Self-Insurance of Workers' Compensation Losses

Abstract

Workers' compensation costs are among the largest insurance expenses incurred by business firms. Yet little research has been published on this topic. The present paper explores the intricacies of the calculation of workers' compensation expenses. Cost comparisons are made among guaranteed cost, retrospective rated, and self-insured plans. Throughout the paper extensive use of the experience modification factor, as used in workers' compensation, is employed. Using discounted cash flow analysis, self-insurance is shown to be a viable alternative to insurance over a broad range of loss situations if excess loss coverage is available. In 1976 workers' compensation produced the largest premium volume (7.8 billion) of any commercial insurance line. For many businesses it represents their single largest insurance expenditure and if the present trend continues this expenditure will increase substantially. In 1976 the loss ratio for this line was 79.3 percent. With such a high loss ratio, rate relief for insurers can be expected. The growth in workers' compensation also is reflected in the costs of claims index. On a 1967 base, the cost index for workers' compensation has risen from 143.8 in 1971 to 244.3 in 1977 and is forecast to reach 272.3 in 1978 [4]. On a cost index basis it has shown the greatest growth among major lines of commercial insurance. Given the size and rate of growth of the workers' compensation sector of the insurance industry, surprisingly little research on this subject has been reported in professional journals. This observation is especially true regarding an individual firm's insurance costs. This cost problem is the one to which the present paper is directed. Specifically, the goal of the present research is to analyze the issue of insurance versus self-insurance. The approach taken is numerical vs. qualitative. The major emphasis is centered on discounted cash flow analysis of experience rated, retrospective rated, and self-insured plans, rather than qualitative items such as the level of services and relations with the firm's employees. James S. Triesclhmann, CLU, CPCU, is Associate Professor and Acting Head, Departnent of Risk Management and Insurance, The University of Georgia. E. J. Leverett, Jr., CLU, CPCU, is Professor of Risk Management and Insurance, Trlhe University of Georgia. The autlhors thank Mr. Beach Clark of Bayly, Martin and Fay, Inc., Atlanta, and the editor of this Journal for their aid in developing this paper.