Monday, January 20, 2014

Innovation At The Front End

Most of what we become concerned with in workers' compensation is the end result: claims.

But the front end of the equation, preparing against the financial risk of claims, should draw attention too, particularly when some very creative techniques and methods are being devised and deployed. After all, the first part of the grand compromise was devised to spread the risk of financial ruin to a broad base of employers.

A lot of attention recently has gone towards Oklahoma and its newly passed "opt out" laws, but under more traditional systems self insured employers have found relief by partnering up in groups and then seeking alternative security programs.

The ability to engage in such a strategy is highlighted in California with last year's SB 863.

While most of the work comp world and media has focused on the extreme changes to claims processing, medical treatment and billing (including liens), what has largely been passed over is that nearly half of SB 863's voluminous tome was all about self-insurance.

A huge change to the law regarding security deposits coming out of SB 863 is that the bill eliminated the requirement that self-insured employers and groups post collateral at or above 135% of their estimated future liabilities. Instead, security deposits are now calculated based on actuarial studies due Dec. 31 of each year projecting liabilities at an 80% actuarial confidence level.

Some smart brokers have figured out that they can pool self insureds into groups, then collateralize their security requirements with a more traditional insurance mechanism. A bank issues a letter of credit that the groups can post to satisfy security deposit regulations. The letter of credit is backed by a credit insurance policy that transfers the risk back to the insurance market.

In 2003, Marsh & McLennan Cos. created the Alternative Security Program as a way to free up working capital for some self-insured employers. But it wasn't until SB 863 that there was any viability to the program.

In addition to the new rule requiring actuarial-based security deposits, California already required that the claim administrator, the company managing the group and the group's actuary all be independent. 

“When you're looking at the credit worthiness of groups, you look at the regulatory framework,” Quentin Hills, managing director of MMC Securities Corp. told WorkCompCentral. “California, which requires segregation of duties, is a positive. If you didn't have that, you'd increase the risk and then get into questions of price and whether you can do it at all.”

The Alternative Security Program for self-insured employers was the first of its kind in the nation and has since been implemented in North Carolina. Several other states, including Minnesota and Washington, are also looking to implement similar programs.

Groups typically would have had to rely on bonds to ensure adequate cash flow, but bonds require collateral of about 50% and the instrument also costs about 2% of its value, consequently the market was limited, which constricted the ability of the self insured employer to negotiate a better deal. Being able to use an insurance product to ameliorate the risk frees up this cash.

While being part of a self insured group may be more expensive initially, the huge upside of freeing up cash flow because of the reduced security requirement makes the alternative much more attractive to large self insured employers with the resources to use the strategy.

The alchemy of finance has always amazed me.

My finance professor in business school reiterated every single class from day one the golden rule of business finance: "Cash is King." SB 863's amendment to security deposit requirements and the ASP strategy embraces that maxim.

Keep the cash flowing so the bills can be paid which keeps everyone working. After all, if there is no work, there is no workers' compensation...


Post script - clarification from Joe Burgess, Sr Exec VP at CHSI: the 80% confidence level referenced is not in the regs now and the requirement per 863 is that the security deposit equate to reserves at the expected confidence level, as opposed to 80%.  At the time 863 went into effect on 1/1/13, Jon Wroten included in the emergency reg package a change to expected from 80%.

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