5 August 2016USA analysis

The benefits of pooling workers’ comp risks

As small and medium-sized companies increasingly understand the benefits of using captives to manage their risks, some are also starting to take advantage of certain schemes that were previously available only to much larger companies—schemes such as being able to fund the large deductibles on their workers’ compensation programmes using their captive.

This concept was first pioneered by some of the larger insurance brokers and has been around for more than a decade—Marsh, for instance, runs the Green Island pooling facility—but such schemes have been available only to much larger companies.

That is, until four years ago when Artex, a company that specialises in designing innovative insurance and risk management solutions, launched the Artex Exchange (AEX), a scheme specifically designed to allow smaller companies to do exactly this.

The scheme works as a risk management pool that allows companies with an existing captive to share their primary layer of workers’ compensation risk with other companies without adjusting their existing commercial insurance arrangements—this scheme covers only the deductible—and in a way that benefits their own captive.

“We have been doing this for four years and we feel that the market is at a tipping point, with more companies ready to embrace this form of risk transfer." Karl Huish, Artex

The scheme uses a contractual agreement whereby each participating business pays in an amount equal to their estimated workers’ compensation losses annually up to a limit of $100,000 per occurrence. The minimum annual transfer of risk is $400,000.

These premiums and risks are pooled and transferred pro-rata to each individual captive. A redistribution based on losses and retained premiums then happens on an annual basis to even up the pool.

A smoother path

“The concept allows small and medium-sized businesses to better manage these risks and diversify their own captives,” says Karl Huish, president–captive division, Artex.

“It means they get the economic and risk management benefits of such a scheme that will reduce the annual volatility of losses without increasing the cost of risk; plus, this adds underwriting portfolio diversification to their captives. This may lead to that captive being classed as an insurance company for US federal tax purposes, which for some companies is significant.”

TJ Scherer, account executive at Artex, adds that without a workers’ comp pool to bring in unrelated risk, these companies are treating these losses as self insurance, deductible only when paid. Funding these risks through a captive is more efficient as companies are able to deduct the premiums paid to the pool as an expense. It also means each company has more predictability in knowing what it is paying each year for workers’ compensation losses, because the volatility of such losses have been reduced.

Scherer underlines the benefits of a company keeping its existing insurance arrangements. “Our clients typically keep their existing large deductible programme, third party administrator, excess carrier and broker—those arrangements have often been in place a long time and there is no reason to change them,” he says.

Having been up and running for four years, AEX now has 10 participating companies with over $25 million in premium and, Huish says, interest is growing. The momentum towards embracing this more innovative form of risk transfer has come from the fact that more medium-sized companies are starting to embrace captive-based risk transfer solutions anyway.

“Midmarket companies have started adapting to the benefits of captives relatively recently,” says Scherer. “This is another level of sophistication but momentum is building and we are seeing growing interest all the time. Much of the interest is being driven by brokers—they like this product because it is another service to offer and it means they are adding value to their clients.”

A new concept

Huish acknowledged there are some challenges that Artex must always overcome when speaking with potential clients. “There is usually a discussion about the concept of sharing risks with other people, as this is a new concept for many companies.

“Clients can be concerned about the potential of large losses from other participants and consider all the worse-case scenarios. But we stress that this isn’t problematic because each company’s risk is priced up front based on five years’ worth of loss data—the pricing is then updated annually based on the most recent five years. We work with very good actuaries and it is a sophisticated process,” he says.

Huish adds that another benefit of this scheme is that it potentially allows letters of credit to be funded more efficiently using surplus funds in the captive.

“People often forget how expensive letters of credit can be,” he says. “If you can use the captive in this way it can reduce the cost significantly.”

He points out that some clients also believe they may be too small to participate in such a pool or that they will not fit correctly.

“Pooling workers’ compensation risks has historically been a solution only for big companies, so for midsize companies there is a lot of education to do and often a long lead time on getting companies ready to join in,” he says.

The AEX is unusual because it is effectively a so-called virtual pool, with risk being pooled on the basis of contractual agreements between the companies’ captives, as opposed to pooling through a fronting carrier.

There are many benefits to this, including the fact that companies do not have to post collateral. There is also no clearing house—the premiums simply flow through Artex and are ceded to the various captives.

“It is done with an innovative approach, yet we make the process very simple and straightforward in the way that claims are allocated at the end of the year. We track claims during the year. These claims are paid by the individual captives before an actuarial assessment and settlement is completed between members once the 12-month period is up,” says Scherer.

“As part of the annual assessment and settlement, some companies will pay in and some take money out, but the pool always balances annually. That is the nature of sharing risks within a pool.”

He adds that, now the pool is established and the concept proven, he sees strong growth in this market. While most AEX clients are not 831(b) companies, the 2017 premium limit increase for 831(b) captives will lead to more companies becoming suitable for taking part in this scheme as they become more aware and willing to innovate in their approach to risk transfer generally.

Brokers are increasingly embracing the product now they have seen it work successfully. “Most brokers are risk-averse but once they can see the benefit to their client they are increasingly keen to explain the concept and get their clients involved,” Scherer says.

He says Artex has ambitions to bring at least half a dozen new clients per year into the pool. In theory there is no limit on how big the pool can become, or how many members might participate, but Scherer admits that as more growth occurs, Artex may consider setting up individual pools to group together companies in similar industries.

Huish adds: “We have been doing this for four years and we feel that the market is at a tipping point, with more companies ready to embrace this form of risk transfer. We believe a lot more companies can profit from this and we are happy to speak to anyone who feels their company would benefit.

“Any business using a large deductible workers’ compensation programme with a deductible of at least $100,000 per occurrence should definitely explore it.”

Karl Huish is the president–captive division, Artex. He can be contacted at:

TJ Scherer is an account executive at Artex. He can be contacted at: