Workers Comp Continues To Be an Excellent Opportunity for Captives
Adam Miholic | May 17, 2023
Editor's Note: Hylant Global Captive Solutions contributes this Thought Leadership article examining the use of captive insurance in workers compensation programs.
Among the earliest widespread use of the captive insurance concept was an effort to improve control over workers compensation premiums. For many companies, managing the financial impacts of workers comp claims provides a satisfying and educational introduction to captives, leading to subsequent moves to employ captives as a tool for other risks.
While workers compensation continues to be a prime target for captive consideration, it plays less of an introductory role in most sectors. Today, most of the companies exploring the captive concept are more interested in addressing coverage costs reflecting the current hard market, such as property and casualty, errors and omissions, cyber, and catastrophic risks—for instance, those related to extreme weather events.
Workers comp tends to be far more straightforward and predictable than other risks. Companies understand their premiums are calculated by multiplying payroll by the classification code rates and the experience modification ratio. They also see the annual claims data, so they are aware of where and how injuries are occurring, making it easier to take meaningful corrective actions like facilitating strong safety cultures. With all this awareness of their exposures to workers comp claims, they are more comfortable retaining the risk.
As with other types of captive structures, using a captive for workers compensation permits the insured to transfer retained risk by pre-funding anticipated medical and other costs related to workplace injuries. The capital invested in the captive prepares for anticipated losses, which is more attractive than paying out claims as they occur and negatively impacting future financial performance. With a captive, the company is able to take an income tax deduction for the claims expenses before those claims actually occur, depending on their tax election.
Captives for workers comp also incentivize their owners to apply loss control strategies. An example is the aforementioned effort to enhance workplace safety. If a sizable percentage of claims involves hand injuries, changing the ways specific tasks are performed or taking steps to reduce the risk of those injuries is likely to reduce the amount of premium and/or capital the company will need to invest in the captive in future years. Other strategies, such as encouraging the use of site-based clinics or local industrial medicine facilities, may result in significantly lower claims than the standard default for many companies, namely a trip to the local emergency room.
A key advantage to using the establishment of a captive to address workers comp is the inherent flexibility of the strategy. Depending upon the statutory requirements of a particular domicile, a captive may be used to take a primary layer of coverage, therefore allowing the company to accept a higher deductible in return for substantially lower premiums. Or, a captive may be used to cover a particular tranche, such as between the primary insurer and excess coverage.
Increasingly, captives are being employed to fill specific gaps in coverage. As insurers begin to carve out exclusions for specific risks or set sublimits on types of claims, companies may be left with troubling exposures. Creating a captive can offer an affordable and effective way to cover those types of gaps. A savvy risk manager and an experienced captive consultant can develop creative approaches.
Flexibility also applies to the nature of the captive facility. For some companies, a single-parent captive offers the most advantageous structure, with the greatest control and autonomy. A group captive, composed of multiple organizations with similar workers compensation exposure and claims histories, may provide a more economical alternative with less direct involvement in management and compliance. Still, other companies may choose the comparative simplicity of a cell captive, in which they "rent" access to a captive structure created by another organization or brokerage firm.
Another worker-generated exposure that is motivating the increased use of captive strategies is liability for employment practices. That may include exposures related to workplace harassment; discrimination by race, age, or gender; or other claims under Equal Employment Opportunity Commission and other regulatory measures. As with workers comp, companies can mitigate the risk of such exposures through training and policies, but the captive protects the organization from extraordinary or unexpected situations.
Even though workers compensation may no longer be the poster child for considering a company's inaugural captive structure, it continues to provide practical advantages. As a result, when risk management leaders identify other exposures for which some type of captive is a prudent choice, they may be willing to add workers comp to the structure they develop. So even if we do not think of the coverage as trendy, it is a safe conclusion workers comp will remain a popular area for captives throughout the near future.
Adam Miholic | May 17, 2023