Self-insured workers’ compensation is when business owners choose to cover their employees’ workers’ comp benefits instead of purchasing a policy from a carrier. If an employee suffers a work-related injury, the employer pays the costs usually covered by an insurance carrier, such as medical treatments and lost wages, out of his or her own pocket.
Who Can Self-insure Their Workers’ Compensation Insurance?
Not every small business owner can self-insure their workers’ compensation, partly because of state regulations. Two of the monopolistic states―North Dakota and Wyoming―don’t allow any self-insurance, while a handful of others let individual business owners self-insure but not form groups. Two more states―New Jersey and Washington―only allow certain institutions, like hospitals or schools, to form self-insurance groups (SIGs).
More importantly, self-insurance isn’t the right answer for every business owner looking for affordable workers’ compensation insurance. Workers’ comp claims can be unpredictable and catastrophic, so business owners need to have enough cash on hand to cover them when they occur. This is why business owners have to share their financial records to get state approval to self-insure.
How Does Self-insuring Workers’ Compensation Work?
Self-insuring your workers’ compensation insurance is fairly straightforward. You decide you don’t want a workers’ comp policy, so you take on the risk of paying employees’ claims if there’s an accident. Business owners can usually accomplish this in one of two ways: they can either take on the entire responsibility, or they can join a SIG. In either case, the self-insurer must follow the same laws as other employers in the state.
Self-insured Workers’ Compensation Employers
Employers who want to self-insure without the assistance of a SIG almost always have to get approval from their state governments. Each of the 48 states that allow self-insurance for workers’ comp have their own requirements, but most want at least some of the following:
- A completed application and fee
- Audited financial statements
- Payroll reports
- Credit rating
- Workers’ compensation claims history
- Evidence of an occupational safety program
- A security deposit
- A plan for administering, investigating, and paying claims
- Information about business owners
Every state that allows employers to self-insure also allows them to carry excess workers’ compensation insurance to ensure the employer can cover claims further. An excess workers’ comp policy covers losses after the employer has paid a previously agreed-upon amount.
Finally, handling workers’ compensation claims requires a lot of specialized knowledge and hiring an in-house team to administer them is expensive. As a result, many employers who decide to self-insure often hire a third-party administrator (TPA) to manage claims.
Self-insured Workers’ Compensation Group
Small business owners who are interested in self-insured workers’ compensation but find self-administering coverage unwieldy can turn to self-insurance groups. SIGs, also called trusts or funds, are groups of businesses that band together to cover workers’ compensation. These groups handle:
- Claim administration, investigation, and payment
- Purchasing excess workers’ comp insurance
- Creation of a safety program
- Investing members’ premiums
Employers can either create or join a self-insurance group by applying and paying a premium for coverage. Once they’re part of a SIG, employers have bylaws and participation agreements to abide by, but they also may receive dividends when the group has a surplus. SIG members typically have similar operations. Many states only allow associations to create self-insurance groups for workers’ compensation.
Pros & Cons of Self-insured Workers’ Compensation
The cost of workers’ compensation insurance can leave many business owners wondering if there is a better, more affordable way to meet their obligations to employees. Self-insuring is an option, but it has its drawbacks. Below, we list the advantages and disadvantages of self-insured workers’ compensation insurance to help you decide.
Pros of Self-insured Workers’ Compensation
Some of the advantages of self-insuring your workers’ comp are:
- Potential savings: Employers who self-insure aren’t responsible for many of the overhead costs that are baked into insurance premiums. SIG members typically see savings because they don’t pay taxes on their premiums or the extra charges that support workers’ comp state funds.
- Improved safety: Business owners who opt for self-insurance have an incentive to reduce claims through better safety practices. A safer workplace has the added benefits of improving morale and productivity.
- Better cash flow: Self-insurers only pay when an employee suffers a compensable injury, which means they can use the money that’s not being paid in premiums—as long as they have cash reserves in case of a claim.
