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By Dennis J. Incitti
Director, Statewide Policyholder Services
New York State Insurance Fund
In the last decade, with the growth of group self-insurance, the alternative market has forever been opened up for smaller and medium-size businesses.
While there is always a place in the market for well-managed self-insured groups made up of businesses that share a keen interest in loss prevention and risk management, all state funds now face increased competition in retaining profitable small- and medium-size accounts.
Self-insured trusts aggressively pursue trade groups and business associations of related industries. Restaurants, hotels, retailers, auto dealers, farms, trucking companies and municipalities top the list of primary targets. Funds providing workers’ compensation coverage to trade and association safety groups are challenged by the intense competition.
Regardless of the state, group self-insurance has had an impact on our ability to compete in the marketplace. All workers’ compensation insurance carriers must cope with the shrinking of the fully insured market. Nationwide, the number of businesses opting for alternative workers’ compensation coverage is growing every year.
Take heart! We need not roll over in defeat. There is much we can do to maintain market share and protect our profitable books of business.
There are four keys to success in marketing against group self insurance:
• Know your product.
• Know your competition.
• Train your staff in marketing against the competitor.
• Above all, take every opportunity to educate your policyholders.
While we should never attack the competition, in competitive situations we must have a complete understanding of our product and that of the competitor so our policyholders may be educated to make informed decisions. That is why it is critical to train our policyholder service staff in the compelling reasons we believe fully insured plans may be a better choice for most businesses than self-insured trusts.
1. Guaranteed asset protection
Whether you are talking to a new business or a well-established company, the key to business success is asset protection.
The first thing people do when they buy a home is purchase homeowner’s insurance. They don’t make the purchase with the intention of using the insurance. They make that purchase to protect their most valuable asset. People purchase life insurance because they want to protect their families, not because they think they are going to die.
The financial well-being of a business is the most critical concern of the businessperson. A key component of protecting a business is choosing the proper workers’ compensation insurance. Fully insured plans include coverage for employers’ liability and legal defense costs. Almost always, there is a guaranty fund to deal with insolvency issues concerning insurance carriers. Usually, there is no such guarantee for self-insured trusts. Bottom line: The assets of a business are tied to the success of the self-insured trust.
Guaranteed asset protection is the single most important reason businesses purchase insurance. Don’t miss the opportunity to use this as your lead in discussing the pitfalls of self-insurance.
2. Reinsurance
There are two types of reinsurance that a trust is likely to purchase—specific stop loss and aggregate stop loss.
Specific stop loss limits the liability on an individual occurrence. Aggregate stop loss limits the liability on the total of all claims for a specified period of time. Specific and aggregate stop loss insurance is only as good as the paper it’s written on. It is necessary for the customer to know who the reinsurer is and have confidence that the reinsurer will be able to live up to its contractual obligation.
Buyers need to examine the reinsurance contract to determine whether the limits of the insurance will cover all losses and future loss development above the level of the initial contribution. Often, prospects are told that re-insurance provides coverage when the group has a 100 percent loss ratio; consequently, there will never be the need for future contributions. The specific and aggregate stop loss insurance will not relieve the group from having to pay the fixed expenses of the trust, which may run from 30 to 40 percent. Stress the point that reinsurance only applies to claims.
Annually, reinsurance companies fall on hard times and come face-to-face with issues of solvency, issues that can affect their financial rating. Insurance companies are rated by organizations such as A.M. Best and Standard & Poor’s. The rating is a measure of their ability to meet their financial obligations. Insolvency of a reinsurer can mean future liability to trust members.
3. Joint and several liability
Regardless of the terms of the reinsurance contract, every member of the trust is held liable to pay the claims and expenses of the group by virtue of joint and several liability. This may not become an issue until losses in the trust begin to fully develop. Excellent individual performance is no protection from future liability since each participant in the trust is liable for the performance of the entire group.
Bottom line: If contributions are not enough to cover loss development and fixed expenses, the funds required must be raised by increasing future cost or imposing an additional contribution on all those who participated for the year in question.
4. Premium versus contributions
Fully insured plans cap liability at premium. That means regardless of loss performance or future loss development, the premium for that year is capped. In alternative plans the final cost is never known until all the expenses of the trust are paid and all the claims are closed and retired.
There are examples of trusts that have underestimated initial contributions and have been forced to impose additional contributions on group participants. These obligations from prior years send budgets out of whack and affect a business’s ability to afford current and renewal contributions
In the final analysis, the premium paid to an insurance carrier is the policyholder’s only liability. In a trust, assessments are issued to cover any additional payments needed down the road.
Many times, policyholders equate the payment to the trust as premium similar to that paid an insurance carrier. Always point out that trusts do not charge premium; insurance carriers do. Trusts require contributions from all members to cover the cost of reinsurance, current claims and future claims development, as well as the fixed administrative expenses of the trust. In a fully insured program, liability is limited to premium paid. In a trust, additional contributions may be required simply to meet incurred expenses.
