Beleaguered Workers' Comp Lines Seek Captives as a Solution

With workers’ compensation insurance costs skyrocketing, many companies are considering a captive solution, but industry observers say companies should first consider all alternatives, and if they do decide to set up a worker’s comp captive, ensure that it is well-designed and managed.

“Workers’ comp is a controllable cost,” said George Levine, a senior manager with the actuarial services practice of KPMG in Hartford, Conn. “And captives are one way to help a company manage those costs.”

Levine and other industry professionals discussed workers’ compensation insurance issues at the recent Vermont Captive Insurance Association meeting in Burlington. Most observers agree that workers’ comp costs are at a crisis point, although there has been some leveling off, said Lewis Pacala, vice president of General Reinsurance Corp.

“There is talk about how workers’ comp reserve deficiencies decreased from a high of $21 billion in 2001, and that’s good news,” he said. “But I don’t think that a continued $10 billion to $15 billion in under-reserving is good news.”

Both indemnity and medical claims for workers’ comp have accelerated since 1995, Pacala said. For example, the annual cost growth for indemnity claims for the first half of the 1990’s was 0.3 percent, but skyrocketed to 7.4 percent annually between 1996 and 2002. The average annual change for medical claims between 1996 and 2002 has been 9 percent, while the first half of the 1990’s tracked a 3.9 percent annual change. Increases in workers’ comp costs are attributable to many factors, including the rise in medical claims, increased fraud, and insurers’ reserve problems.

Currently, the majority of captives formed in the U.S. are created to cover workers’ compensation. According to the 2003 Captive Insurance Companies survey, more than 34 percent of companies said that workers’ comp was the major line fronted by their captive.

The most significant change in workers’ comp has been the rising costs of medical liability. “For the first time, two years ago, medical claims outpaced indemnity,” Pacala said. Currently, workers’ comp costs are now split 45 percent for indemnity and 55 percent for medical. This is primarily due to the move away from managed care programs, Pacala said, which were able to keep health care costs down.

As with many other insurance lines in crisis, companies want to contain costs through a captive program. But before setting up a program, the CFO and management need to test and fully analyze whether a captive makes financial sense, KPMG’s Levine said.

“It’s important that a company get together its own loss history and analyze [it] to better understand the costs involved,” he said. This includes an independent liability valuation, which determines the program’s reserve adequacy, the effectiveness of claims handling and payout pattern.

Management needs to be pragmatic about a captive solution and make sure other alternatives–like reducing liabilities with a claims management program or transferring the liabilities to an insurer or reinsurer–are explored.

Article reprinted with permmission from KPMG’s Insurance Insider. Copyright 2004 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Disclaimer from KPMG: All information provided is of a general nature and is not intended to address the circumstances of any particular individual or entity.

Topics Claims Workers' Compensation Medical Professional Liability