Can you protect your company from work comp claims with a trust?
By David Parkhurst
The precast concrete industry, like many others, is burdened with the challenge of managing expenses. One of the largest cost factors for a precaster is managing and mitigating work-related injuries. Most precasters use some form of workers’ compensation insurance to help accomplish this, and as such we are always looking for creative ways to manage and contain these costs.
Workers’ Compensation Trusts are a type of non-traditional insurance program often used as a solution. What are these trusts? How do they work? And what are the positive and negative aspects?
What are they?
A Workers’ Compensation Trust is a type of self-insured group insurance plan (also known as SIG) designed to enable its member companies to lower their workers’ compensation costs through several key areas:
- Who can be a member
- Aggressive pricing
- Claims administration
- Loss control
- Fund management
- Member involvement
How do they work?
A Workers’ Compensation Trust establishes a fund for claims through premiums collected from its members. In addition, the trust will purchase reinsurance to cover catastrophic losses of its members. The premiums collected are used to pay hard costs of claims management, loss control and administration. The remaining dollars are used to fund the members’ claims obligations.
Two types of reinsurance are used by most trusts: Specific Excess and Aggregate Excess. Specific Excess reinsurance usually has a deductible amounting to a couple of hundred thousand dollars. For a claim of $500,000, for example, the trust would pay $200,000 and the reinsurance would pay $300,000. The second type of reinsurance trusts normally purchase is called Aggregate Excess reinsurance. This can be used to pay a large amount of smaller claims or a portion of a larger claim depending on program design. The deductible for this is usually a percent of written premium.
The premium dollars paid into a trust are used to:
- Pay hard costs (loss control, claims management and administration, usually between 36% and 48%
- Pay for the first portion of claims up to where the reinsurance kicks in
- Pay dividends of unused premiums back to members
Here are some of the key differences in a trust versus a traditional guarantee cost program:
There are some simple things to consider when considering a Workers’ Compensation Trust.
- Who is eligible for membership? There should be a small, focused group eligible for membership. Members could be homogenous (same industries) or heterogeneous (different industries). Either way, they will have excellent safety cultures and financial strength.
- How is my company protected from the liability of the other members? The members’ financial obligations should be collateralized and underwritten. This ensures payment by the member company if needed, even if it goes out of business or leaves the trust.
- How easy is it for me to exit? Any non-traditional insurance program – and specifically trusts – should be hard to enter and easy to exit. The need to identify your liability is crucial and will determine if it is a smart and viable business decision to enter into a trust. If you are considering selling your business in the next three to five years, what liabilities will you be creating when you are ready to exit your business?
- What happens to my unused premium dollars? Some trusts will return unused premium dollars back to members as a dividend. Some trusts will keep all or a portion of the unused dollars to fund losses and drive continuing premiums lower. Either way, this should be clearly defined, and the management of these dollars is essential to the trust’s performance. Keep in mind that any insurance program is driven by how well the money in its funds is managed, and the purity of the underwriting results (losses divided by premium).
- Who qualifies for a premium return, and how much is that return? Trusts will return unused premium dollars in different ways. They should reward companies based on performance or loss ratios. Most have entry requirements, such as the need for a 70% or less loss ratio, to receive any dividend – it is then up to the board to set up annual dividend guidelines.
- What are the positive and negative aspects?
David Parkhurst is a commercial agent with IBG (Insurance Benefits Group) of Kansas City, Mo., and a member of NPCA’s Safety, Health & Environmental Committee.
SIDEBAR 1: Interview with a Precast Safety Professional
In this interview, Don Graham, director of safety with Jensen Precast based in Sparks, Nev., shares some of the best and worst things he has experienced with Workers’ Compensation Trusts.
Q. What caused your company go into a trust?
A. The company I work for was looking at options to reduce our workers’ compensation premium. At that time in Nevada, there was not an open market for comp insurance. Several associations formed retro programs that evolved into self-insurance groups. Our self-insurance group was able to help select other companies that met the risk profile of the group and also was willing to comply with the group’s requirements for safety inspections, accident investigation and hazard corrections. The end result is a premium reduction greater than 50% based on the cost of the state system.
