Tag Archives: actuary

Experience Mod Is Losing Key Role

The insurance industry has a reputation for being slow to change, but the “big data” revolution is driving significant changes in workers’ compensation underwriting. The emerging use of “big data” analytics in underwriting is diminishing the purpose and value of the experience modification factor and beginning to affect middle-market agents and their clients.

Big data has already redefined industries like retail (Amazon), entertainment (Netflix) and content publishing (Facebook). Stock and mortgage brokers are well ahead of insurance with their own predictive models. Big data in insurance is still under the radar for many, but it’s beginning to affect pricing and how agents work with their middle-market clients.

The National Council of Compensation Insurance’s (NCCI) experience rating plan was created to adjust premium costs to reflect “the unique claims experience of each eligible individual employer relative to other employers within the same industry group.” The experience rating plan helps insurers charge the appropriate premium for an individual employer’s work comp policy. Or, as one actuary stated, “The experience mod is a predictive indicator of future losses.” Traditionally, a higher experience mod predicts that the employer will have greater than expected losses in the coming policy period, so the insurer needs additional premium for the risk.

Many experts would agree that the experience rating plan, created in the 1930s, has historically served the insurance industry well. However, we are entering a new era where individual insurers are building their own predictive analytics models because of:

  • Recent and swift explosion of huge databases;
  • Inexpensive computing power and data storage; and
  • Advances in data acquisition and aggregation from multiple sources.

Computer hardware and software advancements, along with smart people, now allow insurers to quickly process millions of calculations, analyze the data they produce and promptly validate their emerging predictive models. Prior to these technological advances, insurers relied on the rating bureaus, such as NCCI, to collect and manage the data.

In addition, there are significant inefficiencies in the rating system that data-savvy insurers can leverage to gain a competitive advantage. For example, they can analyze their own data instead of relying on the rating bureau’s broader, aggregate view to create a competitive advantage.

Let’s assume the rating bureau’s data indicates that claim costs are rising for plumbers in a given state. The rating bureau will likely increase advisory and expected loss rates for plumbers in the entire state. However, an individual insurer may analyze its own book of business and see a decrease in claims costs for that state’s plumbers. The carrier could set a lower premium for plumbers and capture greater market share from competitors that only use aggregated rating bureau data.

It’s no surprise that large global actuarial and consulting firms are working with insurers to develop and enhance predictive models. Insurers already possess a treasure trove of data just waiting for those, affectionately known as “data nerds,” to spin it into gold. As one actuary from a well-known consulting firm said at a recent industry conference, “Underwriters have been using about six to eight data points to determine acceptability and pricing of a risk. We can build them a model with 400 to 600 data points.”

Big data brings big opportunities to insurers and agents; however, as with any collision of old-world and new-world methodologies, there will be some challenges and casualties. For example, let’s assume an underwriter receives an application for a workers’ compensation renewal, and the experience modification factor is renewing lower than the prior year. And the governing class code advisory rate is lower, as well.

However, the insurer’s predictive model indicates an increase in pricing is needed. As a result, the underwriter removes the scheduled credit and adds a scheduled debit to the pricing. Now, the agent has to explain an unexpected higher premium to the client.

Or, worse, the underwriter cannot even make an offer because the maximum allowed scheduled debit will not provide the pricing needed, according to the predictive model. In this case, an applicant’s reduced experience modification factor actually prevented the employer from getting a renewal offer from its current or preferred insurer. This may seem crazy, but when you add more and new data to a pricing model, you often get a different indicator.

Enhanced data analytics can turn traditional rating and pricing upside down. The purpose of the rating bureau’s experience rating plans is to assist the insurers appropriately set a price for the risk. However, with advanced analytics and regulations mandating the use of the experience mod, employers may find themselves in the residual market because the insurer was unable to make an offer at their price.

Workers’ compensation experience rating and experience modification factors are not going away any time soon; they are enmeshed into each state’s regulatory and statutory framework. And not all insurers will create and use their own predictive models, so some will continue to rely on the rating bureaus. However, you’re probably beginning to see anomalies between the old world of “predictive indicators of future losses” and the new world of insurance-specific predictive analytics.

Agents must not only be aware of these underwriting changes but must educate their clients and prospects. The brightest future belongs to employers that can move the loss data in the right direction over the long term. The agent’s role is to help them establish processes to make that happen.

