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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 02

Considerations for Workers Compensation Self-Insurance

Posted on August 2, 2012 at 10:32 AM by Chris Baucom

As the standard insurance market place continues to harden, I am asked more often about the necessary consideration to self-insure county exposures to loss – more specifically workers’ compensation. While there are varying “shades” of self-insurance, in the context of this article, it means from a singular, stand-alone county perspective. So one might ask, what are the general rules of thumb for a county risk manager to contemplate to safely make the transition from a fully insured workers’ compensation program to one of self-insurance?

In House Risk Manager

By far the most important factor is someone needs to “own it.” Meaning 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 having an individual who in fact may have multiple job responsibilities, but risk management is their first and highest priority. In such a case when there are conflicts as to what is first, the default answer should be risk management. Otherwise, over time the county’s loss experience will erode to the point that the long-term financial feasibility of your self-insured plan will likely falter. Self-insurance does not mean realizing a large initial savings going in, switching to “autopilot” doing nothing going forward and then hoping for the best. It takes even more, not less, attention 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, or else you have started a long progression towards failure.

Premium Size $450,000 Annually

Generally, the average size in fully insured, premium dollars should range in the area of $400,000 to $450,000 as a minimum, each year before applying your experience modification factor. The reason being the annual cost for a “standard” policy needs to be large enough that the savings for going self-insured will allow accumulation of a pre-loss expense fund as rapidly as practically possible. Consideration before applying the experience modifier insures that the bottom-line true cost basis will be large enough to continue to allow pre-loss fund accumulation in the “bad” loss years. In terms of payroll size for a County Government, this translates to approximately $20 to $22 million in annual payroll.

Data Point Count of 30 Each Year for Minimum of 7 Years Running

Your loss experience should show that each and every year you average over 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 aspect with any degree of 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. A better example to support the adage “Garbage In, Garbage Out” could never be made. Your loss data needs to be preferably from a single carrier, and if it is derived from several insurance carriers, accumulated in the same format. Each year needs to be reported and reflected as identically as possible, else trending, forecasting and loss development factors will be wrong.

Chosen Retention ½ Size of Annual Standard Premium (ASP)

Often once the choice has been made 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. So getting back to our general rule of $400,000 to $450,000, that translates to a retention or per occurrence deductible of no larger than $200,000 to $225,000 respectively. This is not to say being forced to initiate a plan at $500,000 deductible/retention is prohibitive, but it does raise the stakes considerably. A poor loss year during the first three critical startup years could prove catastrophic – it is best to start with a lower, conservative deductible/retention, allow your reserves to accumulate and then begin to assume more risk.

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 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 – not an asset, even though technically it is an asset until it is actually needed for losses. Doing so will help others from seeing it as a bucket of “extra” or found cash. Workers’ Compensation losses can have a terribly long “tail” taking a considerable length of time before they ultimately are closed – in some cases for decades. The healthier your prefunded loss account is, the more control you have, from the ability to meet your claim payment obligations to easily increase the size of your retention (lowering your initial costs each year) to deriving more leverage 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 the possibility 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 though you have gone back 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, therapists, medical bill reviews, structuring long-term debt instruments for injured workers, etc. Should you opt to return to a fully insured, first-dollar basis, there will be costs associated with any open claims, and they will continue to 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 may 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. Further, know if there will be any ancillary charges for data conversion should you need to have your loss data uploaded to another TPA or excess insurance carrier. This can be expensive and in some cases not possible, depending on how automated the TPA is handling your losses.

Have the Stomach for a Stretch of Poor Performing Years

Regardless of the best intentions, good decisions and full support from management, there will be periods of time that it may in fact be temporarily less expensive to revert back to a fully insured status. While this is of course possible and even warranted given the right circumstances, it should not be a decision made lightly. Rather a firm, long-term commitment should be made initially and a commitment to a longer term – say 5-7 years – is optimal. This underscores all the more how important it is to determine your account is large enough to statistically make self-insurance “fly” in the first place. You must be willing to examine your total costs – administration plus actual claim dollars over a longer time horizon than a single year. This is not to say plan design changes will not be made during this initial term. Your deductible/retention may be increased or decreased depending on excess limits costs and fluxuation of open case reserves. Self-insurance adds a significant element of unknown total cost, with the potential to be severe and long-term. As such, there are plenty of counties that meet all of these general criteria that refrain from taking the self-insurance path.

Loyalty is in fact a fundamental ingredient in any self-insurance program as undoubtedly there will be an occasional year that it may not always be the least expensive answer. You might be able to find an insurance carrier that will offer to provide workers’ compensation at a lesser annual cost temporarily – but if your management is loyal to your program, it will allow your Risk Manager to make adjustments where necessary and get things back on track.

Obviously, this list is not intended to be exhaustive or applicable in any or all cases. It is a short answer to a large question – to be self-insured or not. As stated also, there are shades of self-insurance. Finally, as a footnote for clarification, being a member of the NCACC Workers’ Compensation Pool is a form of self-insurance. The Pool’s Members collectively share their risk of loss to a certain dollar level and then use the leverage of large numbers and size to secure excess limits at typically lower costs than if purchased on a single, per county basis. They do allow retentions as low as $150,000 per occurrence and are managed by a Board of Trustees comprised of County Staff and Commissioners. For the past 31 years the majority of all 100 counties have made up the core nucleus of loyal Members allowing a myriad of different plan designs to address the exposure of workers’ compensation in the State of North Carolina, regardless of the current standard insurance market conditions.