Expert Commentary

Considering Self-Insuring WC in a Tight Market?

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.


Workers Compensation Issues
May 2002

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 website 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 website. 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


Information Required from State Agencies for Self-Insurance Cost-Benefit Analyses
Information Needed What to Ask For Significant Issues
Initial Application and Forms All forms and schedules needed to complete the initial process and the application fee
  • Subsidiaries: Some states require every subsidiary of a parent corporation to file individual applications. This can dramatically increase the effort required to apply.
  • Financials: All states require detailed financial information to determine if the applicant is a viable candidate for self-insurance. Private companies need to determine if they are willing to divulge the necessary information. Some states require that every subsidiary provide financial information as well. This may be confidential information that will not be disclosed even by publicly traded companies that publish consolidated financial statements.
  • Board Resolutions: Some states require that a company's board of directors pass a resolution authorizing its managers to apply for self-insurance.
Application Timetable

What is the estimated time to complete each phase of the self-insurance process

The process takes several months in some states and may even include a safety inspection at every location. An employer with a renewal in 3 months will find it is already too late to attain self-insurance in some states by then.
Annual Renewal and Other Periodic Filings A summary of any annual reapplication process, annual filing fees, and all periodic filings
  • Annual Filings: Every state requires at least an annual report updating the employer's financial information and claim history.
  • Quarterly or Semiannual Statistical Reports: Many states require more frequent reports on losses, payments, payroll, or a combination of these. Some states also require the employer to develop the statistical data and apply to the National Council on Compensation Insurance (NCCI) for an experience modifier for its self-insured entities.
  • Actuarial Studies: Some states require employers to have periodic actuarial studies done to evaluate the adequacy of their reserves. Actuarial studies can be expensive.
  • How Long Do Reporting Requirements Continue? Some states require employers to continue filing statistical reports for as long as they have self-insured claim activity. If this is the case, the employer may be committing to file reports for many years, even if it gives up self-insurance after a few years. An employer may wish to avoid self-insurance as a short-term option in these states.
Assessments; Rates and Calculations A summary of all current assessments levied against self-insurers Few assessments are fixed, and most are based on calculations done during the year. For example, second injury fund and self-insurance guarantee fund assessments are usually based on payments made during the prior year. Therefore, a state may not be able to tell an employer what the rates will be in the following year, but should be able to provide rates for the current year.
Security Requirements What security is required and what forms of security are accepted? An employer may be unwilling or unable to post security in the form or amount required by the state. Most states accept cash, a bond, or a letter of credit, but some will not accept a letter of credit. An employer unwilling to post cash and unable to obtain a letter of credit or bond will not be able to self-insure.
Excess Insurance What is the requirement for excess insurance? All states require specific excess that protects employers against a catastrophic event. In some states, the attachment point is low and in others, aggregate excess is required. An employer should make certain it can purchase the required insurance at an affordable price.

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. Expert Commentary articles and other IRMI Online content do 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.

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