As with most leadership challenges, agents need to start with a new conversation and dialog. Questions might include:

  • Are you aware of how the “big data” revolution is affecting your insurance program and pricing?
  • Has anyone shared with you how the insurance company’s underwriting process is going through its most dramatic change in more than 50 years?
  • Have you taken steps to adapt and align your business objectives and risk management practices to leverage this new approach?

Agents often say they want a way to differentiate in a crowded and noisy marketplace.  This underwriting revolution presents a sustainable competitive advantage to those willing to invest in gaining knowledge and expertise.

Tips on Evaluating a Wellness Program

This is news you can use.

If you want to evaluate the cost/benefit ratio of a wellness program, the following is a list of costs that are almost always overlooked in wellness evaluations. These are not the only things that need to be evaluated, just the ones most commonly overlooked.

When the items in the following list are fully considered, wellness evaluations can look entirely different.

1. The cost of staff hired to manage the program. A rule of thumb is to multiply their salary times two to account for FICA, benefits, office space, training, workers comp, management, etc.

2. The cost of wages for workers while attending wellness events at work. One company I looked at was spending about $175 per employee per year on this, not a trivial sum.

3. The opportunity cost of the HR staff running the program.

4. The full cost of wellness communications. Sending wellness communications to people at work has a wage cost. See #2 above.

5. The total cost to evaluate the program periodically.

6. The cost of false positives, which come from sending employees to doctors when they’re not sick. This is especially pernicious if you’re paying for wellness exams for employees. At one company, the cost of the false positives, sometimes as high as $80,000 per event, nearly cost more than the physical exams themselves. You have to examine claims data to see this.

7. If you have a fitness center, you need to take into account sports injuries for users. (Understanding this also involves access to claims data.) I’ve evaluated the impact of fitness centers for three very large companies. Taking into account sports injuries, etc., you could not make the case for an ROI for any of the three of them. In one company, we examined claims data on a) moderate or occasional fitness center users, b) people who used the fitness center regularly, and c) nonusers. Nonusers had the lowest average medical costs. Moderate users had higher medical costs than nonusers and regular users had the highest medical costs, a perfect reverse correlation.

Surveys of employees are notoriously unreliable. They measure employee opinions, at best, and opinions are not facts. As we all know, sometimes in employee surveys people will say what they think the surveyor wants to hear.

Medical claims and sick pay data are about the most meaningful ways to measure wellness outcomes. Short- and long-term disability data can be useful, too, as can life claims experience when compared with norms. If you only use employee surveys and other surrogate data, too bad.

I met an actuary who spoke at a conference on this topic and used the measurements above to evaluate wellness programs. He said he’d never seen one that had a positive ROI, except ones that used payroll deduction penalties.

Thought Leader in Action: At Google

Loren Nickel, who has a major role in our profession as the director of business risk and insurance at Google, got his start without even doing a job interview.

That story begins when his mother researched careers and suggested that in college he study to become an actuary. Nickel pursued statistics and actuarial science at the University of California, Santa Barbara (UCSB), and became president of the Actuary Club – with its maybe 10 members, he says.

He wanted to build interest, partly to get more prospective employers to come to UCSB, so he decided to set up a website – this was in 1994 and 1995, before Netscape exploded on the scene through its initial public offering and introduced the Internet to the public consciousness. Nickel wrote the software for the website himself and paid $35 of his own money to get the UC system to host the site. He then used his e-mail address to answer questions from students and others about the actuary program at UCSB.

The word got out, at least to one UCSB alumnus who played an important role in Nickel’s career. John Alltop, who was in charge of the actuarial services division of Fireman’s Fund, asked Nickel if he knew of anyone who would be interested in an internship. Nickel raised his hand. Alltop, who is now president of Actuarial & Risk Management at Bickmore Risk Services, asked him to visit. At his own expense, Nickel drove 365 miles up the coast to Novato, north of San Francisco, and paid for a night in a hotel. He says that the second he walked in the door he was given the internship even though “I told them I hadn’t even done anything for them yet.” Shortly thereafter, Fireman’s Fund hired Nickel full-time.

