Workers’ compensation is necessary for all US employers, and why not? It enables employees to trust that their jobs are safe. According to NCCI, in the last century, worker’s compensation has made America safer and helped millions recover from workplace accidents and injuries.
However, when it comes to implementing a workers’ compensation program, employers have two choices. They can either self-fund the program or purchase a traditional insurance policy. Self-funding offers potential benefits such as cost savings, increased control, and tailored solutions but also carries inherent risks.
Understanding the factors influencing this decision is crucial for businesses that balance financial prudence and effective risk management. In this article, we look at some factors that make employers want to use the self-funding option.
Understanding Workers’ Compensation
Workers’ compensation is a safety net for employees, providing medical benefits and wage replacement for work-related injuries or illnesses. It is a legally mandated insurance program designed to protect workers and employers in most jurisdictions.
Traditionally, employers purchase this insurance from commercial carriers, transferring the financial risk of claims to the insurer in exchange for premium payments. The core idea of workers’ compensation insurance remains the same. However, as Forbes states, all 50 states and Washington, D.C., have their respective workers’ compensation programs.
The Self-Funding Option
Self-funding, also known as self-insurance, involves the employer directly assuming the financial responsibility for workers’ compensation claims. Rather than paying premiums to an insurance company, the employer establishes a fund to cover anticipated claims and reserves for future liabilities.
Self-funding allows for greater control over claims management, customization of benefits, and potentially significant cost savings. This is particularly true for larger organizations with stable claims experience.
According to Prescient National, a self-insured company does not have to buy the traditional workers’ compensation program. Instead, it buys an excess insurance policy. What this means is that an attachment point (a claim limit) is decided in the policy. When the compensation amount exceeds that point, only then the employer has to pay the excess amount; hence, the name.
Since the attachment point is decided beforehand and the employer can customize the policy, this program acts as an alternative to guaranteed cost insurance. In this policy, the cost of the claims that occurred during a term is considered during the audit as the ultimate cost.
The State of California Department of Industrial Relations mentions that the state has the largest workers’ compensation self-insurance program in effect. As of January 1, 2023, 6,939 California employers were actively self-insured.
Factors Influencing the Decision
The decision to self-fund workers’ compensation can be influenced by several factors, including:
Financial Considerations
Self-funding requires sufficient cash reserves to cover claims and administrative expenses. Businesses must evaluate their financial stability and cash flow projections to ensure they can meet ongoing obligations.
This program offers the opportunity to lower overall costs by eliminating insurer profit margins, administrative fees, and risk charges associated with traditional insurance policies. However, businesses must weigh these potential savings against the risks of higher claim costs.
Self-funded employers assume the risk of fluctuating claim expenses. Those with a high-risk tolerance and stable financial resources may be better positioned to absorb unexpected costs and benefit from long-term savings.
Claims Management Capabilities
Effective claims management is crucial for controlling costs and ensuring timely claim resolution. Self-funded employers must possess or have access to the necessary expertise, resources, and systems to handle claims efficiently.
Self-funding requires a thorough understanding of historical claims data, industry benchmarks, and risk factors. Employers must be able to analyze this information to identify trends, mitigate risks, and implement targeted loss-prevention strategies.
Regulatory Compliance and Legal Considerations
Workers’ compensation regulations vary by state, and self-funded employers must comply with specific legal requirements. This can include minimum funding levels, reporting obligations, and reserve requirements.
Many self-funded employers mitigate catastrophic risk by purchasing stop-loss insurance covering claims exceeding certain thresholds. Understanding stop-loss coverage’s legal and contractual aspects is essential for managing risk effectively.
Employee Population and Risk Profile
Self-funding may suit larger employers with a stable workforce and predictable claims experience. Smaller businesses or those with high employee turnover rates may face greater uncertainty and financial risk.
The nature of the industry and work environment can significantly impact the frequency and severity of workplace injuries. Employers operating in high-risk industries may find self-funding more challenging due to the potential for large and unpredictable claims.
For example, the Centers for Disease Control and Prevention states that transportation-related injuries account for 48% of fatalities in the construction sector. Falling objects are another inherent risk for struck-by injuries in the sector. Due to the high risks, construction companies may find it challenging to leverage the full potential of a self-funded insurance policy.
Long-Term Strategic Objectives
Self-funding offers greater flexibility in designing and administering benefits, allowing employers to tailor programs to meet the needs of their workforce. Businesses that attract and retain top talent may view self-funding as a strategic advantage.
This program can provide greater control over insurance costs and cash flow management for companies seeking long-term financial stability and growth. However, it requires a commitment to proactive risk management and ongoing evaluation of performance metrics.
Frequently Asked Questions
How Does Self-Funding Workers’ Compensation Differ From Traditional Insurance?
In a traditional insurance model, companies pay premiums to insurance carriers, who assume the financial risk of providing workers’ compensation benefits. In contrast, self-funding allows companies to directly fund claims and retain control over their workers’ compensation programs.
Is Self-Funding Workers’ Compensation Suitable for All Companies?
Self-funding workers’ compensation is typically more suitable for larger companies with sufficient financial resources and robust risk management practices. Smaller companies may find it challenging to manage the financial and operational complexities associated with self-funding.
What Are the Potential Benefits of Self-Funding Workers’ Compensation?
Benefits of self-funding workers’ compensation include cost savings, greater control over claims reserves, tailored coverage, improved cash flow, and the potential for investment income.
To conclude, the decision to self-fund workers’ compensation is a complex process that requires careful consideration of various factors. These factors include financial stability, claims management capabilities, regulatory compliance, employee demographics, and strategic objectives.
While self-funding offers potential benefits such as cost savings and customization, it also entails inherent risks and responsibilities. Businesses must conduct thorough risk assessments, seek expert guidance, and develop robust risk management strategies to navigate the complexities of self-funded workers’ compensation.
