A loss sensitive rating plan……
such as a high-deductible plan is an alternate method of financing an employer’s workers compensation risk from guaranteed cost programs. Under a guaranteed cost policy, an employer pays a “fixed” premium each year based on the company’s rating classifications and payrolls, the one element which can vary during the course of the year is payroll, which is why an audit is conducted at the conclusion of each policy term to determine the proper payrolls and charge appropriately for the actual exposure.
Under a loss sensitive rating plan, the employer is willing to assume a substantial amount of risk for the trade off of lower premiums. The most common type of loss sensitive rating plans is the use of a high deductible program, followed by retro-rated plans, dividend plans, and self-insurance. Since most of the loss sensitive rating plans for middle market firms fall into large or high deductible programs we’ll focus our discussion here.
The High Deductible Plan
In a nutshell, a high-deductible plan will have a per claim deductible of $100,000 or greater ($250,000 is common). The trade-off of assuming this much risk, is that the insured’s premium is greatly reduced. Sometimes as much as 50% from their guaranteed cost plan. As the insurer pays for claims in a high-deductible plan it will draw down the insured employer’s cash balance account which is established at inception, or bill the insured at the end of the month for payments made. If the insured fails to make payments back to the insurer, the insurer can draw on a letter of credit established at policy inception which is used to collateralize the insured’s obligations under the plan. There is a maximum aggregate stop-loss which will be the most an insured will have to pay for all claims under the policy and that is typically around 110% to 125% of the insured’s guaranteed cost premium. This way the insured does not face unlimited liability and has the top end of the risk covered.
As mentioned, most small and medium sized employers will use a guaranteed cost workers comp to finance their workers comp risk. The costs are fixed, there’s no downside risk, and once you decide who your insurer is, there’s not much to worry about. So, when should an employer start to think about moving away from a guaranteed cost plan and towards a high-deductible plan?
The starting point is usually when workers comp premiums are at $250,000 or greater. Below that figure it’s difficult to make an actuarial accurate decision. While that’s the starting point for considering a move to a loss sensitive plan, there are several other considerations.
The first of which is the company and its owner’s risk tolerance. Can the company owners stomach fluctuations in risk financing costs with each incurred claim in addition to the reduced premium? Do they have the tolerance to know that the total cost could well exceed the costs of a guarantee program if claims blow up, out of proportion from prior years? Are owners ready to accept potential liabilities that could extend for years to come as some losses may take 5 or more years to close?
For employers moving to a loss sensitive rating plan there needs to be an understanding that they will need to be more engaged in the claims handling as well as the risk control aspects of their business. Hopefully this is something a larger employer is already engaged in, but with greater “skin in the game” they will need to be more aware and engaged in preventing claims and paying claims. This can be time consuming as well as demand a certain level of expertise in the C-Suite depending on the size of the company, so being prepared for that in advance will help the transition to a loss sensitive plan.
With guaranteed cost insurance the insurer has the full obligation of paying claims, with a loss sensitive plan the insurer still is obligated to pay claims by contract, so they have the risk that they will not be reimbursed by the insured. To hedge that risk the insurer will require the insured to provide them an irrevocable letter of credit, set at a level equal to what they anticipate future claim costs will be. That collateral level will be adjusted annual (sometimes more frequently) to cover incurred claims and future claims based on historical experience. This of course ties up an employer’s credit facilities, so careful consideration needs to be given to future credit needs of growing the business, in addition to securing this collateral obligation.
Claims Experience & Risk Control
It should go without saying, but an employer should not consider a loss sensitive rating plan until they have a firm grip on workers comp claims as well as their own risk controls to prevent claims from occurring. If an employer’s claim history is erratic or lacks consistent improvement, then a loss sensitive plan may not be appropriate. Also, if the employer does not have a solid risk control and loss prevention program in place and may have been “lucky” about claims performance in the past, then a loss sensitive plan may not be a good idea. Having both a history of good claims performance and a solid risk control program should be a prerequisite before considering a loss sensitive rating plan.
As the insurer pays claims or incurs claims, they will withdraw those payments from an employer’s bank account. These payments could be small for a first aid type claim, or they could be large for a serious injury involving a hospital stay. Whether it’s $400 or $40,000 the employer needs sufficient cash on hand to pay the withdrawal demands of their insurer. This goes back to the first bullet point of Risk Tolerance; there’s a certain mindset needed by employers engaged in loss sensitive rating plans to accept this up and down roller coaster of payments, as well as sufficient free cash flow to cover these obligations.
All these financial and emotional obligations cannot be left to guessing whether a loss sensitive rating plan is right for you. Simply spread sheeting your options and hoping you’re making the right decision probably isn’t the smartest thing to do. That’s why we believe engaging an actuary to help you make these decision is a good investment. Not only will an actuary help you quantify the risks you’re facing, but they’re also give you guidance on how to best structure a program for the long term.
These are the major considerations an employer should be thinking about before jumping into a loss sensitive or high deductible rating plan, but there are others. For more information on alternate risk financing of workers compensation risk, contact us for a conversation.