He worked on various national accounts, and Fireman’s Fund rotated Nickel every 18 to 24 months to different operating divisions, ranging from workers’ comp and property risks to general liability, enabling him to learn different facets of the insurance business. Nickel learned the “big picture” by seeing how Fireman’s Fund used the actuarial component in its underwriting of client risks. Then he became the underwriting manager.

In that capacity, Nickel was able to work with brokers and sales teams to see how actuarial projections fit in. He developed his communication, sales and people skills. That experience launched Nickel into his next career move, working for AON, a leading brokerage firm. This included an assignment in London to work with the operational risk team, designated as a center of expertise. Returning to the U.S., Nickel led AON’s actuarial division in the Western region, which included providing actuarial consulting services for Google for nearly three years.

He joined Google in the spring of 2015. Nickel, who is 41 years old, lives in Marin County, north of San Francisco, so he commutes perhaps an hour and a half each way on one of the famous Google buses, to his office a few minutes from headquarters well down the peninsula in Mountain View. The bus is comfortable enough and the Wi-Fi so good that the ride is basically an extension of his office.

Nickel says his consulting experience at AON is a good fit at Google, where his risk management responsibilities could be best described as “advisory work.” He works in consultation with various Google teams to help keep them more informed and able to make better decisions from a risk viewpoint. Perhaps the biggest change is that he’s now on the buyer’s side of transactions. This, of course, includes multiple brokers and insurers.

Google’s stated mission is to organize the world’s data and make it usable by everyone on the globe, and all new products or services relate to that vision, but Google’s renowned “moonshot program” searches for disruptive innovations – which, by changing how people do things, can change the nature of risk. Google has fewer boundaries than most business ventures, to stimulate innovative thinking, so a traditional risk management program, with all of its financial constraints, doesn’t fit the Google model of business development. (Nickel is quick to point out that Google does employ a vast number of risk management best practices to protect its employees, property, users and the general public.)

Nickel leads a risk management team of four direct reports, with an additional five Googlers who work within the risk management structure. He says Google is much less about the function where someone works (i.e., risk management) than about the right mix of individual skills. For instance, on his team, some have an insurance background while others have skills in legal, actuarial science, project management, accounting, etc. “It’s a very different mix of personnel than what you would find in a traditional corporate risk management department,” Nickel says.

Asked how he gets in tune with and integrates risk management concepts with Google’s diverse divisions around the world, he says that making strong relationships is No. 1 – knowing the right people. This ensures that Googlers are aware of the advisory and outreach team in risk management. Risk management does not serve as a policing authority but serves more as an information source. Other corporate teams, such as legal, partner with risk management as issues arise. Responsibilities are clearly assigned and managed exclusively by organizational silos, as in most organizations. Nickel says everyone is very receptive about the information that the risk management team shares – in previous jobs, he often saw posturing.

Nickel says a guiding principle at Google is that “Googlers take care of other Googlers,” so risk management is in the culture, and safety is paramount. Even the food choices are healthy. Google provides its more than 60,000 Googlers with free, very nutritional and delicious food and snacks as well as a wide variety of campus features that promote health and well-being. Google even provides onsite medical providers at its larger locations. Without sharing statistics, Nickel makes it clear that Google has “phenomenal” workers’ comp claim experience that is far better than companies of its size. He added that Googlers feel respected and appreciate how well they are treated.

Asked if Google has any official opinion about the ownership or operation of driverless cars, where its pioneering work has sparked extraordinary interest, he said the risk department does not provide opinions on the products that Google creates. He did say the department is focused on making any new Google technology safer, getting it to market faster and winning support from regulators. “We do not determine how autonomous vehicles are used,” he says. “Instead, the goal is to facilitate the creation of great technology that could improve the world.”

When asked what advice he would give to newcomers in risk management, Nickel suggests that they try to experience different roles from different perspectives – from both the insurance and user sides — with respect to the implications of risk in organizations.

“These diverse experiences provide a deeper context to the bigger picture of risk,” Loren says. “Risk managers have to have more than one style, approach or understanding of risk to truly be impactful.”

From an educational standpoint, Loren adds that a “good grounding and understanding of mathematics and statistics is extremely helpful….For me, risk management success is much less a factor of knowledge than it is to gain perspective and practical experience. You need to learn to take nebulous concepts and to organize information that can be put into a plan that other people can understand and act upon.”

