When employers are self-insured or retain risk associated with their workers’ compensation program, it is easy for collateral costs to spin out of control. It is essential that risk managers and claims examiners understand the collateral process in order to make appropriate, conscious and focused business decisions associated with their workers’ compensation process.
Independent actuarial analysis determines the amount of collateral required based on projected ultimate retained loss, which may include claims administration expenses, incurred-but-not-reported claims, as well as total-known outstanding liabilities. Actuaries also calculate the annual projected exposure for the employers.
This is determined in tandem with the financial rating of the company and current market forces for collateral insurance. Companies with a AAA financial rating will pay much less for $100 million of collateral than a company with a B rating. While actuarial calculations are typically done annually, they may be completed more frequently if there is a significant increase or decrease in the company’s level or exposure, risk retention or financial rating during the year.
If a company does not have a financial rating, due to private holdings or a religious affiliation, the underwriting of the collateral will depend on market forces.
Retained risk and collateral requirements
Some self-insured employers are not completely self-insured. They typically have an umbrella, an excess- or high-retention insurance policy, to protect them from a potential catastrophic event. If an employer retains some of the risk associated with its workers’ compensation losses, it is usually required to post collateral with its excess insurance company for the outstanding amount of risk retained, as determined by utilizing actuaries.
Additionally, self-insured companies are required to post collateral in every state that they do business in, since there remains no national policy governing self-insurance certificates. These states have different organizations that approve self-insurance certificates.
In addition to assessing collateral, most state organizations assess the self-insurers' ability to pay benefits to legitimately injured workers. The different state laws and approaches can turn collateral jurisdiction into a nightmare, affecting workers’ compensation claims, as they typically take much longer to be closed due to differing state regulations.
Some large employers opt out of self-insurance due to government financial requirements, administrative and reporting costs, claims oversight and the collateral requirements of being self-insured. They usually have a high cost deductible or high-retention insurance program where they retain a significant amount of risk.
In this situation, it can be difficult to extract the posted collateral from the insurance company, even if all claims have been closed. The insurance company might try to lower rates for collateral or lower projected outstanding exposures as a financial enticement to retain the insurance business.
Either way an employer goes (self-insurance or fully insured), there is not an exact science as to how collateral requirements go, but it is important to know what can affect different decisions and programs.
Impact of claims process on collateral requirements
Collateral requirements within workers’ compensation are significantly impacted by benefit provision, settlement philosophy and the reserve practices. This is, in part, due to the impact these processes have on the actuarial projection for the ultimate loss.
As long as the file is open, collateral will be required for all of the outstanding projected liability and expenses. It is typically more cost effective to settle a claim than stipulate that lifetime future medical care for a specific injury be given. Delays in claims reporting, the reopening claims, the number of IBNR files, and the cost of closing files can all significantly impact the actuarial projections and may increase overall collateral costs.
Companies need to be honest with themselves when it comes to total liabilities and outstanding reserves. Skimping on an actuarial analysis could end up costing millions of dollars in the long run, as reserves are adjusted upward over time An actuary will calculate the final numbers using the paid and reserve triangles, making the company’s liability explicit.
Collateral expense can be a significant cost for a company’s workers’ compensation program. A good claims administration process, the use of an actuary and a clear settlement philosophy can render a more effective strategy, and account for collateral exposure and expense.
William M. Zachry is a senior fellow at Sedgwick Institute. This column is republished with Sedgwick's permission.
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