- Dividends for SIG members: Employers who join self-insurance groups pool their money to cover claims. At the end of a coverage term, surplus funds typically are returned to members.
Cons of Self-insured Workers’ Compensation
The disadvantages of self-insuring workers’ compensation include:
- The need for significant financial resources: If you don’t have the money to cover a series of claims, even for less severe injuries, self-insuring can devastate your business. This is why the states that allow it want to see your financial records and claims history before they will approve you.
- The unpredictability of claims: There’s no telling when an employee might suffer a workplace injury, so not only do you need money available to cover claims, you need it on hand pretty much all the time.
- The need for specialized knowledge: Workers’ compensation regulations are complicated, as is determining the validity of claims. Most businesses that self-insure either hire an in-house claims manager or a third-party administrator. Both options also require additional time and management resources.
Next Steps for Self-insuring Workers’ Compensation
While the idea of self-insurance is simple, the undertaking can be much more complicated. If you decide self-insurance may be a good fit for your business, follow these steps to get started:
- Assess your business situation: Before you apply to be a self-insurer, evaluate whether your business can take on the risk. For example, you should review a few years’ worth of past workers’ comp claims, payrolls, and premium statements to forecast a realistic expectation for future claims. An insurance consultant or claims administrator can assist with this.
- Review your state requirements: The state approves all workers’ compensation self-insurance plans, so determine your state’s requirements before you go too far into the process. You may find out something that disqualifies you automatically.
- Decide who will handle claims: Are you going to have an in-house administrator? Outsource the work to a third party? Join a SIG? Most states want to know who is handling claims when you apply to be self-insured.
- Buy excess workers’ comp insurance: Several states require self-insurers to have excess insurance to make sure employees’ claims are covered. This is something you may need in place before you apply.
- Get your security together: States generally want a security deposit, often in the form of a surety bond. Some may only require a security deposit if a business falls short of the state’s standards for self-insurers.
- Develop a safety program: The safer your workplace is, the lower your workers’ comp costs are. This is true whether you self-insure or buy from a carrier. However, your state may want to see your plan for minimizing losses as part of your application.
- Apply with your state: Most states’ workers’ compensation departments post the appropriate application on their websites.
If this process seems overwhelming, then it’s possible that self-insured workers’ compensation is not for you. You may still be able to find affordable coverage by comparing rates from top workers’ compensation companies. If multiple insurers decline your business, you may be able to find coverage through your state’s workers’ comp fund or assigned risk plan.
Self-insured Workers’ Compensation Frequently Asked Questions (FAQs)
This article discusses most of the big issues around self-insured workers’ compensation. However, you may still have a few questions that are just beyond its scope, so we’ve answered a few of the most common questions about self-insurance below.
What is a self-insured retention?
A self-insured retention (SIR) is a dollar amount in a liability policy that a policyholder must pay before the insurer’s contribution kicks in. This is different from a deductible where the insurer pays first and then seeks reimbursement from the policyholder. Most excess workers’ compensation policies have a SIR rather than a deductible.
Can small businesses self-insure their workers’ compensation?
Small businesses can self-insure, but it’s rare. Those that do usually join self-insurance groups. Surprisingly, self-insured workers’ compensation is more common in high-risk industries, like construction and contracting, probably because the increased risk drives up the costs. Conversely, low-risk businesses can often find affordable workers’ comp from insurance carriers.
How can you know if a business is self-insured?
Many states have a database of self-insured business you can access through their workers’ compensation department’s websites. However, you can also ask to see a business’s certificate of insurance to verify that the business has workers’ compensation insurance.
Self-insuring your workers’ compensation plan isn’t something you can implement in a day or two. The risks and rewards need to be thought through carefully in light of your business’ unique needs. Most small business owners find that if they want to self-insure, they’re better off joining a group. They might not have as much control over their workers’ comp programs, but they also face less risk when claims hit.