Getting to 2020: the Finance Function

Even as economies recover, the insurance sector continues to face many competitive pressures and regulatory challenges. Yet a new drive for growth is emerging. The 2014 EY Global Insurance CFO Survey captures the priorities and challenges for finance and actuarial teams as they seek to support business growth strategies while addressing regulatory and cost pressures.

Delivering more value to the business through performance measurement and improved decision support is the top priority for the finance function through 2020. Among senior finance professionals participating in the survey, 71% indicated that “being a better business partner” ranked among their top three priorities, with 35% placing this as number one.

As insurance companies around the world continue to invest in data management and analytics capabilities, the role of finance and actuarial functions has become even more critical. The processes and systems supporting these functions are key to developing deep insights into business performance, as well as customer needs, preferences and behavior. In response, finance leaders have been increasing their efforts to improve the capabilities of their organizations to meet the new demands. In the survey, 89% of respondents stated that they have either begun a change program or are in the planning stage.

However, the drive to better insights is not without challenges. Among the issues is the impact of continuing regulatory compliance demands. According to 35% of those surveyed, implementing new regulatory and financial reporting requirements was the highest priority for finance and actuarial organizations; 56% ranked this among their top three. As a result, the ability for these organizations to strike a balance between delivering value to the business and meeting daily operational demands will continue to be a challenge.

Not surprisingly, the current data and technology footprint will require significant change to meet the challenges of the finance function of the future. Across the finance operating model, survey participants scored data as the least developed capability on average, while technology recorded the greatest gap between current and required future state.

Other Key Findings

  • Top three business drivers: #1 growth, #2 managing costs and #3 regulatory changes
  • Two-thirds of respondents rank data and technology issues among the top three challenges facing finance and actuarial functions; participants on average score data as their least developed capability
  • By 2020, the most significant shifts in maturity levels by operating model will be in data management and technology capabilities
  • Respondents expect onshore shared services to support transaction processing functions, with outsourcing selectively used for payroll and internal audits
  • Decision support and controls are expected to account for a larger share of finance and actuarial headcount by 2020

What insurers must do

We see three key areas where insurers can take action:

  • Modify current reporting processes by developing an efficient reporting solution architecture.
  • Deliver timely and relevant management information and link strategic objectives to performance indicators.
  • Improve finance and actuarial operational performance by using the right skills and processes to strike a balance between effectiveness and efficiency.

For the full survey from which this excerpt was taken, click here.

The Key Choices in Workers’ Comp

Workers’ compensation is a no-fault form of insurance that an employer is legally obligated to secure, providing wage replacement as well as medical, rehabilitation and death (survivor) benefits to employees injured in the course of employment. Workers’ comp is in exchange for mandatory relinquishment of the employee’s right to sue his or her employer for the tort of negligence. The lack of recourse outside the workers’ compensation system is sometimes referred to as “the compensation bargain.” This compromise system also establishes limits on the obligations of employers for these workplace exposures, so that the costs are supposedly more predictable and affordable.

The system is always evolving, and there are key choices in workers’ comp, which I will cover here — and update as the system continues to evolve.

First, some background:

Where did workers’ comp come from?

Workers’ compensation has roots all the way to 2050 B.C., where ancient Sumerian law outlined compensation for injury or impairment involving loss of a worker’s specific body parts. Beginning in the 17th century, most pirate crews, including the one led by English privateer Capt. Henry Morgan, organized fairly sophisticated and favorable benefits for injured crew members. Injured pirates were treated on board and fitted for prosthetics – as popularized in literature and film. Furthermore, they were compensated in pieces of eight depending upon the type and severity of injury. As for modified duty, crew members were oftentimes offered non-physically demanding work on the ship. Such work could include cleaning cannons, cooking meals and washing the ship decks.

In modern times, workers’ comp as we know it today was first modeled in Germany and Prussia in the late 19th century, then adopted in the U.S. in 1908 by the federal government, then in 1911 by Wisconsin. Workers’ comp spread to all states and the District of Columbia by 1948, with Mississippi as the last state to adopt the model.

Why is workers’ comp coverage mandated?

At first, participation in U.S. workers’ compensation programs was voluntary. In 1917, however, after the Supreme Court upheld the constitutionality of compulsory workers’ comp laws, the majority of states then passed legislation that required employers to purchase workers’ compensation coverage for their employees. Requirements varied — and still vary — from state to state. Currently, Texas and Oklahoma have voluntary “opt-out” or “non-subscription” provisions, which allow employers to provide their own formal injury benefit plan options.

