Self-Insured Trusts: Buyer Beware

Sunday, December 19, 2004 | 0

When it comes to self-insured trusts, the policy should be buyer beware. Forty one percent of New York group self-insured trusts are "under funded," according to a recent report* by the New York Workers' Compensation Board. This alarming number should be carefully considered by the insurance buying public, their agents and brokers.

Group self-insurers whose liabilities exceed assets are deemed to be under funded, according to the Rules and Regulations that govern group self-insured trusts. Of the 64 New York trusts listed in the report, 26 are deemed under funded. Of the 26 that are under funded, 58% have "no new members" restrictions imposed by the Workers' Compensation Board, and ten have "membership restrictions."

For existing and prospective members, the fact that 41% of group self-insured trusts are under funded has significant financial ramifications. Members of group self-insured trusts are co-owners. In exchange for what appears to be relatively competitive "contributions," members can be assessed if the trust runs short of funds. Members agree to cover any shortfall when they assume, at time of application, joint and several liability. Agreeing to joint and several liability provides the Trust with signed "blank checks" to be cashed as necessary, for years to come, to cover any shortfalls in funds to pay claims and other obligations arising during the period of the member's participation.

Members can also be assessed for the insolvency of any other trust in New York, according to New York Workers' Compensation law. In light of this additional, broad based exposure, buyers should evaluate the suitability of trust membership.

Also of concern to insurance agents and brokers is the Insolvency Exclusion for self-insured plans in the Errors & Omissions Policy offered by Westport Insurance Company, the carrier for the Insurance Association of Agents and Brokers in New York. Why are small business owners willing to expose their assets to the self-insured trusts' risk of insolvency when an experienced insurance company refuses at any price? Agents and brokers using trusts should review their own exposure.

Self-insured trusts purchase reinsurance in an attempt to protect against high frequency or severity of claims and to avoid triggering joint and several liability. However, the fact that 41 percent of self-insured trusts are under funded is evidence that reinsurance does not provide adequate protection for all of a trust's obligations.

Liabilities can exceed assets without triggering reinsurance for several reasons. Those reasons include under-pricing to attract and retain members, high operating costs, a high frequency of claims that fall below the large reinsurance deductibles, premature payment of dividends, and the ever growing New York State Assessment liability. The New York State assessment, charged as a percentage of paid indemnity claims, is not covered by reinsurance.

Significant problems have occurred in other states with group self-insured trusts. The most recent example is the Associated Industries of Kentucky (AIK) which insures 70,000 employees. According to the Kentucky office of Insurance, AIK requested the state to approve a plan that allows it to assess its members $59 million to cover shortfalls incurred from January 1, 1999 to December 31, 2003. All employers who were members during those years will be assessed. A total of 3,729 current and prior members will be affected. AIK's self-insured trust went from a small surplus to a $59 million deficit in one year.

In Florida, the number of self-insurance trusts dropped from 60 to 4 throughout the 1990's as several were declared insolvent. In Illinois, the Environmental Services Workers' Compensation Trust was liquidated in 2001 and found to be insolvent by $3 million. There have been a total of four group self-insured trust insolvencies in Illinois. These are examples where the actual costs of self-insurance far exceeded projected costs.

Workers' Compensation has historically proven to be unprofitable for most insurance companies. Workers' Compensation is exactly the kind of risk that business owners should transfer to insurance companies, rather than retain. Low upfront pricing is appealing but when employers are forced to assume joint and several liability, which is like signing blank checks, it has proven to be very costly.

* The New York Workers' Compensation Board Group Self-Insured Trusts Summary of Funding Status, dated October 22, 2004.

Adam Friedlander is President of Friedlander Group Inc., New York' market leader of Workers' Compensation solutions to the Retail, Wholesale and Restaurant Industries. Friedlander Group manages three Workers' Compensation Safety Groups underwritten by the NY State Insurance Fund. He can be reached at 914-694-6000, ext. 206 or adamf@friedlandergroup.com.

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The views and opinions expressed by the author are not necessarily those of workcompcentral.com, its editors or management.