Monday, May 14, 2012

Alternatives to Work Comp and Long Term Issues

I had a couple of interesting conversations last week at the NCCI Annual Issues Symposium about alternative risk management in workers' compensation, instigated by discussions on what I thought would be disruptions to the marketplace should Oklahoma non-subscription take hold.

As you likely are aware, it is my opinion that non-subscription represents a real threat to the workers' compensation insurance market and will constitute significant competition for the risk management dollar should the idea spread to other states. Indeed, Stephen Klingel in his State of the Line address acknowledged that many states were watching Oklahoma to see what happens and that this could represent a challenge for the industry to compete against.

One issue with non-subscription that I presume would need to be dealt with if this option were to be a viable alternative to traditional workers' compensation insurance and stay within the Oklahoma mandate that it provide the same or better benefits to injured workers is the life time medical provision - under ERISA plans there are no guarantees of continuing medical beyond the employment period.

In workers' compensation, medical treatment for the condition deemed to have arisen out of and in the course of employment is covered for the life of the injured worker unless compromised by a settlement agreement. I am unclear how ERISA plans would provide for this requirement but I suspect that those who put together such systems have this worked out.

One aspect of non-subscription that plays well to the work force though is the tendency of non-subscribers to become completely obsessive with safety.

In conversations I had at NCCI with people that have been studying the option, employers that do non-subscribe in Texas with ERISA plans are vigilantly safety-conscious because a failure of safety by the employer exposes the employer to big civil damages.

As for the impact on the industry - that is a big unknown. I talked with several actuaries at NCCI. They expressed that the concern over reduction of insured base upon which to spread risk was voiced when large deductible programs were introduced, but the experience was just the opposite.

However, non-subscription is different. Non-subscription takes an employer completely out of the risk pool, while large deductibles keep an employer in the risk pool, albeit at a different loss level.

Another matter of concern should be financial fundamentals of the entire risk management scene - i.e. what happens when a non-subscriber folds, becomes insolvent or otherwise is unable to take care of its obligations.

The one beauty of the workers' compensation system is that an intermediary, i.e. insurance company, takes the financial risk and pays fees and taxes into state systems that guarantee performance if the insurance company can no longer function. Self insureds likewise make payments into guarantee systems to protect injured workers over the long term.

This backstop was beautifully played out in the late 1990s when so many insurance companies fell victim to the intoxication of Unicover brew and laid so many claims into the hands of state insurance guarantee associations.

The risk is playing out now with self insurance groups (SIGs) finding all sorts of financial issues with their programs.

For instance the Healthcare Industry Self Insurance Program of California is encouraging former members to rejoin to help secure the long-term solvency of the self-insured group by offering them the option of paying their liabilities in installments after seeing membership decline in 2009 and 2010 making funding the long-term liabilities of the group a challenge.

One of the oldest self-insured groups in Nevada, the Nevada Restaurant Self-Insured Group, was winding down at the end of 2011after deciding it is no longer financially practical to continue taking on risks, forcing more than 1,700 employers to find a new source for workers' compensation insurance, some who have been covered by the group since it was founded in 1995.

And all of us have seen the mess that has been created by the failure of Compensation Risk Managers and the ongoing litigation and financial aftermath of those programs.

This is all brought home by the recent announcement that the Orange County Board of Supervisors in California adopted a resolution that its self-funded workers' compensation program is to be brought back up to 80% funding of estimated losses over the course of the next five years, moving $2 to $3 million in departmental budgets into the work comp fund.

So where does all this lead us?

Every employer that is part of a SIG, a captive, a Retro Plan, a High Deduct, or has coverage with an A- carrier needs to take a look at the financial underpinnings. We assume that smart people know what they're doing when entering into alternative risk propositions to cover the mandated obligation towards those in the employ of the company.

But we made bad assumptions about those people in many past instances of failed pension plans. Workers' compensation, when one gets down to the basics, is nothing different - it's all about conservative and robust financial planning.

I'm still intrigued by Oklahoma style non-subscription. I think it brings significant market competition to the workers' compensation insurance industry. But these long term issues need to be addressed.

And my guess is that if such optional plans take off in the future, some smart insurance people will put together new specialized products that put all the elements together and address the long term risk issues.


  1. David,

    This is an excellent article. I thought about it for a while and believe a much bigger issue is at stake.

    When it comes to insurance companies and the products the offer, ‘You have to be careful what you ask for because you just might get it.’

    If we’re going to explore alternative risk coverage, we need to tread carefully. It is going to be very difficult to see down the road (and around the corner) to determine what the ultimate consequences of the new risk coverage schemes.

    The basic premise I work with is that ‘the other side’ knows everything I know, and they know things I don’t know. This always gives them a huge advantage. By definition, the relationship between an insurer and the insured is adversarial and zero-sum. In order for one party to gain, the other must lose.

    Think of this – an insurance company will write you a $5 million policy against the Sun coming up tomorrow. Of course, the premium will be $5 million, plus administrative costs, less interest income, plus a profit for committing $5 million in capital for one day.

    If employers get involved in alternative risk scenarios, the first question is, ‘Who will insure the Risk?’ To the degree the employers shoulder the risk, the costs will be greater and the risk for disaster will be higher.

    The primary driver of lower insurance costs is the size of the ‘pool’. A pool of one, or five, or forty, will always cost far more than if the pool had one thousand members.

    If the insurance companies fashion new risk coverage products, there is a great likelihood they will be far more sophisticated, understand the risk better, and will price their knowledge advantage into the premium. This doesn’t mean that the alternative risk coverage won’t be less expensive than the existing coverage – it does mean it will likely cost more than it should.

    The second potential risk is that the insured might not be getting the coverage they assumed they were getting. The new products will be complex. Exactly how it will pay out won’t be known until losses occur, the carrier comes forward with what they WILL pay, and the conflicts work their way through the legal system.

    In a prior life, I worked as a Title Officer. I worked with four separate insurance companies – two national firms and two local California firms. Towards the end of my career as a Title Office, I had the position of Advisory Title Officer. When I tell people that, they always ask the same question, ‘What does an Advisory Title Officer do?’ Simple – that’s when the insurance company knows they have suffered a loss and are trying to figure out how not to pay it.

    Assume for a minute, regardless of how the risk coverage is structured in the future, no state government will violate the ‘Great Covenant’. That is, employers will provide injured workers a benefits system that will provide ‘all requisite (reasonable?) treatment to cure and relieve’.

    Larger companies with higher premiums, and presumably more capital, are already engaged in alternative risk schemes that allow them to price their loss portfolio very near actual costs. Incidentally, we’ve seen how well that works. For the most part, it works very well. But, when it goes bad, the explosions are spectacular. We assume we can regulate a conservative risk-free insurance scheme but the landscape is littered with the failures.

    Giving larger companies new ways to hedge and price risk doesn’t seem to be necessary or even desirable. Giving smaller companies the opportunity to opt-out of the existing system will increase the risk of disaster and lower the ‘pool’, thereby driving up the costs to those that stay in the pool.

  2. Great points Bill. I received a comment from a non-subscriber in Texas in response to this column and his point was that their insurance contracts do, in fact, cover the employee at all times regardless if the worker no longer works for the insured employer or if the employer goes out of business. So there is some risk management akin to the Grand Bargain. The bigger question as you raise is what all of this means to the economics of the rest of the employer population vis-a-vis traditional coverage.