Workers’ Compensation is often a key concern for risk managers, CFOs and business owners. Most employers have seen rising Workers’ Comp insurance costs over the past few years, and this trend is not expected to let up. To cut out insurance carrier profit and capitalize on the law of large numbers, many Fortune 500 and other large corporations self-insure their Workers’ Comp via a captive insurance company. This approach is cost effective and incentivizes risk managers and safety departments because their work can be directly tied to corporate profits (tied to the profits of the captive insurance company).
However, a Workers’ Comp captive arrangement can be quite complicated and usually requires either a fronting company arrangement or the posting of a large bond. Programs also have to comply with federal and state laws. For these reasons, it is particularly challenging for small and mid-size companies to employ the same Workers’ Comp approach as large companies.
Nevertheless, small and mid-size companies can still utilize captive insurance arrangements to help control their Workers’ Comp insurance costs. This article will briefly discuss two approaches.
The first approach is for a group of small or mid-size employers to pool risk in a shared Workers’ Comp captive insurance arrangement. This approach usually results in three layers of payment for claims. The first layer is retained risk and paid for by the employer. The second (and most important) layer is insured and paid for by a shared captive insurance company. Typically, the companies will be shareholders in the same captive insurance company. The captive will issue insurance policies to all member companies. In a shared captive arrangement, employers can spread risk and share payment for major claims. This arrangement almost always requires a fronting company. The third layer is a “stop-loss” layer. The captive insurance company purchases a stop-loss policy from a commercial reinsurer for catastrophic claims (claims beyond the captive’s policy limits).
The second approach is to include Workers’ Comp as part of a company’s overall Enterprise Risk Management (ERM) strategy. One common aspect of ERM is to blend or overlap commercial third party insurance cover with cover from a captive insurance company. This is usually achieved by purchasing a high deductible commercial policy and insuring the deductible via the captive. A fronting company is not required and the overall set-up and compliance burden is much simpler. This approach can be especially effective in businesses with few claims and less risky work environments (EG offices jobs). Low claims years result in both third party insurance cost savings and asset accumulation in the captive insurance company. Without a captive and ERM strategy in place, many businesses with good Workers’ Comp loss history are simply paying for the losses for other companies and funding insurance company profits.
A “captive” is simply an insurance company with the same or related ownership as the primary companies it insures. In recent years, competition between domiciles (states and off-shore) has significantly driven down the cost to establish and operate a captive insurance company.