How is workers’ comp different from other insurance?

Workers’ comp is intended to eliminate tort liability litigation arising from employee injuries or work-related diseases by providing wage replacement, vocational rehabilitation and medical benefits to employee injured in the course and scope of their employment. This is intended to minimize worker conflicts and to avoid costly lawsuits. The standard workers’ compensation insurance policy is a unique insurance contract in many respects. Unlike other liability insurance policies, it doesn’t have a dollar amount limit to its primary coverage. The coverage is considered “exclusive remedy,” to deny employees the opportunity to sue their employee. In general, an employee with a work-related illness or injury can get workers’ compensation benefits regardless of who was at fault — the employee, the employer, a coworker, a customer or some other third party.

Why does a workers’ comp policy have two parts?

Part One is the standard workers’ compensation insurance policy (formerly known as Coverage A) that transfers liability for statutory workers’ compensation benefits of an employer to the insurance company. If a state increases benefit levels during the term of the policy, the employer doesn’t have to make any adjustments to the policy. Instead, the policy automatically makes it the responsibility of the insurance company to pay all claims due for workers’ compensation insurance for the named employer in the particular states covered by the policy.

Part Two (formerly known as Coverage B) addresses employers’ liability coverage. This coverage protects the employer against lawsuits brought by the injured employee or the survivor. If an employer is thought to be grossly negligent, the employer runs the risk of being sued for that negligence. Under Part Two of the workers’ comp policy, the employer would be defended in such a suit. If a judgment were rendered against the employer, that judgment would be paid by the workers’ comp coverage, but no more than the limits provide for in the policy. Part Two also insures an employer in cases such as third-party “over suits,” where an injured worker sues a third party and that third party seeks to hold the employer responsible.

How states differ

Examine your company’s possible exposures to workers’ compensation claims from different states. If you have employees who live and work in or who travel to other states, you need to make sure you are properly covered in each state. In most jurisdictions, employers can meet their workers’ compensation obligations by purchasing an insurance policy.

Five states and two U.S. territories (North Dakota, Ohio, Puerto Rico, the U.S. Virgin Islands, Washington, West Virginia and Wyoming) require employers to get coverage exclusively through state-operated (“monopolistic”) funds. If you’re an employer doing business in any of these jurisdictions, you need to obtain coverage from the specified government-run fund unless you’re legally self-insured. A business cannot meet its workers’ compensation obligations in these jurisdictions with private insurance.

Thirteen other states also maintain a state compensation insurance fund, but their state funds compete with private insurance. In these states, an employer has the option (at least theoretically) to use either the state fund or private insurance. Those states that offer employers this option are Arizona, California, Colorado, Idaho, Maryland, Michigan, Minnesota, Montana, New York, Oklahoma, Oregon, Pennsylvania and Utah.

FORMS OF FINANCING WORKERS’ COMP

  1. Fully Insured

There are more than 300 workers’ comp insurers writing policies in the U.S., although many will only provide coverage with a high deductible. Most states have a State Fund Insurance Carrier that is the insurer of last resort and provides fully insured (no deductible) workers’ comp coverage to entities operating in their state. State fund programs are also referred to as the residual markets. They are more commonly known as state insurance funds, assigned risk plans or workers’ compensation pool policies. Generally speaking, state insurance funds are non-profit entities that cost more than private companies (10% to 40% higher premiums) but that guarantee availability of coverage as a “last resort” carrier.

Some common reasons that employers fail to obtain competitive quotes from private carriers include: 1) a high frequency of claims or a high cost of claims; (2) the dangerous nature of the risk or industry (based on codes from the National Council on Compensation Insurance, or NCCI); 3) prior bankruptcies or poor financial status of the business; and 4) prior cancellations because of nonpayment of workers’ compensation premiums.

  1. Group or Association Coverage Plans

In various states, there are options for small to medium-sized companies to obtain group coverage through their industry associations. These options include Self-Insured Groups (SIGs), which provide a true self-insured option. Group members make contributions to the self-insured group, and the self-insured group pays expenses and claims for injured workers.

SIGs directly contract for services normally performed by an insurance company. Services secured on behalf of members include: elected Board of trustees, program administration, safety and loss-control services, third-party administration (TPA), independent accountants and actuaries and excess insurance carrier.

