Are You A Risk Taker?
As PEO’s focus on accelerating growth and increased margin opportunity, one of the most common lines of questioning we receive from our customers and prospects center around large deductibles, requirements for obtaining, and whether some form of self-insurance is right for their business. Entrepreneurs by nature are educated risk takers so it’s a common progression for most Professional Employer Organizations (PEOs) to entertain the advantages large deductible plans offer.
Most competitive states allow carriers to file large deductible plans but set minimum premium size requirements for insureds to qualify. Statutory minimums typically range from $100,000 to $500,000 but fall well below recommended thresholds for most businesses. With these types of plans, the financial risk a carrier underwrites is greater than the workers’ compensation risk. Accordingly, a prospect’s financial strength is a very important consideration when a carrier decides whether to offer a deductible program. We recommend deductibles be kept at 10% of manual premium unless a prospect has other financial resources. For example, an employer with $1 million in fully insured manual premium should stay at or below a $100,000 deductible.
An often overlooked prerequisite for any loss sensitive program is a strong risk management infrastructure that understands the underlying exposures and can effectively team with an organization’s agent and carrier partners. With increased risk comes increased responsibility, and any employer considering large deductible needs a seasoned staff with a demonstrated history of results. A good risk manager can also be invaluable with evaluating program types and helping find the best options available.
For employers contemplating more risk-taking, large deductible programs are usually the easiest and quickest available option. Other types of loss sensitive programs, including captives, require substantial filing and administrative commitments. Conversely, large deductibles operate much like a fully insured plan.
The primary components utilized to determine a program’s cost are projected premiums and projected losses. Carriers normally request collateral equal to or greater than one year of projected losses. Historically this was facilitated via an escrow fund, from which the carrier makes claims payments and the balance in a letter of credit. The working claims fund is usually set at 2 to 3 months of estimated claims payments and is reimbursed by the insured as payments are made. A letter of credit is the instrument of choice for most carriers as they can’t be pulled into a bankruptcy to reimburse other creditors.
We’ve additionally seen carriers begin to offer an installment plan where one year’s worth of projected premiums and losses is funded over 6 to 12 installment payments. This is an attractive option for many employers when coupled with a deductible buy-back program to convert claim payments into premium for tax deduction purposes.
Under either of these options, collateral is typically only required during the first few years of a deductible program. As dollars are paid out on claims incurred during year 1, the need for collateral in year 1 is reduced by an equal amount. An insured’s collateral position is evaluated for possible adjustment at 18 months post inception and annually thereafter. At each evaluation, unneeded collateral can be moved to later plan years to reduce future obligations. It’s important for an employer to consider collateral “stacking” BEFORE entering into a program as it presents a disincentive to ever leave a carrier.
While it’s not as simple as the insured pays premium and the carrier pays claims, a large deductible program need not be too complex to function well. Most carriers allow claims administration to be unbundled to a third party, but the larger players usually have good in-house teams that they prefer to use. Most states require carriers to provide employers with the choice of billing allocated loss adjustment expense, up to the deductible, inside of the program or leaving the insured as responsible for paying outside the program.
Ultimate loss costs are calculated using loss development factors (LDFs) promulgated by the carrier’s actuaries and published as part of program documents. LDFs are applied against incurred losses, and typically set based on the deductible level. So for example, carrier actuaries will evaluate the loss history of all their insureds with $100,000 deductible programs when setting the LDFs for a $100,000 deductible. Said LDFs, when applied against incurred losses, reflect an employer’s potential ultimate obligation under a $100,000 per claim deductible.
Carriers sometimes offer a maximum aggregate amount, or the maximum an insured contractually is obligated to reimburse a carrier for, on a large deductible. However, the aggregate is usually set at catastrophic levels and rarely, if ever, comes into play on a program.
Most PEOs ultimately move to a loss sensitive program for two reasons: reduced costs and greater underwriting flexibility. With a good risk management team as well as an experienced agent and carrier partners, today’s market offers large deductible plans that will achieve both of these goals. However, It’s important for an employer to consider a couple of facts when evaluating options.
First, while premium credits ranging from 50-85% certainly seem attractive, when coupled with a poor loss history, they might ultimately be more expensive than guaranteed cost coverage. An employer should always take a conservative look at past loss history to predict future results.
Second, the more risk an employer takes on, the greater flexibility a carrier will provide. If you can only afford an entry level large deductible, don’t expect to write heavy construction, transportation, or staffing risks. You need successful experience in managing those types of risks to reasonably expect future success, especially with a new carrier and new program. Most employers achieve better long-term stability by continuously taking small steps forward, building a successful foundation for future growth.