CONTROLLING COSTS Choosing the Right Insurance Program Kevin D. Smith, CPCU, ARM Vice President Workers’ Compensation

2 Considerations Choosing the right service partners Choosing the right program structure

3 your insurance dollar 35-40% fixed costs 60-65% expected losses

4 Controlling Workers’ Compensation Costs What can you do to affect losses to ultimately control your insurance costs over the long term? – Prevent losses from occurring – Control losses that do occur – Best program structure

5 Workers Compensation Pricing Parameters Payroll x Rates = Premium Rules vary by state Estimated Payroll by Classifications Classified based on primary activity as developed by state rating systems Payroll includes salaries, commissions, bonuses and overtime (limited) Limitations on Executive Payrolls Election options for Partners, Sole Proprietors

6 Workers Compensation Pricing Parameters Payroll x Rates = Premium Rules vary by state Regulated by State or Collection of States (NCCI) Applied to Payroll per $100 Developed from loss and exposure data by classification

7 Workers Compensation Pricing Parameters Payroll x Rates = Premium Rules vary by state Modified by Experience Modification Factor (EMF) Construction Credits, if eligible Safety Credits, if eligible Other Factors Expense Constants Premium Discounts State Assessment Second Injury Funds Terrorism Risk Insurance Act Domestic Terrorism & Catastrophic Industrial Accidents

8 Experience Modification Factor (EMF) The experience rating formula is built on comparing actual vs. industry average loss experience. DID: “Actual Losses” SHOULD: “Average Expected Losses” 1.00 indicates an average risk. Greater than 1.00 indicates a risk that is worse than average. Less than 1.00 indicates a risk that is better than average.

9 Do you want to be Average?

10 Experience Modification Factor (EMF) Experience Rating Period 2009 Most Recent Year Not Included in Calculation 2010 EMF Effective for 2010 Year

11 Experience Modification Factor (EMF) Sample Company –Approx. $10,000,000 Payroll in PA –WC Premium - $836,500 –$380,000 Expected Losses –$1,040,000 Actual Losses Unlimited –$540,000 Actual Limited Losses* –Actual EMF Maximum value of any one loss capped at $42,500 in PA for EMF calculation *

12 Experience Modification Factor (EMF) MANUALMANUAL STANDARDSTANDARD Minimum EMF: Based on a particular organization’s payroll, there will be a minimum expected loss amount. Premium

13 Experience Modification Factor (EMF) Controllable EMF Controllable Portion of EMF: The difference between this Minimum EMF and Actual EMF. MANUALMANUAL STANDARDSTANDARD Premium

14 What are your alternatives? Guaranteed Cost Large Deductible or Retroplan Captives Self- Insurance Higher Reward Lower Reward Higher Risk Lower Risk Loss Sensitive Traditional Insurance

15 Guaranteed Cost vs Loss Sensitive Traditional Insurance Loss Sensitive

16 Program Alternatives Guaranteed Cost Loss Sensitive Plans –Retros –Large Deductibles –Captives –Self-Insurance

17 What are your alternatives? Guaranteed Cost Loss Sensitive Insured pays a fixed premium (based on exposure). The losses incurred during the year do not directly affect the premium for that policy term. The Insurance Company pays all losses incurred. Advantages All Costs are known upfront. Services (Claims Handling, Filings, Safety, etc.) handled by the Insurance Company. No need to accrue for losses. Disadvantages Advantages Lower Net Costs than guaranteed cost plan, assuming favorable losses Incentive for loss control Programs Insured programs backed up by Insurance Company Services typically handled by Insurance Company Potential Cash Flow and Tax Advantages Disadvantages The total cost may be higher if the claims are not managed. The total cost may not be known until several years after the policy term ends. The insurance company charges to handle claims. Collateral Requirements

18 Loss Sensitive: Initial premium based on exposures with a deductible credit (60% - 80%) Losses under the deductible are reimbursed by the Insured after the Insurance Company pays the claim. Elimination of premium taxes on losses. Better cash flow option than Guaranteed Cost. Costs can be capped with an Aggregate Deductible. Large Deductible

19 Loss Sensitive: Estimated Premium paid at policy inception Adjustment at 18 months based on losses and expenses during the policy term, then annually until all claims are closed. Maximum and minimum costs can be negotiated. Can include multiple coverages  Workers Compensation, General Liability and Automobile Retrospective Rating Plan

20 Loss Sensitive: Insured does not purchase insurance or only excess stop-loss Insured assumes all responsibility for Claims Handling, Filings, Safety, etc. Maximum assumption of risk and services. Often utilized for larger risks for Workers’ Compensation and is subject to state approval. Self-Insurance

Loss Sensitive: Captive Insured owns all or part of the Insurance Company, which is called a Captive Insurance Company. The Captive retains substantial portions of each loss and purchases reinsurance as well. Opportunity to recapture underwriting profit and investment income.

22 Workers Compensation Controlling Costs Choose Right Partners Prevent/Control Losses Choose Right Program

23 QUESTIONS Kevin D. Smith, CPCU, ARM Vice President