Collateral Challenges and Alternatives for Workers Compensation Self Insurers

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1 Collateral Challenges and Alternatives for Workers Compensation Self Insurers SIIA National Educational Conference and Expo September 23, 2009 Self Insurance Collateral Requirements Established by State of Jurisdiction Regulated by: Department of Insurance Division of Workers Compensation Bureau of Workers Compensation Others??? 1

2 Security Instruments Used Self Insurance Bonds Direct Letters of Credit Cash Escrow accounts Others? Criteria used by Regulators Usually established by statute or self insurance rules Loss Experience of Entity Strength of Financial Statement Excess Terms: SIR or Aggregate attachment 2

3 Self Insured s Reporting Requirements Quarterly or Annual Reporting Financial Statement Update & Review? Payroll Reports Standard premium reports Loss History Disability or Lost Time claims Actuarial reports? The Conundrum What is Collateral? Who is required to post collateral? Why do insurance carriers/state insurance departments require collateral? How do collateral requirements adversely impact insureds? Why is insurance collateral an increasing issue today? What can be done? 3

4 The Retention Problem $1 M Per Occurrence Commercial Insurance Specific Excess Risk Transfer Deductible / Retention Collateral required for unpaid claims Per Year / Aggregate Commercial Aggregate Protection Total claim payments by policy year (Ultimate Loss) Less claims paid Plus loss forecast for upcoming renewal = collateral requirement Stacking Over time, collateral obligations grow (usually stabilizes after 4-7 years) Policy Year Assume 5 policy years $10M Loss Pick $1 M paid per year Report Year Annual Collateral Requirement Data Global Corporate Finance Average Cumulative Default Rate ( ) 25% 20% 15% 10% 5% 0% AAA AA A BBB BB B CCC To C Source: Fitch Ratings 4

5 Have the Right Loss Pick? The Loss Pick Drives Premium, Program Expenses & Collateral 1 Cumulative Probability Expected Losses Aggregate Price Risk Transfer Price Aggregate Attachment Contingent Capital VaR 0 $2,000,000 $2,500,000 $3,000,000 $3,500,000 $4,000,000 $4,500,000 $5,000,000 Retained Losses Market Conditions Collateral Alternatives Trust Accounts - Reinsurance Cash & Compensating Balances (Asset- Based Collateral [ABC]) Policy Forms (Buy-outs and LPTs) Rent-A-Captive Premium Financing 5

6 Surety, One Form of Guaranty Historically, surety bonds were the dominant way to guaranty WC/SI obligations to states. The states started opening up to other forms of guarantees in the 1980s when some self insurers claimed that they could not obtain surety bonds. LOC Trust Funds, Treasury Bills, Cash Today surety bonds are still accepted in almost all states, however, they are available, unsecured, only for the largest, most solvent firms. What are the Issues That Prevent a Surety from Writing WC/SI Obligations Long Tail. Self insured claimants have caused losses to the surety twenty years after a bond was cancelled. The financial strength of a self insured can change over night. Reinsurance to support the surety against losses can be pulled quickly. At the present time there are only a handful of firms that make a market in WC/SI obligations, however, there is more capacity today than seven years ago when the surety industry was dealing with Enron, Bethlehem Steel, K-Mart, etc. 6

7 The Underwriting Results (From the Surety & Fidelity Association of America) CY Direct Earned Premium Direct Loss Incurred Loss Ratio 1990 to 1994 $192,736,323 $5,300,275 3% 1995 to 1999 $259,769,145 $9,397,691 4% 2000 to 2004 $312,433,901 $277,828,140 89% 2005 to 2007 $156,757,692 $27,079,445 17% Total all years $916,516,359 $319,605,551 35% The California Situation (and other states like it) In 2002, the CA SI Security fund was $12.8 million in the hole. Starting in June 2003 the state released all LOCs and surety bonds and starting charging self insurers a fee comparable to the amount they were paying for these obligations. Presently this alternate security fund has approximately $290 million in gross assets and $170 million in net assets. The annual fee charged to the self-insured is down by at least 35% from the original. These results include the hits the investments took recently and the large payouts the fund had to make with some of the large bankruptcies in the state. 7

8 The California Situation (and other states like it) (Continued) Positives solved a large problem and the cost of the guaranty did not go up The self insurers benefit from the fund build up with lower cost of guaranties Negatives Self insurers guaranty and pay for other self insurers who go broke. The other state that have a similar program NC Cessation of Authority and/or Release of Security Groups & Standalone Groups shutdown, dormant Self managed or state mandated Release of Security All claims closed Statute of Limitations Transfer of Liabilities? 8

9 Transfer of Liabilities Loss Portfolio Transfers: 100% transfer to carrier Carrier admitted and form approved? Guaranteed Fund Coverage or protection? Prior excess Carrier position? Dealing With Your Surety Communicate with your surety, treat them like you treat your banker Educate your surety underwriter about your business Communicate important issues. No surprises Form a contingency plan in case your surety exits the business or your business 9

10 Points to Remember There are no absolutes in the determination of collateral requirements! Use the right loss pick! Communication Information is key to determining collateral levels Financial information Non-financial material Build relationships through-out! Collateral requirements are set on a case-by-case basis Collateral requirements are not static Participants Skip Shewmaker- Safety National Vice President Business Development skip.shewmaker@safetynational.com Steve Luebbert Safety National Executive Vice President Business Development steve.luebbert@safetynational.com 10

11 Participants (Continued) Pamela F. Ferrandino Willis HRH Executive Vice President National Casualty Practice Leader Theodore C. Sevier, Jr. Marsh Managing Director Commercial Surety Practice Leader 11