states would do well to follow California’s lead.