Workers Comp 20/20: The Future Of Self-Insurance And Other Alternative Risk Funding Options

St Louis, MO (CompNewsNetwork) - For years, companies have found alternative risk funding options for workers' compensation to be an avenue that pays fruitful dividends in the short and long term. There are several options within the alternative risk funding realm:

Self-Insurance 
This is almost always the most cost-effective option available for employers. The employer accepts direct responsibility for payment of its claims. Employers purchase excess coverage to cap their liability on large losses. The biggest strength of self-insurance is it gives the employer total control over its insurance program with the least amount of frictional costs.

Large Deductible
A large deductible policy combines the loss sensitive nature of self-insurance with the structure and some of the expenses of a first-dollar program.

Captives
This option involves the employer establishing an insurance company to handle its insurance needs. Employers pay premiums to the company like they would any other carrier. There are some tax advantages to this, but the long-term costs are significantly higher than under self-insurance or large deductible options. 

History and growth of Alternative Risk Funding
Self-insurance and large deductible workers' compensation has grown steadily over the years. When rates for primary insurance became extremely high in the 1970s, companies turned to self-insurance as a more economically viable way to cover work comp. Now, almost 50% of America's workforce is covered under self-insured or large deductible workers' compensation. Although insurance rates have increased and decreased over the years, the number of employers choosing self-insurance and large deductible programs has continued to rise. This is due to the significant cost savings that can still be realized from the reduced overhead and increased efficiency of these programs combined with a more focused emphasis on loss control and accident prevention. Employers also prefer the control over their workers' compensation program derived from these alternative financing arrangements. 

The Future of Alternative Risk Funding
Many factors will shape the landscape of self-insurance in the next 10 years. In the short term, the tumultuous economic activity in the last two years has caused collateral costs for employers to increase significantly because of tightening credit markets. However, when considering the future of alternative risk funding for workers' compensation for the next 10 years, four main issues seem to rise to the top.

The Impact of Healthcare Reform

Recent passage of healthcare reform legislation could have broad implications to the workers' compensation industry. There is uncertainty about how healthcare in the United States will look in 2020.  Taken to the extreme, there is potential that medical costs could be taken completely out of the workers' compensation arena due to implementation of 24-hour medical coverage. On the flip side, if reimbursement rates for Medicare and group health remain flat or decrease, the medical community may shift costs to workers' compensation in order to make up these revenue deficiencies. Traditionally, utilization and costs for aggressive treatment in workers' compensation can be significantly higher than treatment for the same diagnosis under Medicare or group health. This gap could increase even more in the future. 

Regulatory Environment

The alternative funding market, like all insurance markets, is subject to regulatory oversight. Over time, regulators and agendas change, and such changes could impact the alternative funding market.

Support for individual self-insurance is still strong in most states, but a number of jurisdictions are considering tightening collateral requirements. This consideration may be a result of several factors, including recent employer insolvencies, the economic conditions of the last few years and the misguided belief among some regulatory agencies that collateral is the only means by which a state can mitigate default by a self-insured entity. This could increase the costs for self-insured employers in the future. 

Also, for several years the federal government has been considering changing the tax treatment of captives. This could reduce the tax advantages associated with this alternative risk option. 

Rising medical costs

It is no secret that claim costs are on the rise. What is unclear is how significant these increases will be in the next few years and what affect they will have. Through studies on claim severity conducted by Safety National, we have found that large loss incurred costs have increased by more than 20% in the last two years. There are many reasons for this. Increases in medical expenditures continue to outpace inflation. Ten years ago, medical costs represented 40% of total claims expenses. Today, medical represents 60% of workers' compensation costs. On high-dollar claims, medical represents an even higher percentage of the total exposure. Additionally, industry data and Safety National's experience indicates that co-morbidity factors such as obesity and the aging workforce are significantly increasing medical costs. Finally, the utilization of opioids, or narcotics, continues to rise at alarming rates.

It's also important to note that advances in medical treatment contribute to rising claim costs. Ten years ago, an injured worker with a severe spinal cord or brain injury had a very short life expectancy. However, medical advances are allowing these injured workers to live longer and with a higher quality of life. In addition, new prescription drugs are constantly coming into the market. These new drugs cost significantly more than the current drugs being utilized, because there is no generic equivalent available. 

These increasing claims costs are having a significant impact on the traditional workers' compensation market. In many states, the industry combined ratios are over 100% despite declining numbers of indemnity claims. In order to stay solvent, the carriers will be forced to raise their rates. When this happens, it will likely result in even more employers turning to the lower costs associated with alternative risk funding.

Employers Turning to Unbundled Claims Options

One of the many reasons employers are turning to self-insurance is the ability to better control costs by contracting through a third-party administrator (TPA) or self-administering claims services. This allows the employer the benefit of a more hands-on approach to claims handling rather than being forced to rely on a primary carrier's process that, in many cases, does not have the focused attention necessary for the best outcomes. We see many companies switching to, and staying with, self-insurance not only because it allows for better control of their cash-flow, but because it allows them to ensure that their injured employees are receiving the best possible care. Employers like the option of being able to select the claims handling option that is best suited for them, whether by finding a TPA that best meets the exact needs of their company or through the self-administration of their workers' compensation claims.  

Conclusion
What will the alternative risk market for workers' compensation look like in 2020? In all likelihood, very similar to how it looks today. Our expectation is that self-insurance and other alternative funding options will continue to be the preferred choice for most employers. The lower costs and control associated with alternative funding mechanisms will continue to be attractive to employers who are focused on reducing employee accidents and ensuring that their injured workers receive the best possible care.  

About the Workers' Comp 20/20 Series:
This series asks the basic question, “What will the workers' compensation industry look like in 10 years, in the year 2020?” Numerous professionals and well known industry experts have agreed to contribute to this series, which is designed to evoke discussion within the industry. To that end, your comments below are encouraged and welcomed. Please tell us what you think!

You may read more articles for the 20/20 series here.

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