5. Future loss development
There is no question that self-insured trusts may tout savings over fully insured plans. Self-insured trusts are relatively new. Many trusts are in formation or have only been doing business for three or four years. The claims that trust participants have generated may not be fully developed. Many permanent partial injuries result in on-going loss payments for years. There may be many claims awaiting hearing to determine degree of permanency. As these cases become fully developed, the incurred costs tend to increase dramatically. Assessments based on paid indemnity rise proportionally to the number of open claims.
If a trust is not substantially outperforming a fully insured plan in the first three to four years, what will happen when the losses reported are fully developed?
Trusts often pay dividends to attract new members. Keep in mind that they will demand additional contributions if fully developed losses are higher than anticipated.
6. Controlling your destiny
An astute businessperson actively manages the business and finances and has the ability to control losses. How can that person control the losses of other group participants?As the trust grows, the selection process for trust membership becomes more difficult to control. Who will be allowed to join? Will new trust members be financially healthy businesses? Many of the critical decisions will be out of the hands of the businessperson.
Most successful business owners are proud of their entrepreneurial accomplishments. Many do not want to be in situations they cannot control. It is good to appeal to their independence, but be careful: Safety group participants also share the experience of other businesses in the group. There is, however, one major difference. In a safety group, the liability is capped by the premium paid. These thought-provoking questions require careful consideration.
7. Ability to shop a changing market
Market conditions change continually. Committing to an alternative plan will preclude a business’s ability to shop the open market.
Most trusts have multi-year commitments and penalties for premature withdrawal. Even if you remain in the trust for the prescribed time, the issue of a possible withdrawal penalty is a serious concern.
In some states, once a business becomes self-insured, no experience modification is promulgated by the rating organization. What happens if the business sustains a major loss? How may this affect your membership in the trust? Even more critical, the business may sustain no losses yet other participants may be incurring significant losses.
8. Liability of trust agreement
The law of large numbers, the basis for predictability in insurance, dictates that the group must be large enough to meet fixed expenses and build reserves against catastrophic losses. Certainly, the group will have to grow to be able to outperform a fully insured plan.
Who will decide who may join? If a member is unfortunate and incurs high losses, will it be removed from the group? If a member is asked to leave the trust, who will meet the obligations of loss development on the claims left behind?
Be sure to ask whether the policyholder has been shown a copy of the trust agreement. The trust agreement generally contains the rules that will govern the operation of the trust. It details how contributions from each member will be determined and how decisions regarding who may join the trust will be made.
Make sure the businessperson takes a close look at this document, asks the right questions, and is comfortable with the answers.
In addition to the trust agreement, there is also an agreement that binds the member to the self-insured trust. This agreement is often part of the application. Trust and trust binding agreements may be complex and bear scrutiny by the prospect’s legal counsel.
9. Carrier as partner in risk
Often, proponents of self-insurance will market better services. Make sure your fund is marketing proactive claims management, elimination of fraud, and targeted loss control service. These services are recognized as the most important in driving down the cost of workers’ compensation.
Most trusts are free to hire and fire service providers in an effort to obtain the most proactive claims management and loss control service. However, consider that third-party administrators charge according to the number of lost-time and minor medical claims processed. The more claims filed, the more money they make! In fully insured plans, the insurance carrier has a stake in reducing losses and managing claims proactively.
Trusts may promote the concept of unbundling services. They allege they can retain the most aggressive risk managers, the most experienced lawyers, and the best safety consultants. Make sure your policyholder is aware that providing the highest quality services is to our mutual benefit. Insurance carriers share risk; trust managers and service providers hired by the trust don't share in the risk. Should losses exceed premium, the insurance carrier takes the hit. In a trust agreement, the member is always liable; the third-party administrator is not.
10. Administrative expenses
All self-insured trusts have administrative expenses, including legal services, claims management, marketing costs, and underwriting and loss control services. These services are expensive. In most instances, the administrative costs of the trust are considerably higher than those of a fully insured carrier.
Trust expenses, including the cost of reinsurance, may average 30 to 40 percent. That means only 60 cents out of every dollar of the member's contribution is left to pay claims and any projected dividend. It is impossible to predict the future cost or availability of specific and aggregate stop loss insurance, a key component of trust expenses.
In addition to these expenses, trusts are required to pay assessments. In most states, self-insurers and insurance carriers are required to pay assessments to support the administrative expenses of the workers’ compensation system. In many cases, these assessments are not even determined until long after the closure of the period.
The ultimate expenses of the trust will include fully developed losses, administrative expenses, the cost of reinsurance, and assessments. If they have not collected enough in contributions or have returned too high a dividend, they simply will bill all the participants in the plan to make up for the shortfall. Keep in mind, reinsurance only covers losses; it does not cover expenses or assessments!
Risk versus reward
In the beginning, most trusts are established with a group of similar-size risks with similar loss ratios. As a trust grows, new participants come on board. Make sure the businessperson asks the key questions:
•Who will be admitted into the plan as the trust grows?
•How much am I likely to save in the first year?
•How long am I committed to the plan?
•Is there a penalty for withdrawal?
•Who is providing the reinsurance?
•Will reinsurance continue to be available and affordable?
•Do I really want to assume liability for someone else’s losses?
•Does the potential gain outweigh the risk?
•Ultimately, the decision has to be made. Do I really want to risk the assets of my business, or is it prudent to remain insured?
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