An Actuarial Analysis of Servicing Carrier Profit Margins

Adequate servicing carrier allowances are critical to the success of residual market pooling mechanisms, as they help to attract and maintain a sufficient supply of servicing carrier capacity. Regulators, legislators, servicing and non-servicing pool members, and other interested parties need to understand the expenses and general operations of servicing carriers so that their experience can be properly evaluated. The paper presents a methodology to evaluate a servicing carrier allowance, with particular emphasis on the profit provision. Based on the operations and reporting procedures of servicing carriers, a cash flow model is used to evaluate profit provisions within a rate of return context. The paper focuses on servicing carrier operations for the workers compensation residual market. Two distinct roles of the servicing carrier emerge: 1) a service company, collecting a fee for insurance services performed and costs incurred, and 2) a collection and payment agent for the assigned risk reinsurance pool. The cash flow model is a useful tool to help understand and analyze the financial effects of each role. The model reveals a subtle, but real cost to servicing carriers of the second role, as they use their own funds to pre-pay the excess of losses and expenses over premiums on behalf of the pool.