Companies must apply for membership and generally indicate adherence to effective risk management and loss control programs.

  1. Large-Deductible Plans

This is a form of self-insurance where the employer is responsible for reimbursing the insurer for claims up to a certain dollar amount and the insurer is responsible for paying claims in excess of that deductible. The insured funds an account (loss fund) to pay losses, and the insured reimburses the fund as losses are paid. The insured must collateralize, usually by letter of credit, an amount approximately equal to the difference between paid and ultimate losses. The actuary is typically one assigned by the carrier.

With the advent of the high-deductible program in the early ‘9Os, actuarial efforts focused principally on pricing issues. Employers are able to save significant premium expenses if they manage their loss-control and return-to-work programs effectively. The “deductible” is a sum that is subtracted from the insurer’s indemnity or defense obligation under the policy. Importantly, the responsibility for the defense and settlement of each claim rests almost entirely with the insurer, and the insurer typically maintains control over the entire claim process.

Large-deductible programs were slow to find favor in the U.S. In 1990, only six states approved of such deductibles. Currently, at least 45 states utilize large-deductible programs for workers’ compensation.

Deductibles are based on a per claim or per occurrence basis, with self-insured retentions of $100,000 to $1 million. The insurer sets the minimum deductible allowed. Insurers initially developed this program to provide both themselves and insureds certain advantages, including:

  • price flexibility, by passing risk back to the insured
  • reduced residual market charges and premium taxes in some states
  • better cash flow
  • coverage options for aggregate limits
  • broadest choice of insurance carriers
  • the possibility that a separate TPA may be allowed as an option to the carrier
  • that certificates of insurance issued to the employer’s key business partners show full coverage and policy limits

With a well-designed and -managed, loss-sensitive product, companies can potentially lower costs by assuming a greater proportion of their risk. You get increased cash flow and lower costs and improve claims outcomes for the business and its employees. What’s important with a loss-sensitive program is that the organization is committed to fully leveraging the insurer’s loss control, claims, medical and pharmacy management programs.

Additionally, it is critical to choose the right risk-financing structure. That involves having the business itself, you, the agent and the carrier carefully examining the organization’s current financial situation and short- and long-term goals.

Because the carrier is legally responsible for the employer’s claims, the carrier will require collateralization of existing and future claims covered by the policy period. Collateral is usually a letter of credit, surety bond or cash.

Keep in mind, however, that choosing a high retention is all about the frequency and severity of your workers’ comp claims as well as the responsiveness and quality of your claims administrator. In essence, the employer is giving the insurance company an open checkbook with respect to the handling and disposition of claims.

  1. Retrospective (Deferred) Premium Options

Retro programs are written through an endorsement on your large-deductible workers’ comp policy. It is the ultimate amount of money you will owe your carrier for the contract period. It can be broken down into installment payments. It consists of basic premium and converted losses, both of which get adjusted by the tax multiplier, which are the taxes and assessments due to the state. The insurer provides you a written agreement that defines the terms of your contract. It will show the basic and maximum and minimum premium, how the premium will be paid during the policy year, how the retrospective premium will be calculated and, most importantly, when you will be eligible for a premium refund. The agreement also defines any penalties associated with a midterm cancellation of the contract.

The two major retro payment plan options:

A.   Incurred Loss Retro:

You’ll pay the same up front as with a guaranteed-cost program, but you’ll be refunded money if your loss experience is favorable. The risk, however, is having to pay additional premium if your loss experience is unfavorable. The cost of the insurance program is determined by the actual incurred loss experience for a specific policy period. Incurred costs include paid costs as well as future expected costs (reserves). The premium is adjusted annually until all claims are paid and closed.

B.     Paid Loss Retro:

Premiums are determined using paid only loss amounts rather than incurred (reserved amounts). Timing of premium and loss payments are negotiated before inception, and disbursements are made as costs are realized and billed. Because this option is typically the favorite of insureds, this option is typically only offered to large entities paying in excess of $1 million in premium.

How is the basic premium determined?

Basic premium is basically the insurer’s cost of doing business plus expected profitability. The amount is determined by multiplying the standard premium by a percentage called the basic premium factor. This factor varies based on your actual premium size and the amount of risk you are assuming. In general, if you take on more risk for your claims, the amount you will pay for the basic premium decreases.

