Workers’ compensation Featured

7:00pm EDT December 31, 2006

Recent legislative changes in California have altered the landscape of workers’ compensation. It is crucial for companies to be aware of these reforms when evaluating current insurance plans.

One way to revisit workers’ compensation plans is by conducting a collateral review, which typically centers around collateral on loss-sensitive workers’ compensation programs such as large deductible or retrospectively rated plans. “Some of the initial collateral calculations from several years ago do not now reflect current regulatory or credit risk requirements,” says Dennis Olsen, area senior vice president for Arthur J. Gallagher & Co.

Smart Business spoke with Olsen about the types of collateral that are available, how often collateral should be reviewed and what should be done to prepare for a collateral review.

What is the basis for carrier collateral requirements?
Typically, these types of programs require collateral for two reasons. One is that the insurance carriers themselves have statutory regulations that require them to collateralize self-funded losses. The other reason that they require collateral, aside from the regulatory requirements, is that they want to avoid a credit risk. Insurance companies don’t want to be on the hook for claim payments below the deductible layer.

What types of collateral are available in the market?
The most common form of collateral that is requested by insurance carriers is a letter of credit. But there are many other types of collateral that are used on occasion, such as surety bonds, trust programs and cash.

A trust program provides an alternative to a letter of credit and allows the insured to place negotiable securities into a trust account where the carrier can access the trust assets. The advantage of this option is that the insured is able to earn an investment income on those securities and they don’t impact their balance sheet as a letter of credit would. Trust programs also tend to be less expensive, with savings of up to 50 basis points over letters of credit.

Surety bonds, over the last several years, have not been widely used, as the surety bond market has been restricted.

When should collateral be reviewed?
We normally recommend that collateral be reviewed twice a year. When an insured has been on a loss-sensitive program for a period of time, there tends to be a pyramiding of letters of credit. Currently, we’re in a market where it’s especially important to do the review twice a year because there have been quite a few changes over the last few years. In states like California, where there has been recent workers’ compensation reform, the loss development on claims has been dropping rapidly.

How should a business prepare for a collateral review?
The first step is to do a comprehensive claim review and to evaluate individual case reserves, plans of actions and the potential for closing old claims. The second thing we recommend is to do an actuarial analysis and project ultimate losses using current loss development. This should be done in conjunction with the collateral reviews that are done twice a year.

Insured companies that have former carriers holding collateral often will discover that these carriers will only allow an annual claim review. Typically, the second evaluation is going to be done without a claim review, but it is still important to do a real study to evaluate what the estimated loss reserve is for those open cases. That is then used to negotiate with the insurance carrier as to how much collateral you really need to be holding.

What other factors should be considered when negotiating collateral?
In the past, few collateral agreements specified adjustment time frames or even the loss basis for reducing collateral. Some insurance companies are now more willing to define specific security terms, which will greatly ease future collateral reduction negotiations. If you’re negotiating collateral with the current insurer, you want to bring the leverage of the pending renewal to the negotiations. In a lot of cases, a reduction in old collateral or waiving collateral requirements on the renewal policy can be negotiated. There is also the potential for replacing older forms of collateral by consolidating letters of credit or by substituting letters of credit with cash or trust programs.

DENNIS OLSEN is area senior vice president for Arthur J. Gallagher & Co. Reach him at (818) 539-1323 or