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Alternative risk financing for workers compensation.

Alternative risk financing for workers compensation A number of alternatives to the standard workers compensation policy and financing method have been appearing in the marketplace over the last few years. The cost of providing workers compensation benefits to employees has become a burden that employers are no longer able to bear without that cost threatening the survival of the very organization itself.

At a time when many medium-to-large companies are operating on razorthin profit margins, the cost for workers compensation benefits cannot always be passed on to the customers. As a result, a number of innovative financing methods have been developed. Four of the most prominent methods include: self-insured pools, captive insurance companies, promissory note arrangements, and integrated employee benefits/workers compensation plans.

While the reasons for developing and using these alternative plans are essentially driven by cost, simply devising a new plan will not solve this problem. The cost of workers compensation benefits is attached not only to higher medical costs and employee wages, but also to the increasing number of accidents, in both severity and frequency, that happen in the workplace.

Methods of loss reduction are a real key to providing innovative financing methods. Each of the alternative financing methods mentioned above should integrate complete loss control and claims-handling strategy in order to contain and reduce the costs.

Self-insured groups

Legislation has been passed in most states which allows employers to gather together to form self-insured workers compensation programs with a modicum of regulation. Previously, these pools would have been termed insurance companies and become subject to heavy regulation and administrative costs that are typical of the insurance industry but are unnecessary in the smaller pools.

Many mid-size employers would like to be self-insured and are capable of handling it, yet are too small to bear the significant budget swings that occur in self-insurance. It is these employers who benefit the most from self-insured pools.

A pool is formed by a multiple of employers who share common interests, an association membership, or the same industry background. These businesses essentially "pool" their insurance premiums and losses.

The pool itself secures reinsurance, with support services such as loss control and claims handling being provided by an insurance company or a third-party administrator. Legal representation for claims defense could be handled by a law firm chosen by the client or provided by the administrator or insurance company.

Some benefits of such self-insurance include:

* The members purchase reinsurance and administrative services at a volume discount.

* The individual retention in the event of significant losses is less than if individually insured.

* The members are not assessed the residual market charges applied against insurance companies.

Some drawbacks to membership in a pool include:

* The individual employer is jointly and severally liable for the losses of the group.

* The individual's favorable loss experience may be outweighed by the poor loss experience of other members of the group.

* The loss experience of the group may eliminate the cost savings.

Properly structured pools, however, would include careful underwriting of individual risks, both at initial application and upon renewal. It would include securing a solid reinsurance carrier as well as superb loss control and claims management.

Captive insurance companies

Although captive insurance companies have been historically used in areas other than workers compensation, the use of a captive insurance company can be an excellent and less expensive answer to their company problems as well when employers in more than a handful of states wish to pool their premiums.

In a captive insurance company alternative, a "fronting company" is used to actually issue the insurance policies and provide regulatory compliance in all of the states involved. This allows the employers to show evidence of insurance, as they are not qualified as self-insurers. Although this adds additional expense over and above the self-insurance, including the residual market charges and taxes, fronting companies do provide an alternative for these companies.

The benefits of a captive insurance company include:

* Ease of formation.

* The ability to use the captive for other lines of insurance (e.g., products liability, professional liability).

* The freedom to select loss control specialists, claims handlers, and reinsurers.

The negatives of this alternative include:

* The high cost for the fronting company.

* Capitalization of the captive insurance company itself.

* The need to explain the captive to senior management.

Promissory notes

Promissory note arrangements provide the financial benefits of self-insurance without the administrative and regulatory requirements. A promissory note is provided by the employer to the insurance company in the amount of the expected "ultimate" losses for the policy year.

If, for instance, the actuarial estimate for expected losses provided by the insurance company is $700,000, then a promissory note is issued by the employer to the insurer in the amount of $700,000. The note bears a legally required interest rate (typically 3 percent simple annual) in order that it can be counted as an asset on the books of the carrier for regulatory purposes.

The insurance company issues a traditional workers compensation insurance policy and bills the insured quarterly for:

* Policy expenses (i.e., taxes, overhead, profit, regulatory expenses, etc.)

* Actual losses paid during the previous quarter.

* Interest on the outstanding note.

This alternative works best for the larger employer who has at least $600,000 of expected losses and who may have operations in multiple states. These plans are less expensive than the conceptually similar "paid loss retros" and captives, and sometimes less expensive than traditional self-insurance. There appears to be substantial justification for the employer to deduct the note, expenses, and paid losses as a business expense under this plan. This issue, however, is still being discussed on the legal front.

Integrated programs

The integration of employee benefits and workers compensation recognizes that both health insurance and workers compensation insurance may be asked to respond to one event. Typically, where the employee is hurt, on the job or off the job, determines whether the claim is submitted under the workers compensation benefit package or under the health plan offered by the employer.

In addition, it has become quite obvious that few workers compensation insurance companies have been able to manage the medical portion of their claim as effectively as the majority of health insurers do, and many claims are submitted inadvertently to the wrong (or both) insurance carriers.

The advantage of a combined, so-called "24-hour coverage" concept is three-fold:

* The plan tends to eliminate "double-dipping" (i.e., medical payments made by both the health insurance and workers compensation insurance policy).

* The employer has a substantially larger volume of premiums and losses to attract an insurer.

* The claims handling is done by a single party or department more efficiently.

The difficulty with this combination plan is finding a single insurance company that is competent at both workers compensation and health insurance claims. Integrating these programs will not be an easy task for any insurer, but the concept of combining medical claim payments for the worker on and off the job is a concept whose time has come.


While this is only a brief, over-simplified summary of four alternatives to financing workers compensation benefits, it is obvious that the system is causing many states and businesses catastrophic problems and must be revamped.

The success of any alternative risk financing program will include organized loss control, efficient claims handling, and persistent case management if it is to be truly cost efficient. The elimination or reduction, however, of some of the upfront charges, such as residual market charges and taxes, is inherent to many of the alternatives mentioned and very attractive.

As these programs become more commonly understood and historically successful, many risk managers and businesses will be adopting these alternatives to solve what has become a major financial crisis.

William L. Granahan is a consultant for Betterley Risk Consultants, Inc. He has served in the insurance and investment field for over 10 years. He has worked in the property/liability industry with a major Massachusetts underwriter and the financial/business/estate planning field for The New England.
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Title Annotation:Insurance Insights
Author:Granahan, William L.
Publication:Journal of Property Management
Date:Jan 1, 1990
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