What are converted losses?

 Converted losses are the total claims, also called incurred losses, adjusted by the tax multiplier (see below) and multiplied by the loss conversion factor (LCF), which is negotiated with you prior to the inception of the coverage. As the loss conversion factor increases, you assume more risk, so the basic premium decreases.

What is the tax multiplier?

This is a factor that is applied to the basic premium and converted losses to cover state taxes and assessments that must be paid by your insurance carrier.

What is the maximum premium?

Maximum premium is the most you will have to pay under a retro plan. It helps protect you by placing a limit on the impact of any substantial losses you could have. It can range from 100% up to 150% of audited standard premium. For example, if the audited standard premium was $100,000, and you selected a 125% max, the most you could pay for the total of all retro charges under the specific contract period is $125,000.

When will my money be returned if losses are low?

After completing the full contract period, the first adjustment for a possible refund is usually calculated six months after the policy expiration date. The premium is adjusted according to the retro formula, using the basic premium, converted incurred losses and taxes. If your claim losses are better than expected, you will get as much as 50% of the total estimated refund. Another adjustment is usually made in 12 months, with as much as 25% of the total estimated refund. The final adjustment is at least 12 months after that, with the final 25%. If, however, you have complex indemnity (lost-time) claims that are unresolved, the adjustments may drag out for years.

  1. Captive Insurance

A captive insurance company is an insurance company formed by a business owner to insure the risks of related or affiliated businesses. A captive permits a business to manage its risks while potentially providing substantial benefits to that related business. More than 75% of the Fortune 500 now utilize some form of captive insurance, but captives are usually not a viable alternative for most small to medium-sized companies.

Is a captive still a viable alternative?

The number of captive insurance entities is growing worldwide. Today, nearly 10,000 businesses in the world employ some form of captive insurance coverage. Those totals are expected to triple over the next 10 years as more companies further examine comprehensive and well-targeted risk-management plans. More than 5,750 large companies have their wholly owned captive insurance entities that were formed to insure the risks of the parent company and its subsidiaries.

What risks does a captive typically underwrite?

Captives are formed in 30 domestic locations (state) or in foreign (“off-shore”) domiciles like Bermuda and the Cayman Islands. Vermont is the most popular state. Each domicile has its own set of laws and regulations. To be successful, captives usually cover disparate types of risk, with a good geographical or industry spread. Captives are intended to build financial strength over time and help insulate the parent company from price fluctuations in the traditional insurance market. Increasingly, captives’ owners are also looking to their captive to provide broader coverage, including unusual or emerging risks, where risk transfer is either expensive or unavailable.

The type of risks that captives cover is expanding rapidly, from the more common property damage and casualty coverage, to employee benefits, environmental, cyber, business interruption and other non-traditional covers like operational risk and supply chain. Captives typically provide large companies an opportunity to insure against risks that are generally uninsurable or exotic.

Are there different types of captives?

There are at least 10 types of legal insurance captives, including:

  • Pure captives (single parent)
  • Industry group captives
  • Agency captives
  • Association captives
  • Risk-retention groups (RRGs)
  • Rent-a-Captives
  • Segregated and protected cell captives
  • Special-purpose reinsurance captives
  • Series LLC captives
  • Internal Revenue Code 831b captives.

How is workers’ comp coverage provided in each state?

A commercial insurance company (“fronting company”), licensed in the state where a risk to be insured is located, issues its policy to the insured. That risk is then fully transferred from the fronting company back to the captive insurance company through a reinsurance agreement, known as a fronting agreement. Thus, the insured obtains a policy issued on the paper of the commercial insurance company.

The cost varies for a fronting carrier, which legally assumes the workers’ comp risk it fronts, in the event of default by the captive. The fronting company will almost always require collateral to secure the captive’s obligations to the fronting company under the fronting agreement, in addition to a 4% to 10% fee.

Is there a tax advantage to using captives?

While the tax advantages from captive arrangements should never be at the top of any company’s list, captives can offer accelerated premium deductions, unlike most self-insurance programs. However, if the IRS believes that a captive has been established purely for tax purposes, the agency may challenge the captive status of the company. Comprehensive documentation of the objectives of the captive structure is important.

