How Does Self-Insured Workers Compensation Work?

According to Statista, the percentage of employees covered by self-funded workers compensation plans increased from 44% in 1999 to a record high of 67% in 2020. Two years later, during the height of the pandemic, that figure had decreased slightly to 65% in 2022, but the trend for employers to self-insure is still on the rise.

What are the advantages and disadvantages of self-insuring workers compensation?

Most companies purchase workers compensation coverage from traditional providers, either through a private insurance company or from a state-owned insurance company. You pay your premiums, and your insurer takes care of handling and paying all claims, and it bears all financial risk.
Self-insurance is an alternative that has become increasingly popular among larger employers.

What Are the Benefits?
• Taking a pay-as-you go approach to claims rather than paying high premiums frees up cash flow.
• Claims management expenses are usually lower when handled in-house or by a service company or third-party administrator (TPAs).
• Administration costs are usually lower because you are not paying for insurance company profits and the insurance company’s higher overhead costs.

What are the Disadvantages?
Lack of Expertise
Most companies have no expertise in claims handling and loss control. But there are very workable solutions to these problems. In fact, most self-insureds don’t handle their own claims. They use service companies or TPAs for these and related services. For example, depending on the industry, specialized medical and legal knowledge may be required, along with negotiation skills, risk management, safety, and loss control expertise. All these services can be outsourced to reputable and dependable providers.

Severity and Frequency Issues
The other disadvantage to self-insurance is that while most claims are small, a single large injury claim can wipe out whatever reserves you’ve allocated to fund your workers compensation losses in a particular year. Two or more such losses could be devastating. In addition, there could also be an explosion of small claims that add up to break the bank as well.

The simple solution to both scenarios is to purchase insurance — or, as it’s also called, reinsurance (since the primary insurer is the self-insured business). This is not typical workers compensation insurance, however. It’s money to pay the workers compensation losses that you, as a self-insurer, have taken on for yourself if your losses exceed your budget.

Two types of insurance available
Specific Excess Insurance limits the amount you must pay out on any individual claim. Aggregate Excess Insurance limits the total amount you must pay out for all losses per year. (See the sidebar for more information about these two kinds of insurance.)

Primary Reasons for Employers to Consider Self-Insuring Workers Comp

• You have good claims experience and think you’re paying too much.
• There’s a lot of money held up in claims reserves that you are not getting cash flow benefit from.
• You would like to be more involved in the claims handing experience.

Of course, self-insurance is not a practical alternative for many businesses, simply because they are not large enough to scale to the level needed to make self-insurance really work. But even then, it’s good to know about it. Because even if you aren’t sufficiently large now, you could become so someday.