Self-Insurer Solvency and Estimating the Collectibility of the Retrospective Premium Reserve

Several states have various requirements to provide funds for claimants and injured workers in the case of a self-insured entity’s bankruptcy. Typically, the state requires self-insurers to post surety bonds or other collateral with the state in order to minimize the burden on society in the case of a bankruptcy. The collateral should be a function of at least the following three factors: 1) The amount of the self-insurers’ unpaid claim liability; 2) The financial condition of the self-insured employer; and 3) The variability of the actual unpaid claim liability around the expected value. This paper describes two statutes in detail that attempt to relate the collateral to the above three factors. In addition, provisions from other state statutes that do a particularly good job of meeting one of the three criteria are discussed. The paper also discusses the credit exposure associated with writing retrospectively rated policies and outlines a procedure that can be used to estimate a bad debt reserve - for expected premium defaults on retrospectively rated policies - for GAAP statements. A procedure utilizing Moody’s bond default probabilities is used to estimate the bad debt reserve. The credit exposure is similar to the potential burden on society due to a self-insured’s bankruptcy. In the case of a bankruptcy of a self-insurer the burden (of the bankruptcy) in on society. Whereas if a retrospectively rated insured becomes bankruptcy, the burden (credit exposure) falls on the insurance company. Therefore, the credit exposure will be a function of the same three factors which should be used to set collateral requirements for self-insurers. Other key words: large accounts, regulation, reserving, retrospective rating.