Industry professionals discuss how a captive can be used to provide coverage for the long-tail risk of workers’ compensation, and how the COVID-19 pandemic has impacted this market
Workers’ compensation refers to the provision of benefits to workers who suffer injury or illness while on the job. This can take the form of medical treatment for work-related conditions, cash payments to replace lost wages, temporary total disability benefits, or vocational rehabilitation benefits, according to the US Social Security Administration.
Agnes Hoeberling, CEO of InterCare Holdings, explains: “Workers’ compensation is a type of insurance coverage that is required for all businesses to cover their employees when they are injured on the job or become ill from their job. Benefits include payment for lost wages from time off work to recover from the injury or illness, medical treatment, disability benefits from permanent impairment, money for retraining, and death benefits.”
Before workers’ compensation laws were introduced in the US, an injured worker had no other option but to bring a tort suit against their employer to prove employer negligence caused the injury. Although it was unlikely that employees would recover damages, employers also disliked this system as they were at risk for substantial and unpredictable losses if the employee’s suit was successful.
Therefore, both sides favoured the introduction of state programmes on the basic principle that benefits would be provided to injured workers without regard to fault, while in return employers would face limited liability.
Although the Employers’ Liability Acts mitigated the defence of contributory negligence, it fell to the states to take responsibility for designing and administering workers’ compensation programmes.
Across states, programmes vary in terms of who is allowed to provide insurance, which injuries and illnesses are compensable, and the level of benefits. State laws generally require employers to obtain insurance or to prove they have the financial ability to carry their own risk.
Jason Wheeler, vice president, national sales and account management, CorVel, notes: “Almost all states require that employers have workers’ comp insurance. A majority of employers buy workers’ comp insurance coverage through private insurers or state-certified compensation insurance funds.”
Owing to the fragmented, state-based nature of workers’ compensation programmes in the US, there is no central data source, although organisations such as the Workers Compensation Research Institute collect statistics, benchmarks and the medical price index on a state basis.
However, it is recognised that medical costs are often the most significant expense for companies in terms of workers’ compensation. Therefore, it is fundamental for a company to have sufficient tools in place to help mitigate medical costs for claimants.
Statistics compiled by the US Department of Labor and Bureau of Labor reveal that the most significant losses arise from productivity, as employees must take time off work from an incident. The top private industry occupations with the highest number of injuries and illnesses are labourers, truck drivers, janitors and cleaners, nursing assistants, and general maintenance and repair workers.
A Fitch Ratings report examining trends in workers’ compensation insurance in June of last year identified that workers’ compensation underwriting performance continued to remain strong in 2021 owing to recent reductions in claims frequency and further recognition of material reserve redundancies.
Maggie Jaltorossian, senior vice president of the workers’ compensation division at InterCare Holdings, explains: “Businesses are experiencing flat or slightly reduced rates because of the decline in claim volume from the COVID-19 pandemic, except for some specific industries like healthcare, retail and public entities with first responders.”
She adds: “Since the COVID-19 pandemic, we have seen an increase in inquiries into captive programmes and pools. The top workers’ compensation concerns continue to be the rate adequacy, the long-COVID impacts, rising medical costs and benefits, retaining and attracting talented claims professionals and shifting of workforce and workplace, as well as mental health and wellness.”
In this current environment, David Dougherty, captive producer at Atlas Insurance Management, notes that from a carrier perspective, there will likely be a push to write more guaranteed cost or low deductible coverage, because this provides a larger piece of the underwriting profit for the carrier.
He continues: “On the flip side, insureds will look to take more risk on their workers’ compensation coverage to gain a premium savings. This is especially true for those insureds who are performing well; their strong performance should give them confidence to take on more risk.”
Captives and workers’ compensation
In workers’ comp coverage, captives offer to fund the deductible and take the working layer of risk, which reduces traditional insurance costs while giving the beneficial owners the opportunity to use risk management practices to achieve a higher underwriting profit. Jaltorossian notes that, while smaller employers generally cover their workers’ compensation through primary insurance policies, a growing number of medium-sized companies are joining programmes and exploring the feasibility of group captives. Larger companies tend to self-insure, or else have large deductible programmes and purchase excess policies.
Wheeler says: “Workers’ compensation is a great line to have in a group captive as it is the most predictable line of coverage. It also has a longer-tail, where interest can be earned, although not as much today as other years.”
“Management of workers’ compensation injuries is essential, first to get the employee well and back to work. Second, to ensure that the care provided is appropriate and cost-effective. Captives are highly incentivised to invest in outstanding care and case management for injured workers because they are the ultimate payer,” he adds.
Affirming the advantages of captives for workers’ compensation coverage, Dougherty notes: “A captive offers control over claims and the insured’s data, stability of overall insurance costs, and predictability of cash flow by pre-funding losses.”
He adds that a captive can be employed to reimburse an insured’s large workers’ compensation deductible, with pre-funding losses providing the captive with the ability to establish reserves.
“Captives allow an insured with good workers’ compensation performance to benefit from that performance by sharing in the underwriting profit. Workers’ comp can be a premium driver, so for those insureds who already have a captive in place, adding this coverage can help offset the performance of other lines in the captive, making it more of a self-levelling ship.”
Hoeberling notes that captives also allow greater flexibility in domiciliation, both onshore and offshore, as well as having a captive manager that is responsible for the finance and administration.