Q. What was the best thing about entering into the trust?
A. The best thing about our group was the cooperation among the members. All of the self-insurance group members had an incentive to keep the cost of accidents low, so all members participated in aggressive safety compliance inspections quarterly. At the start of each month, all the accidents were reviewed by the self-insurance group board, and then each company had to explain the root cause of the accident and what was done to prevent it from happening again. This was a positive thing, as all of us were working toward a common goal.
Q. What was the worst thing?
A. In the self-insurance group, each member has to agree to joint responsibility for several liabilities. That meant we were taking on the risks of the other companies in our group, and they were shouldering our risk as well. The risk of this liability extends to claims and the total funding of the self-insurance group. An example is if a company in the group has a severe work comp injury and the assigned premium for the group does not cover the loss, then the other members in the group have to pay the difference. Also, if a group is found by a state’s department of insurance to be underfunded, then each group member will be assessed a fee to bring the group’s funding up to required levels.
Q. Would you consider it again?
A. I would not consider a self-insurance group for our company based on the current markets we operate in. In the states we operate in now, the work comp market is open, meaning that any insurance company can offer a policy for workers’ compensation. So-called “first dollar” policies are priced at a level that make them very competitive at this time without the financial risk associated with a self-insurance group.
Q. What would make a trust work or not work based on your experiences?
A. The critical component of any self-insurance trust or group is the companies that make it up. If those companies have excellent safety programs and balance sheets, this can be a great program to save money on insurance rates. If member companies are cutting corners on safety loss prevention, they are usually not a good fit for a self-insurance trust.
Don Graham has served as director of safety with Jensen Precast since 1996. He currently oversees the safety/workman’s compensation programs for all Jensen Precast locations in California, Nevada, Arizona and Hawaii.
SIDEBAR 2: Claims Scenario
Let’s say that ABC Precast joins a Workers’ Compensation Trust. The trust is set up to take care of the first $200,000 of any one claim. This is the “Specific Reinsurance.” It also purchases “Aggregate Excess Reinsurance” designed to limit the liability of the combined total for small claims and the trust’s portion of the large claims. It is normally a percentage of the total written premium, say 50%.
The trust has a $1 million claim. The trust will pay for the first $200,000 of the claim and the Specific Reinsurance will take care of the remaining $800,000. Then the trust experiences a large number of small claims totaling $300,000 for the year. The “Aggregate Excess Reinsurance” is going to take the $300,000, add to it the $200,000 paid for the large claim and pay 50%, or $250,000. So at the end of the year, the total in claims was $1.3 million and the trust paid out $250,000.
A problem you can run into is when there are no funds to pay these costs and deductibles. This usually happens through mismanagement of the investment of the premium fund account resulting in large losses; mismanagement of the fund by issuing too-large dividends to try to attract and retain new members; or ignoring the potential for large claims either incurred and not reported (IB&R) or continuing a claim payment that could stretch over several years. When the fund is mismanaged and dollars are not there to pay costs and deductibles, members are given an assessment. This is when members are required to pay to enable the fund to meet its obligation. Even if you are no longer in the trust, you still may be required to pay these obligations.
Workers’ Compensation Trusts, if put together and managed correctly, can be a viable solution to help manage and mitigate work-related injury costs. However, there are many variables to consider. The more risk a business takes normally turns in higher rewards or, in this case, lower and more controllable costs. Considering this simple statement is crucial: Why look at a trust? In this market, is the risk worth the rewards, or is your program already as aggressively priced or more aggressively priced than it should be? In other words, does it make sense?
It may be a good move for your company, but it can also be one of the costliest mistakes your business can make. It is crucial that you pair yourself with a professional who understands these programs. If it sounds too good to be true, it just might be. Remember, with every reward in business there is a risk. The potential to be in an assessment situation, where all the members end up owing money to the trust, is a huge liability and one that should be researched thoroughly before entering. If you cannot qualify what your worst-case scenario could be, then there is no way you can make an educated decision.