Despite recent post-recession economic growth, city revenues remain below pre-recession levels, yet expenditure demands are on the rise, according to the National League of Cities.
Findings from the Washington, D.C.-based National League of Cities’ annual survey suggest that more fiscally responsible cities are cautiously preparing for the next economic downturn.
One option public entities frequently consider when developing their budget is to lower insurance costs by assuming more risk.
This can be accomplished by moving insurance contracts from a deductible program to a seemingly more attractive self-insured retention program, known as a SIR, which lowers the up-front insurance premiums, yields increased control through participation and incentivizes accountability and experience.
Both programs identify monetary amounts for which the insured is responsible. But before submitting your cost-savings strategy to your stakeholders, consider the issues and long-term expenses that may come with selecting an SIR program to ensure a successful transition.
Depending on how the SIR is structured, the insurer may not be required to participate at any level, such as the case of an indemnity policy. Others may require co-participation or assumption of the claim once it reaches a certain level. Ultimately, there are procedural reporting requirements that must be complied with in order to preserve excess coverage.
First stop: Claims administration
Claims happen. It’s the reason insurance exists and with a standard first-dollar or deductible program, the insurance carrier is responsible for the administration of all claims, including the payout and/or denial of a claim to constituents. Under an SIR program, the entity is responsible for all claims administration including funding the cost of a loss, both indemnity and expense.
Claims handled below the SIR attachment can turn into much larger claims down the road. This means an excess carrier would need to be involved in the claim. Thoroughly understanding the reporting requirements of an excess insurance company can be complex, as not all companies have standard wording. What may constitute the need to notify the excess carrier of a claim or knowledge of an event, which may result in a claim, will vary widely. By failing to report an incident or claim, an excess carrier could deny coverage. Therefore, when an entity moves to an SIR, the process it adopts regarding reporting of claims and incidents should be clearly defined. Other considerations should include an understanding as to how claims will be transitioned once the retention is exhausted or threatens to be exhausted.
Once the claim-handling hurdles are cleared, an additional consideration entities should acknowledge before moving to an SIR program is the funding of losses within the SIR level. An entity must have adequate reserve funds to pay all claims during the first year and a plan for paying future claims. Analysis of the entity’s claims frequency and severity will help determine the proper funding level. Claim development and claim inflation should also be analyzed yearly and compared to prior years’ estimates. An unexpected increase in claims frequency will adversely affect the entity’s reserve fund and could prove even more costly than paying the higher deductible premiums.
In addition, there must be a level of commitment and discipline to grow the reserve fund over time, which garners even more financial flexibility for higher SIR levels in the future. Using the reserve fund for other services in tight financial years will undermine the entity’s ability to pay claims and threaten the viability of an SIR program.
Having explored the basics of claims administration, a public entities’ next stop on the road to an SIR is to determine their choice to either self-administer claims or hire a qualified third-party administrator.
In a self-administration model, entities must handle all claims needs.
This means employing internal claims management standards and expectations including oversight of external vendors, experts and services, and providing system support, such as a claims management system. Similarly, qualified personnel must be available to work the claims under an SIR within the parameters of good faith and fair dealing, the same standards governing insurers. Before deciding on a SIR, a thorough analysis of an entity’s typical claim counts in the proposed self-insured retention layer will help determine staffing needs.
When considering self-administration of claims, the initial cost to get started may deter even the best-intentioned public entity. Startup costs include the hiring of personnel; supplying of office space, furnishings and computers; and selecting a reliable claims management system. The benefit of self-administration is to develop a claims operation that provides better handling than what can be purchased from a third-party administrator but over time, that benefit may come with steep costs that look nothing like the initial calculated investment.
Because of the many challenges presented by a self-administered claims model, moving from a deductible program can be difficult. While it allows an entity more control, it is advised that only experienced and sophisticated claims management departments consider it.
Electing to hire a qualified third-party administrator may be a better alternative than the self-administration model. This choice allows an entity to attain the efficiencies of claims management processes, systems and personnel with little effort.
Entities must determine the roles and responsibilities of the third-party administrator. Will the third-party administrator be responsible for claims until closed, which is typically more costly, or will the TPA only be responsible for claims while under contract with the entity?
While the latter scenario may be more affordable up front, when you dissolve the contract with that third-party administrator, they may no longer be responsible for handling claims, even those in progress. Transferring claims files and bringing new handlers up to speed can be a setback, prove costly and lead to the mishandling of open claims.
When selecting a third-party administrator, many entities see very little difference from vendor to vendor and place a great deal of weight on the price of the third-party administrator’s services.
Be wary of contracting the lowest price option. Well-handled claims may be more expensive up front but may ultimately cost less than those that are mismanaged. A third-party administrator’s fee is easily comparable from provider to provider; however, the quality of the third-party administrator is not as quantifiable.
Interview your third-party administrator to determine the experience level and caseloads of their adjusters, the average duration of a claim from report to closure, relationships with defense counsel and expense ratios, among other things. Finally, ensure they are experts in legal standards applicable in your state and federal circuit for local governments.
By thoroughly understanding the claims management, reporting requirements and funding requirements associated with moving to an SIR from a deductible program, public entities can effectively evaluate the true cost and benefit of making this structural change to their insurance programs. For those who do it right, it can be rewarding and actually assist your local government in enhancing community image, accountability and ultimately, improving the safety for your constituents. As always, we recommend you review policy terms closely to clearly understand the responsibilities between the insured and the insurance carrier.