No matter the industry, businesses continue to face ever-escalating workers’ comp insurance premiums. In an effort to keep costs down, many companies are turning to an increasingly popular alternative to traditional “guaranteed cost” or “retrospective premium” workers’ comp programs: “large deductible” (LD) policies. LD policies theoretically give businesses greater control over claims exposure and costs while at the same time satisfying regulatory requirements by having an insurance company as the ultimate guarantor of claims payments. But while some businesses may save money with LD policies, they may also find their assets tied up for years unless they challenge some common—and often problematic—terms and conditions of their LD policy programs.
LD Policies & Payment Agreements
First, some background on LD policy programs. LD policies generally have deductibles of $100,000 to $500,000 per claim. The policyholder pays all claims within the deductible and the insurance company pays any claims that exceed the deductible. The theory behind LD policies is that the policyholder is essentially self-insuring for most claims and so will take more control over its risk exposure and claims management, leading to decreased claims and insurance costs.
But the insurance company still ultimately guarantees all workers’ comp payments under an LD policy. If the policyholder does not or cannot pay a claim within the deductible, the insurance company is required to make that payment. As a result, insurance companies generally require the policyholder to provide cash collateral or a letter of credit (LOC) to secure the policyholders’ payment obligations and protect the insurance company from being left holding the bag if the policyholder has financial difficulties and doesn’t pay claims. The terms and conditions for the cash collateral or LOC typically appear in a “payment agreement,” which the insurance company often presents to the policyholder as a non-negotiable requirement only after the policy is issued. Those agreements, however, frequently impose one-sided and wide ranging conditions on the policyholder that can cripple a business’s ability to control its workers’ compensation costs.
Businesses considering an LD policy program really need to understand how payment agreements work, because there are some ways they can protect themselves from onerous terms at the start.
Question Inflated Loss Estimates
At the beginning of an LD insurance program, the insurance company will estimate the policyholder’s probable future workers’ comp losses based on a “loss pick.” The higher the loss pick, the more collateral 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 often will be significantly 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.
Negotiate Process for Discretionary Collateral Calls
Payment agreements often permit the insurance company to demand additional collateral at any time. They also typically provide no mechanism for the policyholder 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 draconian 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.
Central to a demand for increased collateral is the insurance company’s use of “loss development factors” (LDFs) that often are significantly higher than those used by an independent actuary. LDFs are used to project potential future costs on claims, such as unexpected medical complications, verdicts that exceed the claims’ reserves, and costs for losses that have not yet been reported. Payment agreements will often permit the insurance company absolute discretion in setting the LDF which in turn can lead to otherwise unsupported high increases in collateral demands. Businesses should insist their insurance companies disclose their LDFs at the outset of the program and should negotiate a more favorable LDF if necessary.
Avoid Driving Up the Loss History
In theory, the policyholder exerts greater control over its claims administration and risk exposure in an LD workers’ comp program by paying most, if not all, of the claims through the deductible, thereby decreasing its loss history and overall insurance costs in the long run. When selling an LD policy, however, many insurance companies also offer claims administration services either through their own internal claims service or a designated third-party administrator contracted with the insurance company. While this may appear to be an attractive option for a business seeking a one-stop solution to its workers’ comp program, the insurance company’s adjustment and payment of claims within the deductible actually poses significant risks to the policyholder.
With traditional insurance, an insurance company has every incentive to minimize claims payments so as to maximize the return on premium. That incentive does not exist with LD policies. Because each claim within the LD policy deductible is the responsibility of the policyholder, the insurance company has no incentive to minimize payments within the deductible. To the contrary, every incentive exists for an insurance company to settle claims within the deductible for more than they are worth to keep them from ever exceeding the deductible. Not only does the policyholder end up paying more for those claims—this practice also creates a negative “artificial” loss history that may (conveniently) translate into a basis for the insurance company to demand increased future collateral and higher premiums. Businesses should therefore consider carefully whether they would be better off in the long run selecting their own independent third-party workers’ comp administrator.
Challenge Payment Agreement Positions
In an ideal world, businesses should carefully negotiate payment agreements in LD policy programs and have them reviewed by counsel prior to execution as they would any contract that may tie up large amounts of their capital. In the real world, these payment agreements are often executed as side agreements to the workers’ comp policies with terms and conditions that may leave policyholders at a significant disadvantage in the event of a dispute. 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 stay—tied up in an LD policy program.