Large Deductibles and Collateral Damage

Many of the businesses we’ve worked with have turned to large deductible insurance programs – wise move?   Maybe.  LD programs theoretically give businesses greater control over claims and reduce hard costs while at the same time securing insurer paper and the insurer as guarantor of claims payments (most of the time).  For PEOs and staffing companies, LD’s allow for maximizing revenue on existing accounts and allow for new business expansion.

But while some businesses may save money with LD policies, they may also find some significant headaches – it’s not uncommon for the long tail of insurance (and specifically the workers’ comp claim tail) to force their collateral assets to be tied up for years or to be drawn into expensive litigation or even forced into insolvency unless they challenge some common—and often problematic—terms and conditions of their LD policy programs.

The majority of LD policies generally have deductibles ranging from $100,000 to $500,000 per claim.  The insured pays all claims within the deductible and the insurance company pays any claims that exceed the deductible (though with capped exposure by way of reinsurance treaties).   Pretty simple – right?   And as you’d expect (and rightly so) the insurer generally requires the insured to provide cash collateral or Letter of Credit (LOC) to secure the policyholders’ payment obligations and protect the insurance company from being left holding the bag if the insured has financial difficulties and doesn’t pay claims – Also pretty simple and certainly not objectionable.

The Tail

So what is the problem?  Claims have a long tail – and some of these tails may have shark like heads ready to take a bite.  Insurers are ultimately concerned with their bottom-line (again fair enough) but as we’ve seen, insurers have used  LD collateral calls to prop up their own poor underwriting decisions, maintain valuation multiples and raise cash to meet reinsurer and statutory surplus requirements.   Be aware – there are teeth at the other end of that tail.

The terms and conditions for the cash collateral or LOC typically appear in a “payment agreement,” which the insurance company often presents to the insured as a non-negotiable requirement. Those agreements frequently impose one-sided and wide ranging conditions on the insured that can cripple a business’s ability to control the ultimate costs that drive the LD program. Businesses considering an LD policy program need to scrutinize how these payment agreements work.

How best to protect yourself?   Here are some steps to consider:

1. Negotiate Collateral Terms: Payment agreements often permit the carrier to demand additional collateral at any time. The agreements typically provide no mechanism for the insured to challenge either the amount or validity of the increased collateral demand or to demand a return of the collateral in the future. Instead, the payment agreements usually impose substantial penalties if a policyholder fails to satisfy a demand for increased collateral. Penalties can include cancellation of the workers’ comp policy or liquidation of the existing collateral or as we’ve witnessed, taking a book of business and blowing up the program.
   • Work with insurers to negotiate the type and amount of collateral required. Options include letters of credit, cash, or trusts.
   • Aim for flexible terms that allow for collateral reduction/return as claims are resolved.
   • Include contractual provisions for periodic collateral reviews, with potential reductions as liabilities are paid down.
   • Propose structured release schedules or sliding scale reductions.
   • Understand the Loss Development Factors (LDFs) utilized by the carrier (and question their veracity!)
2. Implement Strong Risk Management:  This is a no-brainer – LD or not.   A good program reduces exposure and punitive insurer triggers – Insured driven control of claims severity and frequency and a good solid loss control program is obvious.  And for a PEO or Staffing company, underwriting and responsible pricing is essential and needs to be part of your DNA.
   • Develop comprehensive safety and loss prevention programs to reduce claim frequency and severity.
   • Monitor claims closely to minimize payouts and have a full hand in good claims management.  Control the tail and avoid the teeth!
   • Manage your exposures – Underwrite / Price to risk / Manage / Control
3. Question Loss Estimates/Loss Picks and Funding Rates: Insurers will estimate the policyholder’s probable future workers’ comp losses based on a “loss pick.” The higher the loss pick, the more collateral or funding will be demanded from the policyholder. In order to justify higher loss picks and higher collateral, insurance companies will often use industrywide data to calculate a business’s “loss pick” instead of the business’s individual claims history which should be better than the industrywide data. Businesses should question the methodology used to calculate the initial collateral demand and, if favorable, advocate for the use of their own individual loss history rather than industrywide data.
   • Require independent actuarial reports to justify a lower collateral requirement.
   • Assure insurer transparency with detailed loss projections.
   • Managing Loss Picks (and reserving basis on claims) is essential at inception and long before each renewal cycle.
4. Leverage Third-Party Alternatives:  A problematic and counter-intuitive provision of most LD programs is that the insurer mandates the use of their own TPA or in-house claims team to manage claims.  And under the thumb of the insurer, the TPA has little incentive to minimize payments within the deductible. Seemingly, every incentive exists for an insurance company to settle claims within the deductible for more than they are worth to keep them from getting hit on their layer of risk.
   • Consider collateral trusts, surety bonds, or reinsurance arrangements as substitutes for traditional collateral (easier said than done, I know).
   • Use your own third-party administrator (TPA) to manage claims and assure effective oversight.
   • Reduce carrier theft – check your policy (or your monthly LD billing statement) for what the carrier charges back on fee reduction “savings” – while these don’t hit the collateral burden of your program, these charges are hitting your bottom-line and removing surplus on your billable that could flow to your collateral.   A TPA acting on your behalf can remove this specious line item.
5. Engage with Legal and Insurance Advisors:  You must carefully negotiate payment agreements in LD policy programs and have them reviewed by counsel prior to execution as you would any contract that may tie up large amounts of capital.  But even businesses that already have these onerous terms in their payment agreements may have a way out. The validity of these agreements has been challenged, including by state insurance commissioners, with favorable outcomes for the policyholders. Don’t let your business’s cash or credit get—or indefinetly stay—tied up in an LD policy program.
   • Consult with specialized legal counsel and brokers experienced in large deductible programs to negotiate favorable terms.
   • Evaluate the use of captives or self-insurance for additional flexibility.
   • Consider a Guaranteed Cost program – for larger aggregators like Staffing and PEO groups, there are great options to better reduce reliance on LDs yet provide the opportunity of a cost-effective program with aggressive rates that maintain profit margins and client retention/attraction.

Reach out to us on this topic!  We have run many staffing and PEO large deductible programs and while we’ve had disagreements with some carriers we’ve also seen great service with others under a LD solution.

Happy to share more insights and specifics / [email protected]