  1. Self- Insurance

A self-insured workers’ comp program is one where the employer sets aside an amount to provide for any workers’ comp claims and associated expenses—losses that could ordinarily be covered under an insurance program. Self-insurance is a means of capturing the cash flow benefits of unpaid loss reserves and offers the possibility of reducing expenses typically incorporated within a traditional insurance program. It involves a formal decision to retain risk rather than transfer (insure) and allows the employer to pay workers’ comp associated expenses as incurred.

A self-insured workers’ comp plan is one in which the employer has legal approval from the one or more states to assume the financial risk for providing workers’ comp benefits to its employees. In practical terms, self-insured employers pay the cost of each claim “out of pocket” as necessary. The employer maintains its ability to settle or adjudicate each claim within its self-insured retention – assuming it has excess insurance.

Importantly, key decisions, including which vendors to use to treat injured workers and to administer claims, remain with the employer and not an insurer.

How many employers currently operate a self-insured workers’ comp program? 

It is estimated that more than 6,000 corporations and their subsidiaries nationwide operate self-insured workers’ comp programs. Many other smaller employers participate in Self-Insured Groups (SIGs), where they pool their risks with other companies.

How large do you have to be to self-insure?

Each state sets its own minimum standards for eligibility. For example, in California, you only need to have at least $5 million in shareholder equity and a net profit of $500,000 per year for the last five years. Eligibility is not based on the number of claims.

Keep in mind that each state is a distinct entity, so a company might be self-insured in one state where it has a high concentration of employees and have a large-deductible policy in another state with fewer employees.

Does the state require collateralization?

Every state, except California and North Carolina, has mandatory minimum security deposits that consist of: letters of credit, surety bonds, securities or cash. In many states, the amount posted by the self-insured is less that that required by an insurer or captive.

Can self-insured employers protect themselves against unpredicted or catastrophic claims?

Most states, except California, require self-insureds to purchase statutory (no limit) excess insurance from a state-licensed workers’ comp insurer. Where available, a negotiated, aggregate stop-loss (“attachment point”) endorsement protects an employer to a specific policy period dollar cap regardless of the per-claim self-insured retention or number of claims incurred.

Is self-insurance typically only used by large entities?

No. Employers of all sizes typically choose to self-insure because it gives them the greatest opportunity of any workers’ comp funding alternative to manage their own destiny. A self-insured can control its costs by choosing and managing various program vendors and by implementing a wide variety of loss-prevention and return-to-work programs that serve to greatly reduce workers’ comp claims. Self-insureds choose program components that they feel are the most cost-effective and responsive.

Who administers claims for self-insured workers’ compensation programs?

Self-insured employers can either administer the claims in-house (if allowed by the state) or subcontract to a TPA. Other medical treatment or claim-related services can be “unbundled,” or obtained through TPA contractual services.

  1. Opting Out of Workers Comp

The opt-out concept is appealing to those who believe that statutory workers’ comp systems are hopelessly complicated, burdensome to both employers and their injured employees and out of touch. Privatized opt-out programs are intended to better integrate into the matrix of existing employee health plans and benefits.

Just two states have laws that allow employers to opt out of the state-regulated system: Texas and Oklahoma.  Texas has always had this law, with 114,000 employers (about 1/3 of the total employers) choosing to forgo workers’ comp coverage. Oklahoma recently adopted a variation where employers can choose an alternative to workers’ comp coverage.

Practically speaking, “Opt-Out” (“non-subscription”) gives employers enormous discretion to decide under what circumstances to compensate an injured worker under the employer’s own benefit plan. To protect the employer from most negligence lawsuits, as a condition of employment the employer can force the employee to sign a contract so all cases are resolved through an employer-designed, secret arbitration system rather than in court.

One crucial aspect is the adoption of federal standards under the Employee Retirement Income Security Act of 1974 (ERISA) for administering work-injury benefits. A state insurance or self-insured guarantee fund would not back up an opt-out employer that defaults.

With continuing legal challenges to workers’ compensation, including recent lawsuits against Uber and Lyft seeking court approval to mandate workers’ compensation benefits for “app assigned” work, traditional workers’ comp may give way to modern versions of the opt-out programs. The goal would be to create a more seamless benefit program that participants hope will take out the litigation components that have haunted the “no-fault compensation bargain” that began just more than 100 years ago.