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Managing your risk by Michael Kelly

NCACC Risk Management Director Michael Kelly writes a regular column on risk management for CountyLines. With more than 41 years of risk management/ insurance experience, he holds the CPCU - Chartered Property & Casualty Underwriter, ARM-P - Associate in Risk Management for Public Entities, CRM - Certified Risk Manager, ARe - Associate in Reinsurance and CIC - Certified Insurance Counselor Professional Designations. He can be reached at michael.kelly@ncacc.org or (919) 719-1124.  For archives of this column click here.

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Aug 04

Going Self-Insured for Workers’ Compensation Revisited

Posted on August 4, 2015 at 12:57 PM by Todd McGee

It is that time of year again for counties – time to deal with new budgets and ever-increasing expenses. As a county risk manager, you may be tempted to consider “going self-insured” with your workers’ compensation coverage, or if you are in a standard insurance market, the carrier may be “suggesting” that your retention be increased to a level greater than you think is safe.

So one might ask, what are the general rules of thumb for a county risk manager to contemplate to transition from a fully insured workers’ compensation program to one of self-insurance, and what are the size parameters to be successful long-term?
In House Risk Manager:

By far the most important component to get started is someone needs to “own it.” This means either your county hires a true risk manager with the management of risk (and by extension the self-insured workers’ compensation program) being their sole responsibility, or to have an individual who may have multiple job responsibilities but risk management is their first and highest priority. Otherwise, over time the county’s loss experience will erode to the point that the long-term financial success of your self-insured plan will likely suffer greatly.

Self-insurance does not mean running on “autopilot.” You may realize a large initial savings, but your long-term strategy cannot be to do nothing going forward and hope for the best. It takes even more, not less, input and emphasis from management in order to succeed. There must be buy-in from the top – support, belief and most important loyalty – to the process and your program, else you have started a long progression towards failure.

Premium Size $450-500K Annually:

Generally, the average size in premium dollars should range in the area of $450,000 to $500,000 at a minimum annually before applying your experience modification factor. The reason being the annual cost for a “standard” policy needs to be large enough that the saving for going self-insured will allow accumulation of a pre-loss expense fund as quickly as practically possible. Consideration before applying the experience modifier insures that the bottom-line basis will be large enough, even when your modifier trends more favorably (as it will with good risk management) in the future to continue to allow pre-loss fund accumulation in the “good” loss years. In terms of payroll for an average county, this translates to approximately $22 to $25 million in annual payroll.

Data Point Loss Count of 30 each year for minimum of 7 years running:

Your loss experience should show that each year you average more than 30 workers’ compensation losses per year. In this case, more is actually better, with 30 being the least number of “data points” necessary to be able to forecast future losses, both from a severity as well as frequency with any degree of real confidence. Further, a minimum of seven years of consistent loss data is necessary to calculate loss development factors, payout patterns, etc., with a workable level of accuracy.

Chosen Retention ½ Size of Annual Standard Premium (ASP):

Once your county makes the choice to initiate a self-insured workers’ compensation program, the size of your deductible or retention becomes an important variable. While market conditions of late have dictated, a minimum retention size of $500,000 or more, if given the choice the largest selected, at least to get started, should be roughly half the total of your standard, annual premium. The general rule of $450,000 to $500,000 in annual premium size translates to a retention or per occurrence deductible of no larger than $225,000 to $250,000 respectively. If too large a retention is chosen initially and you have a higher than expected loss year, it can bring your self-insured workers’ compensation to a halt in a hurry – before reserves are built up.

Prefunded Loss Reserves = 2 times ASP or 4 Times Retention:

A reserve fund balance of two times the annual standard premium, or four times each per occurrence retention, allows for some “cushion” for the occasional year that has a catastrophic large loss – or even two such large losses. With alternate sources for dollars constantly being scrutinized by county management – your prefunded loss account is a target to meet other budget needs, but it is also the life-blood for your program’s survival as well as how smooth the ride will be along the way. This account should be setup in your chart of accounts to reflect by its title that it is a liability and not an asset, even though technically it is an asset until it is needed to fund losses.

Workers’ Compensation losses can have a very long “tail” taking a considerable length of time before they ultimately are closed – in some cases for decades. A healthy prefunded loss account gives you more control to meet your claim payment obligations or more easily increase the size of your retention and provides more advantage in securing favorable investment returns from your reserve balance.

Know Your Exit Strategy’s Inherent Costs:

Obviously, no county would expect to have to go back to square one and regroup, but it still should be considered initially. Any claims that you are responsible for as a self-insured group will continue to be your responsibility until the amount of that specific claim reaches the size and amount of your per occurrence deductible/retention. For the first three years of going self-insured, you should know up front what costs could continue from the third party administrator (TPA) even if you decide to return to a fully insured status.

Remember a TPA is the entity that is actually performing the paperwork end of the process of payments to injured employees, doctors and physical therapists, reviewing medical bill, and structuring long-term debt instruments for injured workers, etc. Should you decide to return to a fully insured, first dollar basis, any costs associated with any open claims will be your responsibility until concluded. This means even though you might have paid enough to satisfy your per occurrence retention, if the claim continues to remain open, there maybe be costs associated with a service agreement with the TPA through to its ending. Know the contractual agreement for exiting a relationship with your TPA up front to avoid any surprises at the end.

Loyalty:

Loyalty is in fact a critical ingredient in any self-insurance program as undoubtedly there will be an occasional year or two that it may not always be the least expensive answer. You might be able to find a standard insurance carrier that will offer to provide workers’ compensation at a temporary lesser annual cost. But if your county is large enough to begin with, your management is sold on the idea long-term AND it is set up properly from the beginning, it can work and save you money in the long run.