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Techniques to solve the workers' comp puzzle.

When it comes to workers' compensation insurance, there is no such thing as a soft market. Premiums have escalated at a double-digit rate, and insurers have restricted underwriting or, as in several states, left the market completely.

Yet the National Council on Compensation Insurance estimates that 1990 rates were inadequate by at least 20 percent nationwide. In addition, the NCCI reports that the 1990 workers' compensation combined ratio exceeded 118 percent, down 1.6 percent compared to the preceding year, and workers' compensation expenses exceeded premium and interest income by 5 cents on the dollar. In effect, residual markets now account for nearly 23 percent of workers' compensation premium volume, and assessments to the commercial insurers to pay for residual market shortfalls average more than 15 percent of the nation's workers' compensation premium.

During the mid-1980s, with lower federal income tax rates and Interal Revenue Service positions on tax deductibility more predictable, risk managers of large corporations found comfort in the general competitiveness of paid-loss retro plans. A small contingent even used self insurance to further squeeze costs and exert control over their workers' compensation plans. In the 1990s, however, risk managers can no longer justify the cost of their workers' compensation program within the context of a single nationwide self insurance or insurance program. Insurer strategies, regulatory and legislative reaction and the introduction of advanced financing techniques mandate a state-by-state evaluation of workers' compensation alternatives and a thoughtful analysis of the administrative challenges that come with a multistate hybrid program.

Commercial Programs

Underwriters have used loss-sensitive programs, such as retrospective rating plans and captives, to relieve residual market assessments. Residual market loadings are added to the basic charge, included in the tax multiplier or, in some cases, quoted as a separate fixed charge, increasing the final adjusted cost of premiums. As a result, guaranteed cost programs have been dramatically restricted, especially in Florida, Louisiana, Maine, Massachusetts, New Mexico, Rhode Island, South Dakota and Texas, where residual market loadings often exceed 20 percent of premiums.

Still, commercial workers' compensation programs are attractive in approximately 20 states were residual market loadings average less than 3 percent. In California, however, it is not residual market loadings but the high fixed expenses associated with the state's retrospective rating plans and restrictive self-insurarnce regulations that have led to heightened interest in captive reinsurance programs.

Self Insurance

Self-insured plans should be the most cost-effective, long-term solution for large risks, especially those with a high cost of funds and low tax rates. Reduced third-party expenses, improved claims management control and increased loss control incentives contribute to savings in a well-administered self-insured workers' compensation plan. Two perennial cost benefits, reduced collateral requirements and reduced taxes and assessments, can vary in each state.

A recent Corroon & Black survey found that 13 states had collateral requirements equal to or exceeding those of comparable commercial cash flow programs. California, for instance, requires an initial security deposit equal to three years of expected losses. Self-insured taxes and assessments are also rising, with at least 12 states incorporating self-insurance guarantee funds and corresponding assessments. States with material taxes on qualified self insureds include Kentucky, 16.9 percent of workers' compensation premium; New York, 18 percent of indemnity payments; and West Virginia, 24 percent to 28 percent of workers' compensation equivalent premium.

These requirements may make commercial insurance alternatives more attractive than qualified self insurance in some estates. Excess insurance is mandated for qualified self insureds in 20 states. Excess market restrictions have increasedx the threshold whereby qualified self-insurance savings are sufficient to offset increased financial risk. The market for excess compensation insurance routinely requires minimum retentions of $250,000 to $300,000 per occurrence. The market for aggregate excess insurance is even more restricted, with high premiums and higher attachment points. Aggregate protection may also be restricted by available limits, which are rarely greater than $5 million.

State regulators are increasingly scrutinizing the financial condition of self-insurance applicants prior to approval. Some states, such as Massachusetts, New Jersey and Ohio, have restricted approvals or have extended lead times for approval. At the same time, North Dakota, Wisconsin and Texas prohibit self insuring workers' compensation, although recent statutes in Texas will allow large commercial accounts, consisting of $750,000 in Texas premium or $10 million of unmodified premium nationwide, to self insure as of Jan. 1, 1993.

For insureds with potential occupational disease exposures, qualified self insurance with limited aggregate protection presents a serious financial risk. In the District of Columbia and under th ulS. Longshore and Harbor Workers Act, directors and officers can be held personally liable for workers' compensation claims in the event of corporate insovency. In additiona, failure to maintain adequate insurance can drive directors' and officers' liability claims, but is a frequent exclusion in D&O policies.

Assigned Risk Plans

Because of rate inadequacy, residual markets have, unintentionally, become the largest underwriters of workers' compensation insurance in the United States. The premiums in these markets are often more competitive in the short term than commercial alternatives. Yet what the insured gains through lower costs, it often loses in terms of quality and effectiveness in claims management services.

Currently, six states are represented by monopolistic funds, 14 by competitive funds and the remaining 30 are represented by residual funds. Thirteen states still provide premium discounts to risks, seven states surcharge all risks and five states use a combination of premium surcharges and discounts. The balance charge premiums based on the NCCI or individual state promulgated rates, without surcharge or discount. Colorado, Florida, New York, Ohio, Pennsylvania and Texas use retrospective rating plans for large risks. However, while these are both mandatory and punitive in Florida and Texas, they are optional and quite competitive in New York and Ohio. Furthermore, New York recently authorized the optional use of approved, independent cost-containment services, for an additional fee, in an effort to improve claims management for insureds in the state fund.


Several alternatives have arisen in response to the workers' compensation crisis. One is a self-insurance wraparound involving a paid loss retro plan in which high residual market loading states are carved out and self insured within the retro retention with the approval and assistance of the insurer. The advantages of this type of program are a coordinated service package and more favorable excess premiums and attachments. The insurer provides claims administration, loss runs and spcific excess insurance for all states, and may even provide aggregate protection for the self-insured states. Consequently, the overall residual market loadings and collateral requirements of the insurer are reduced.

Another alternative is deductible workers' compensation plans, which are being filed by several insurers, including Aetna, CIGNA, CNA, Hartford, Liberty Mutual, Travelers, AIG, Continental, St. Paul and WAUSAU. These programs, similar to deductible automobile or general liability plans, offer deductibles of $100,000 to $5 million per occurrence. Unlike most auto or general liability plans, they may include aggregate excess insurance. The advantage of these plans is that losses paid under a deductible do not technically qualify as premiums for premium tax or residual market loadings.

In Texas many large employers are opting out of the workers' compensation system. This type of action should be carefully considered because it requires public filing and posting and results in the voluntary revocation of common law defenses for employee injuries. It does, however, require the employee to prove negligence for the injury to be compensable. Proponents are suggesting savings of 30 percent to 50 percent in claims costs, although there is a limited track record to date on which to base this conclusion. The employer's liability is statutorily unlimited, but approved excess programs are being underwritten by London and AIG.

Lucien P. Laborde Jr. is president of Corroon & Black Corp.'s Research and Development Division in Nashville, TN.
COPYRIGHT 1991 Risk Management Society Publishing, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
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Title Annotation:includes additional article on evaluating workers' compensation program options
Author:Laborde, Lucien P., Jr.
Publication:Risk Management
Date:May 1, 1991
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