Thursday, January 22, 2009

Self Insurance and Workers' Compensation

I read the following headline recently: "North Dakota Weighs Letting Firms Self-Insure for Workers' Compensation" (see Insurance Journal, Midwest News, January 20, 2009). The article briefly outlined an initiative that would allow self insurance and alluded to various other states that are monopoly providers of workers' compensation coverage. Unfortunately, the article does not define self insurance or the various forms of workers' comp insurance arrangements.

A self-insured firm in a workers' compensation context, is one that carries the risk of work-related injury, illness and disease to its employees without pooling or sharing that risk with other employers. For individual firms with enough employees and a stable injury rate, the risk can be quantifiable and, over time, the costs can be predictable.

Self insurance can be with or without self administration. Self-administered firms come in a range of 'flavours' along a continuum between the following extremes:
  • all aspects of claims management and rehabilitation handled internally for their own employees
  • all (or almost all) of the administration contracted out to a third party.
Self insurance without Self administration usually leaves the adjudication and administration of claims to the state agency with the firm carrying the costs of injuries and paying for the administration. WorkSafeBC, for example, has Deposit Class employers who are essentially self insured but the claims from these employers are handled just as they would be for all other insured employers by WorkSafeBC.

It makes little sense for small or medium sized firms to self insure. Work-related injuries are relatively rare and serious injuries with high costs are thankfully even rarer. Unfortunately, one rare but costly work-related injury could bankrupt a small firm. As with other risks of rare events (fire, flood, third party liability), it makes sense for most firms to be insured. And since administering workers' compensation claims is not the core business of most firms, self insurance is rarely considered even where it is offered.

Allowing self insurance where it does not exist or expanding it can create a lot of additional and unanticipated costs. There are monitoring costs by the insurance regulator, the question of appeals or dispute resolution and the assurance, bond or other security the self-insured firm normally has to post with the state to guarantee payments should the firm be unable to do so. This last point was unthinkable a few years ago but the viability of once blue-chip firms is a painfully real issue in light of the current economic crisis.

Allowing or expanding self insurance has other consequences for the remaining insured parties or the state. On what basis should the costs of workers' compensation research, oversight and appeals be shared by self-insured firms? Removing firms from existing pools will also have an effect on the remaining firms in the pool. Credibility from an actuarial point of view may be lost and wider swings in premium rates are more likely if the largest firms in a rate group are removed to become self insured.

The article also points out that North Dakota is one of only four exclusive state funds in the US. It should be noted that exclusive state funds are the norm in Canada where each province has made its workers' compensation agency the sole provider of workers' compensation insurance. In a sense, the federal government in the US is also an exclusive state fund providing the insurance administration for federal government departments. (And in some sense, the federal government departments are like self-insured firms contracting with the exclusive insurer for administration).

A few years ago, Best Practices LLP produced a report entitled "Excellence in Workers' Compensation Program Administration". It focuses on very large self insured organizations and how they structure the administration of their programs. Interestingly, the costs for administration vary widely in the surveyed population. More importantly, the costs of the best performing firms appear similar to or higher than those of several exclusive state funds in Canada and the US.

Self insurance with Self Administration may make sense particularly for very large multinational firms if there are no other alternatives. That said, many such firms already operate in states, provinces or countries that do not allow self insurance so the insurance arrangement is not a barrier to locating operations in a particular market.

Self insurance without Self Administration has its place but it also has costs and risks. Any jurisdiction considering introducing or expanding the number of self insured firms in its jurisdiction needs to be aware of these.

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