Considering Self-Insuring WC in a Tight Market?
May 2002
Martin McGavin examines the reasons self-insurance
can be less expensive, its intangible benefits, and how to perform a cost-benefit
analysis between insurance and self-insurance.
by Martin
McGavin
When the insurance market tightens, and insurance prices are increasing,
many employers consider alternatives to traditional insurance. One commonly
used alternative for workers compensation is self-insurance. Self-insurance
is sometimes less expensive than insurance, but not always. And, it almost always
creates a much greater administrative burden. This means that an employer that
is facing rising premiums cannot jump to self- insurance and automatically expect
to improve its situation. It may not materially reduce cost while, at the same
time, it could increase its administrative workload.
An employer considering self-insurance should first perform an evaluation
to determine if self-insurance will result in savings and if it is feasible,
given the employer's limits on resources to manage administration. This discussion
will cover the reasons self-insurance can be less expensive, the intangible
benefits to consider from self-insurance, and the process to use for doing a
cost-benefit analysis between insurance and self-insurance.
Why Self-Insurance Can Be Less Expensive Than Traditional Insurance
There are four reasons an employer can potentially realize savings from self-insurance.
The first is that the employer retains the risk for its predictable losses and,
therefore, purchases less insurance. When premiums rise, the savings is compounded
because the employer is purchasing less of a higher-cost commodity.
Employers with retrospectively rated plans or high-deductible programs may
believe that they have already realized the savings from self-insurance by retaining
the risk for expected claims within their insurance program. That is not automatically
true. Losses paid through retrospectively rated and high-deductible programs
are technically insurance premiums. An insurer may need to add some profit and
overhead loads to these premiums to meet its profit goals. Moving to a true
self-insured retention reduces the amount of premium paid and possibly avoids
some insurer profit and expense loading.
The second way employers can save on self-insurance is through more favorable
treatment on assessments and taxes. Every insurance policy includes assessments
levied by the state for such things as the second injury fund, the assigned
risk pool, and the insurance guarantee fund. There are also taxes on premiums.
Employers can avoid some of these, or can sometimes obtain more favorable treatment,
by self-insuring.
Some assessments are not applicable to self-insureds, such as those for the
insurance guarantee fund and the assigned risk pool. Others, such as the second
injury fund, are sometimes calculated differently for self-insureds. For instance,
insured employers may pay second injury funds based on premiums, and self-insured
employers may pay based on losses. Self-insureds with excellent loss history
can pay much less under this method than they would as insureds.
Other assessments are only applicable to self-insurers. For instance, most
states now have a self-insurance insolvency fund. If a self-insured is financially
unable to pay its claims, the claims are paid by the fund. The fund generates
its revenue by assessing self-insureds. This effectively amounts to joint and
several liability among self-insureds because, as a condition of self-insurance,
every self-insured must agree to contribute to the fund and thereby assume responsibility
for the losses of bankrupt self-insureds.
Self-insured assessments are not always less than those paid by insurers,
and in some instances they are higher. This must be carefully investigated during
the cost-benefit analysis.
The third way an employer can save is by purchasing lower-cost claim service.
Most self-insureds will operate in only one or a few states. If so, they can
retain a smaller regional claims administrator to handle claims. Smaller regional
administrators can generally offer much lower rates than their national competitors.
Regional vendors also tend to be more responsive and flexible. This is particularly
true for smaller employers that have little leverage when dealing with larger
vendors.
The final way a self-insured employer can lower cost is by improving its
management of claims and achieving better results. Self-insurance does not automatically
lead to lower claims costs, but many self-insurers believe the intangible benefits
of self-insurance, described below, lead to improved results.
Intangible Benefits of Self-insurance
Many employers use self-insurance as a financing method for the workers compensation
risk only when it is more favorable than traditional insurance programs. To
other employers, self-insurance is part of their culture and reflects their
workers compensation management philosophy. As self-insured employers, they
are committed to controlling costs by actively participating in the management
of their claims.
Self-insurance gives an employer more latitude to manage its claims. Self-insureds
can choose any qualified claims administrator to handle claims or may even administer
them themselves. Regardless of who administers claims, self-insureds generally
have much more control than they would as insureds. With a few exceptions, they
become the final decision-makers on when to accept or contest claims, on what
vendors to use, and when to settle claims and for how much. Many self-insured
employers believe that greater control over claims leads to much better results
and lower costs.
Another advantage of self-insurance that some employers cite is the clear
incentive for improved safety performance and post-injury claim management.
This incentive also exists with cost-sensitive insurance programs, but it often
requires an understanding of a company's insurance arrangements to recognize
the incentive. With self-insurance, the incentive is readily evident and indisputable.
Many self-insureds also value the direct relationship they retain with injured
employees. They believe that employees are more comfortable knowing their employer
will be making decisions on their claims rather than a third party.
In virtually every state, a community of self-insurers has formed under the
banner of a state self-insurance association. The associations typically allow
only self-insured employers to be full voting members. Service companies and
other vendors are allowed to join as associate members. The associations provide
training opportunities and represent the interest of self-insureds before the
legislature and regulators.