“There is more flexibility on investments — more choices on the investment portfolio and, depending on the investment portfolio, may also generate a larger return. The tax advantages are also more considerable, and there is a heightened focus on loss prevention,” she adds.
Furthermore, Hoeberling contends that larger employers with large deductible programmes can benefit from using a third-party claims administrator (TPA) to focus on expedited claims management.
This is affirmed by CorVel’s Wheeler, who explains that TPA services can include customised provider networks, utilisation and bill reviews, and ancillary benefit management to oversee total spend and utilisation. TPA services also encompass pharmacy benefit management to provide visibility into prescriptions, reporting and trending, and case management with visibility to risk scores, clinical modelling, adjustor notes and documents.
“There are many positives to an unbundled TPA and loss control programme in a captive. The captive can limit the TPA authority to settle claims or increase reserves. This is a whole new dimension for the insureds to have a say in, and understanding of, why a claim is being settled at a particular amount. Depending on the captive structure, there will, or should be, peer pressure not to have the worst losses in the programme, since the other captive members will share all the losses. This peer pressure is a good thing, as it focuses management on preventing losses and managing their claims,” Wheeler explains.
This loss control is highlighted as a key advantage of captives, with most group captives employing standard safety operating procedures (SSOPs). Since being part of a workers’ comp captive does not guarantee lower premiums or dividends, losses must be reduced.
“Most group captives will engage loss control experts that specialise in their industry. Working with the loss control experts, the insureds will come together and develop best-in-class SSOPs. The purpose is to reduce losses and get more employees home safely every day,” Wheeler affirms.
Challenges
However, there are obstacles in using a captive for workers’ comp, particularly for COVID-19-related claims. Logistically, it is extremely difficult to prove claims by healthcare workers that contracted the virus at work. Some states are forcing carriers to accept compensability for these claims, which for large employers could cause a significant amount of claims and liabilities.
Wheeler says: “The primary risk is that the employer, through the captive, can potentially hold huge risk involved in a major workers’ comp loss. Captives can be costly to establish and incur ongoing costs to be maintained.”
He continues that there are several other cost and tax considerations: “If you decide to self-insure using a captive, the best long-term strategy might be to invest heavily in safety and loss control. Essentially, the more you invest in safety, the higher chance that you will incur fewer losses that you, as the captive owner, may have to pay.”
A captive can mitigate these challenges through robust capital management, which begins with the company considering whether they want to keep a large portion of their event risk on the balance sheet and allocate the required capital, or allocate the risk capital through insurance premiums and retain the passive risk demanded by the insurance providers.
Noting other challenges that may arise, Dougherty adds that carriers are beginning to use workers’ comp coverage to write other property and casualty lines. He explains: “A carrier may provide more aggressive workers’ comp rates to write the general or auto liability lines, which could lead to the traditional market offering rates that are competitive enough that a captive may not make financial sense.”
Jaltorossian points out that, as with any programme, results are likely to fluctuate unless properly managed. For a captive to offer a cost-effective solution, therefore, it must be structured to allow policyholders to participate in the profits of their own risk as well as the cost, and be able to pay claims and secure future losses.
“To fully realise the value of a captive programme, policyholders must be in it for the long-term due to the fluctuations in risk, loss costs and investment return. Over time, the risk and cost balances itself out and there is greater return on the investment. All things considered, if policyholders are aligned in their risk control, loss prevention and underwriting policies, over time they should realise an investment income,” Jaltorossian explains.
The challenges of long-tail risk
CorVel’s Wheeler highlights the two most significant challenges in using a captive for workers’ comp to be the following:
Closing out an underwriting year: workers’ comp has a long-tail, meaning it may take years to close a claim based on the injuries.
The captive should wait to release underwriting profits until all claims are closed and the possibility of claims reopening has passed.
Collateral: since most group captives are unrated, the fronting company will need to have a letter of credit or cash securing the unearned premium and loss reserves.
The amount of collateral is generally between 30 and 35 per cent of the premium collected for each of the programme’s first three years.
This is because the fronting company is ultimately responsible for paying claims, so must maintain collateral equal to the underwriting year’s ultimate expected loss.
Evolution
Looking at the future of workers’ comp coverage, it seems inevitable that the ongoing effects of the COVID-19 pandemic will include clarification around the inclusion or exclusion of infectious diseases and pandemic coverage.
Atlas’ Dougherty affirms that US states may follow suit of Tennessee and Washington in passing laws to extend workers’ compensation presumptions around infectious diseases and public health emergencies.
“These presumptions allow for employees to claim workers compensation more easily from infectious disease with the burden of proof falling on the employer to prove the disease was not contracted at work,” he explains.
He adds that the COVID-19 pandemic has spurred growth in telemedicine, citing that eight per cent of all primary care visits were done through telemedicine in 2021. Digital healthcare has transitioned to the best practice for employers seeking to reduce their workers’ comp claims costs.
Wheeler reflects: “There have been several disruptions to the workers’ comp market during the pandemic. Specific very risky industries — where workers’ comp costs can be very high and so often used captives — may have seen an economic downturn and lower workers’ comp costs. All these issues factor into deciding whether to use traditional insurance or self-insure using a captive.”
“The overall drive for more control and better management of injured workers is anticipated to make captives an attractive option. The cost benefits of captives versus third-party insurance premiums continues to hold,” Wheeler concludes.
