July 2003
By JAMES S. ANCHIN, CPA
As if the uncertain economic climate weren't enough of a headache, contractors face another hurdle. The construction industry is in the midst of a hard insurance market, with policies becoming more expensive and more difficult to obtain Ñ a real problem for contractors whose daily work is fraught with substantial risk. One alternative to pricey insurance premiums is to self-insure. But what exactly does this mean, and is self-insurance for every contractor?
Generally speaking, self-insurance for contractors refers to worker's compensation insurance. A contractor may form a "single-parent" captive insurance company or band with other contractors to form a group captive company. Insurance premiums are paid directly to the captive and the captive pays losses. The captive insurance company will contract with a standard insurer to issue the necessary insurance certificates and will reinsure the insurer for losses above specified limits. Going the "captive" route has become increasingly difficult in the current hard market.
Another option is to become a state approved worker's compensation self-insurer. Going this route means you are approved by the state as a self-insurer and become part of a group of self-insurers that pay your own claims and purchase insurance only to cover the largest claims. The group can admit companies of any particular size that do not have to meet any specific financial requirements. All states have minimum requirements in terms of self-insurers' net worth and net profits over a certain period. Some states set such prohibitive requirements that few contractors may be eligible to take this option. Added to these requirements are administrative stipulations, which at the very least include evidence that a benefits delivery system Ñ often outsourced to specialists in workers comp claims Ñ and an injury prevention program are in place.
To avoid having your entire reserve obliterated by one mega-claim, excess coverage must be purchased. However, at what dollar value should you start the excess coverage? Before tackling that, you'll need to examine how much you can afford to pick up. It's best to take a pessimistic view of your risk, even if your company has generally not had significant claims in the past. While underwriters use standard formulas to calculate your loss rate, which is then applied against an increasing payroll, simply taking the year in which you experienced the highest number of claims and then doubling the claims amount paid would put you in the same ballpark for expected losses. Remember, the construction industry is notorious for multiple claims during a single year. Companies offering excess coverage generally won't kick in for relatively inexpensive claims, at least not at a cost that is affordable to the self-insurer. They're more likely to pick up the slack between $500,000 and $1 million per claim. The aggregate stop loss covering all losses over a combined dollar amount would generally be one to 1.5 times the standard premium.
If you do self-insure, controlling the frequency and amount of your company's losses is paramount. One way to do this is to establish a "safety consciousness" within your company. Progressive and sustained ways to motivate your work force to be committed to safety should be a top priority. Safety programs should be paramount, particularly in the construction industry, where the workforce is uncommonly transient. Keep in mind that every new employee represents a potential claim and thorough safety orientations and ongoing safety seminars should become standard operating procedures. All employees must be familiar with and adhere to the company's safety standards and requirements.
Contractors should also retain legal counsel to represent them in large-dollar claims. Your attorneys should be specialists in workers compensation issues, and they should be more than forceful in representing your interests in legitimate suits and fending off bogus claims.
The decision to go with self-insurance is not an easy one. Certainly, you'll have to look at the costs of self-insurance Ñ costs related to expected losses and the purchase of excess coverage for catastrophic cases versus the costs of traditional coverage this year, and in the years to follow. Bear in mind that some traditional coverages offer guaranteed cost and large deductible plans that may make sense for your company.
With self-insurance, you'll have lower fixed costs, more control over claims and the ability to better manage the cash flow for insurance costs. You'll also have increased risk and more hassle, stemming primarily from having to meet state regulations and from situations where you have employees in several states. You'll also incur the expense of establishing effective safety and claims management programs.
In the current economic climate self-insurance may be an alternative worth pursuing.
About the author: Mr. Anchin is a managing partner of Anchin, Block & Anchin, LLP, a regional certified public accounting firm with offices in New York City and Westchester, that specializes in meeting the needs of contractors in the tri-state area.