Most state organizations and many individual self-insureds are also members
of the National Council of Self-Insureds (NCSI). The NCSI has similar goals
to the state association and also lobbies and files friend of the court briefs
on the national level. The NCSI Web site describes the association's goals in more detail and provides links
to many of the state organizations.
The intangible benefits of self-insurance are difficult to measure and probably
cannot be included in a self-insurance cost-benefit analysis. Moreover, the
intangible benefits are probably not important to employers that do not wish
to take a direct role in managing their claims. But, many employers who are
self-insured believe the intangible benefits are most important and are reason
enough for self-insuring, regardless of any underwriting advantage.
Obtaining Information for a Self-Insurance Cost-Benefit Analysis
Perhaps the most difficult part of a self-insurance cost-benefit analysis
is gathering the necessary data. A broker or agent may be able to help, but
more often the data must be obtained directly from the state agency that administers
self-insurance. Contact information for the self-insurance-administering agency
is often available through the state's workers compensation agency Web site.
However, self-insurance is not always administered by the workers compensation
agency, so it may take some digging. A call to the state workers compensation
bureau or commission will likely head an employer in the right direction even
if that agency does not regulate self-insurance.
The table below shows the critical items needed, what to specifically ask
for, and significant issues to be aware of. An employer should pay particular
attention to the significant issues. Many could be insurmountable barriers to
self-insurance. For instance, an employer may be unwilling to provide the required
financial information. If so, it is better to know this before doing a great
deal of preparatory work.
Table
1
Other Information Needed
An employer will also need an estimate of the cost for claim service and
a loss projection to perform the cost benefit analysis. An employer must select
a potential claim vendor before it can obtain an estimate of service pricing.
Although it may seem that finding a claim partner should be the last step, it
can be beneficial to do it early in the process because many claims administrators
can provide assistance with the application process. Some may even be willing
to do most of the work on the periodic and annual filings. Regional vendors
or those operating in only one state are usually more likely to offer this sort
of service.
The final piece of information required is a loss projection. A loss projection
is the total estimated cost of all claims for the next policy period that would
be paid once all claims are closed. A loss projection is needed to determine
retention levels for excess insurance, to estimate state assessments, and to
determine the total cost of the self-insured program. Also, the employer will
need an estimate of losses so the cost of injuries can be included in its operating
budget and built into the price of its goods and services.
If an employer does not routinely develop a loss projection, it will require
some assistance from its broker or agent. Larger employers should consider an
actuarial study even if it is not required by the state.
The Cost-Benefit Analysis
Once the necessary information has been gathered, the employer may already
be at a decision point. It may have determined that the application and ongoing
reporting requirements are too burdensome and that self-insurance is not feasible.
Or, the employers may have determined that it is unwilling to comply with some
requirements, such as divulging financial results for its subsidiaries. It may
even have determined that it cannot comply with some requirements, such as posting
adequate security.
For those that decide they wish to further consider self-insurance after
gaining an understanding of the requirements, the next step is to formulate
a total cost of self-insurance. The total cost of self-insurance can be calculated
as follows:
- Total estimated losses (cost of claims)
- The estimated cost of claim service
- Cost of security (bond or letter of credit fees)
- Excess insurance premiums
- Application fees and costs (including actuarial study where required)
- + State fees and assessments (assessment rates applied to employer's
losses and payroll)
- ______________________________________
- Total Cost of Self-Insurance
Developing the numbers in this formula will require using the data gathered
from state agencies, the broker or agent, and possibly an actuary. It will require
some calculations and some estimates. Essentially, the self-insured employer
is underwriting its account in the same fashion as an insurance company underwriter
would. After the prospective self-insured has determined a cost for a self-insurance
program, it can compare it to the cost of programs offered by insurance company
underwriters. It can then weigh the savings—if any—against the added internal
administration. It can then factor in the intangible benefits, if it values
them, and then determine if it wishes to pursue self-insurance.
Conclusion
Self-insuring the workers compensation risk is a major decision for an employer.
Self-insurance brings with it an administrative burden that may be offset by
reduced nonloss costs. An employer must gather a significant amount of information
and do a cost-benefit analysis to determine if self-insurance will reduce costs.
Many employers believe that self-insurance provides other intangible benefits,
such as greater control over the claim process and claim decisions. They believe
that greater control leads to lower workers compensation cost. Many are so convinced
that self-insurance provides significant benefits that it has become part of
their culture, and they have joined with other companies in associations that
promote and preserve self-insurance.
Most employers initially pursue self-insurance as an alternative to commercial
insurance when insurance prices are high. Once self-insured, an employer is
likely to reach one of two conclusions. It may find the administrative requirements
for self-insurance overly burdensome and develop a greater appreciation for
insurers. The other possibility is that the employer will find the increased
claim authority and flexibility to be extremely valuable and hope that it is
never in a position where it again needs to purchase commercial insurance.
For more information on self-insuring workers compensation, including a table
of which states allow individual and/or group workers compensation self-insurance,
see The Workers Compensation Self-Insurance Decision on IRMI.com.
Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author’s employer or IRMI. This article does not purport
to provide legal, accounting, or other professional advice or opinion. If such advice
is needed, consult with your attorney, accountant, or other qualified adviser.