The WorkCompEdge Blog

by Michelle Bradley, SIGMA Actuarial Consulting Group

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In October 2006, Lloyd Kelly and I authored a paper titled “Reducing Collateral Uncertainty: A Primer for Negotiations” that was published in Risk Financing Perspectives for the International Risk Management Institute.  We expanded the paper in 2008 and published it as “Reducing Collateral Uncertainty” for the Institute’s Risk Financing Manual.

For the purposes of this article, collateral is one type of security that can be provided to a fronting carrier or regulator by a self-insured entity for the credit risk assumed by the carrier or regulator.

During 2009 and the recent global financial crisis, new trends and challenges have emerged in the area of collateral for self-insured companies. Both fronting insurance carriers and regulators in self-insured states normally require collateral for self-insured programs.

Many situations directly related to overall current economic conditions may affect the collateral requirements for a company. These include factors such as rapidly changing exposures, changes in credit ratings, or financial stability. Insurers face similar challenges with their own financial ratings and stability.

SIGMA has monitored these emerging issues during 2009. The following provides a summary of our perspective as well as recent changes that we believe are important to understanding the current collateral environment.

• The Commonwealth of Massachusetts, Department of Industrial Accidents issued a revised calculation method for self-insured bond requirements. The initial calculation was proposed in March of 2009 and revised again in mid 2009.  SIGMA reviewed the March 2009 revised formula. At that time our opinion was that the formula was conservative and would lead to significant increases in bond requirements for many self-insureds.  The new formula (as of mid year) has not yet been formally released, but preliminary information leads SIGMA to believe that it will be less onerous than the March 2009 formula. SIGMA continues to monitor this situation.

• Several other states continue to require self-insured liabilities to be determined with actuarial methods at pre-determined intervals.  Some states require specific actuarial analysis for self-insureds in “run-off” (meaning the self-insured is no longer with the carrier for which liabilities are being disputed) that request to post collateral below minimum bond or collateral requirements. For example, a state that has minimum bond requirements may consider specified actuarial studies in the support of lowering collateral below the minimum.

• Some self-insured companies have had to replace security instruments with instruments from a new issuing institution at the request of their carrier because the issuing institution no longer had a credit rating or financial strength that was acceptable to the carrier.

• The current financial situation is causing significant changes to the projected 2009 and 2010 exposures for some companies in payroll, revenue, and other factors which can in turn significantly affect the “add on” collateral.  For example, consider the situation where a company’s payroll is anticipated to decrease by 30% following several years of stable payroll and reserves.  Assuming that experience has not deteriorated, the workers compensation collateral for the projected year should decrease.  However, if accurate exposure and loss projections are not made, the “add on” collateral could be overstated. Accurate and well documented exposure projections as well as involved communication are becoming increasingly important.

• We have observed a slight increase in self-insureds considering litigation or mediation to resolve collateral disputes. We observe this primarily in situations of “run-off,” as mentioned above. In such situations it is customary for a self-insured to have both a legal team and actuarial team working to demonstrate that held collateral is unreasonable for the remaining liabilities.

• SIGMA continues to recommend that collateral agreements be reviewed and parameters agreed to on the front end of the policy. We continue to see many insureds that are trying to unwind collateral situations with no contractual verbiage in support of their efforts. In some cases the contractual verbiage so strongly favors a carrier that it is difficult to negotiate collateral reductions even with actuarial support.

SIGMA understands that each relationship between a self-insured, carrier, and regulator (if applicable) is unique.  It is also important to note that the collateral situation for some of our clients has remained stable.  However, for companies with rapidly changing exposures or for companies changing insurance carriers or program structure, collateral issues may require significant attention.