Life After Unicover.

Workers' comp insurers still need life reinsurers to spread the risk.

Recently, concerns over carve-out reinsurance have garnered a lot of attention in the workers' compensation industry. For many, the losses associated with the Unicover incident of 1999 prompted the first serious doubts about the usefulness of carve-out reinsurance, in which a life reinsurer covers the accident and health aspects of a workers' comp risk.

In the Unicover incident, workers' comp business that was passed through a pool of reinsurers managed by Unicover Managers Inc. to other life insurers who acted as retrocessionaires led to nearly $2 billion in potential losses and allegations that the retrocessionaires were misled into accepting more business than they wanted to. The resulting problems left many people wondering what life reinsurers are doing in workers' comp business. Among those considering the issue is the National Association of Insurance Commissioners, which is investigating new regulations, financial reporting and disclosure requirements pertaining to the carve-out industry.

Despite the losses of recent years, the carve-out market remains very important to the workers' comp segment of the insurance industry. While the Unicover situation was disturbing, it represented an instance of some reinsurers not thoroughly understanding the risks they were writing. It did not represent a fundamental reason for excluding life reinsurers from the workers' comp arena.

Traditional workers' comp insurers need reinsurance from the life industry to help spread the risk. Life reinsurers provide value to the workers' comp industry in three ways:

* life reinsurers provide needed capital;

* parts of the workers' comp exposure are very much like exposures of life reinsurers; and

* workers' comp coverage is not correlated with life insurance.

More Capital

While at lower layers, the workers' comp insurance industry may have enough capital--some even suggest it is overcapitalized--more capital than the property/casualty industry can provide is needed at high layers.

Required capital is related to the maximum loss potential for any one occurrence. Workers' comp insurance is unique, in that there exists no finite maximum per occurrence loss for the insurer. Three reasons account for this:

* the policy provides for unlimited medical benefits to each injured worker;

* in an individual occurrence, there could be a virtually unlimited number of claimants under a single policy; and

* a single catastrophe has the potential to cause losses for several workers' comp policies written by the same insurer.

Not only is there no maximum possible loss, but there is no accurate way of estimating an individual insurer's loss potential, because of these three factors. Even the largest of insurers--with larger blocks of business, more insured lives and greater resources to call upon--have a hard time estimating these losses, so small or midsize workers' comp insurers will assuredly have difficulties with this. In addition, a small insurer is exposed to the prospect that one occurrence could cause inconceivably large losses.

Reinsurance at High Layers

Because required capital is related to the maximum loss for any one occurrence, every insurer needs reinsurance at very high layers to lessen the likelihood of one event rendering it insolvent. Reinsurance can spread the risk of having one occurrence cause a loss that is much greater than what might be anticipated based on experience. Regardless of how much capital the property/casualty industry provides to workers' comp insurers, there is still an advantage to accessing the capital of the life insurance industry. Because of the potentially unlimited losses, it is more difficult for property/casualty insurers to control maximum workers' comp exposure than exposure for other lines. Therefore, reinsurance is demanded from alternative sources.

Familiar Territory

Not all parts of the workers' comp excess exposure mimic exposures faced by life reinsurers. The aspects of workers' comp insurance with which life insurers are unfamiliar include employers' liability, occupational disease claims and cumulative trauma claims. The reinsurance offered by life insurers generally "carves out" these types of benefits. The remaining benefits provided by workers' comp are similar to the accident and health benefits with which life reinsurers are familiar. In fact, carve-out reinsurance is accident and health reinsurance provided to workers' comp insurers by life reinsurance companies.

The exposure remaining after the "carve-out" has one difference from traditional life exposures: The risk for each workers' comp policy is closely related to the business of the insured employer. In traditional accident and health insurance, the risk is closely related to the activities and age of an insured individual.

By avoiding involvement in working layers of workers' comp (that is, less than $1 million per occurrence), life reinsurers can modify their exposure to exclude areas with which they lack familiarity, such as the specific risks of particular types of employers. At higher layers, the frequency of claims is less predictable, and the familiarity with underwriting and safety issues in various industries is less relevant.

The life reinsurance market has developed reinsurance policies in three areas to provide more capital where it is needed by workers' comp insurers:

* Per person. This covers claimants whose costs from an accident exceed a large retention, at least $1 million. This coverage helps spread the risk caused by unlimited medical benefits.

* Per occurrence. This covers losses that involve more than one injured person in a single occurrence. The reinsurance takes effect with a loss that exceeds a specified retention limit. The interaction between the limit per person and the retention is known as a "life warranty." For example, a policy that provides excess of $5 million per occurrence with a $1 million per-person limit could not generate a claim unless at least five workers were injured in one occurrence. This would be called a "five-life warranty." This coverage spreads the risk caused by the possibility of many employees of a particular employer being involved in one accident.

* Catastrophe. This is per-occurrence coverage with a retention at least $5 million up to several hundred million dollars. This coverage helps spread the risk if many employers covered by the same primary workers' comp insurer are involved in one occurrence, such as an earthquake.

Each of these three types of coverage also has a defined limit of liability for the reinsurance carrier.

A Different Drum

Workers' comp coverage is not correlated with life insurance. If a natural disaster were to generate a flood of workers' comp claims, the life reinsurance industry offers a group of reinsurers not exposed to property losses. While a large earthquake would trigger life, accident and health claims, life reinsurers would not face the large property claims that most workers' comp carriers on the property/casualty side would. This is a significant reason that many primary carriers prefer catastrophe coverage, rather than the life reinsurance market.

To maximize the capacity of catastrophe coverage, a single catastrophe should not have a significant impact on the profitability of more than one aspect of a reinsurer's business. This assumption applies to life reinsurers in the workers' comp arena and is a primary reason that the industry is needed in securing this coverage.

In summary, workers' comp insurers need life insurers to help spread the risk of the coverage. Life reinsurers provide capital not affected by catastrophes to support a portion of workers' comp claims. They offer a coverage that helps assure the continued solvency of the workers' comp market and the insurers that participate in it.

Michael C. Dubin is senior vice president-chief actuary with AUL Reinsurance Management Services in Princeton, N.J.