By S. Lance McNeel, CPCU, ARM
Capstone Associated Services, Ltd.
What is the Texas Nonsubscriber Option?
There has been much discussion in recent times on the topic of workers’ compensation opt-out statutes making their way through state legislatures. Our good neighbors to the north in Oklahoma have passed such a law, but it was declared unconstitutional by the Oklahoma Workers’ Compensation Commission. That decision is currently being appealed. South Carolina and Tennessee have had bills stall in recent months, and only time will tell the outcome of these initiatives. And then there is Texas!
Early in the 20th century, the topic of how to protect workers from job-related injuries was hotly debated throughout the country. It was generally acknowledged that powerful companies had an advantage in cases where employees sued for work-related injuries. Defenses included contributory negligence, assumption of risk and the fellow servant rule. These defenses were limited by federal and state governments shortly after the turn of the century by the issuance of employer liability laws, however, these simply left employers as vulnerable as the employees were previously. A fair and equitable solution was needed that provided benefits to employees and protection to employers.
In 1911, Wisconsin passed the first workers’ compensation law followed quickly by most of the other states by the end of the decade. The initial Texas workers’ compensation legislation was passed in 1913, and yes it was elective from the beginning. The provisions for elective workers’ compensation resulted from real concerns in Texas that a mandatory workers’ compensation system was unconstitutional, since it limited both the employer’s and employee’s right to bring a lawsuit for damages. For this reason, both employers and employees in Texas have the right not to subscribe to the system.
There was little interest in opting out of the system, which generally worked well, until the 1980s when decades of attorney involvement in even minor claims and inflated medical costs pushed the system to the brink of collapse. During that time, over 40% of Texas employers looked to nonsubscription to avoid a corrupt system. Today, the Texas Department of Insurance estimates that 44% of Texas employers are nonsubscribers and 20% of Texas employees are employed by non-subscribing employers. Of those employers, the highest percentage of nonsubscription occurs in manufacturing (53%), finance (51%) and wholesale/retail (49%). See: A study of Nonsubscription to the Texas Workers’ Compensation System; http://www.tdi.texas.gov/reports/wcreg/nonsub93.html1
Why choose not to subscribe?
Cost is the primary reason for choosing not to subscribe, however that goal can take different forms. Cost savings that can be realized through eliminating workers’ compensation premiums can often be replaced with a lower cost occupational accident policy. Many argue that the cost reduction is the result of far lower benefits to the employees, while others argue that the benefits are comparable and the cost reduction is based on the elimination of fraud and waste in the workers’ compensation system. An employer may also wish to have greater control over the choice of medical provider or to coordinate better with a group health plan. Finally, the employer may want to retain tort defenses that are given up under the workers’ compensation system. The common thread in these goals is to take greater control of an increasingly large expense facing the employer.
Why choose to remain in the workers’ compensation system?
The primary reason to remain in the system is that if you leave, you no longer have the no-fault protections of the workers’ compensation system. Employers’ liability coverage can be purchased, but will it adequately protect the employer? Also, many employers have contractual relationships that require them to be covered by statutory workers’ compensation coverage. Examples of this include a sub-contractor agreement with the contractor, or a professional employer organization that is obligated to provide workers’ compensation. These businesses cannot choose to be nonsubscribers. Finally, many employers are in industries that are competing for qualified employees and do not want to give the appearance of providing sub-standard benefits to workers.
Is there a middle ground?
There are a couple of ways that employers can potentially reduce the cost of risk and increase control over their workers’ compensation program while staying with the system and thus maintaining their tort protection. One involves filing as a certified self-insurer (CSI), and the other makes use of a negotiated deductible with a standard insurer writing workers compensation in Texas. I say potentially because both methods rely on a level of risk retention that could result in favorable or unfavorable results.
Filing as a CSI with the Texas Department of Insurance is an option to employers that meet certain size financial qualifications including manual insurance premiums in excess of $500,000, approved credit ratings, the posting of a minimum-security deposit of $300,000 and the posting of excess insurance in the amount of $5,000,000. While this is certainly an attractive alternative for very large employers with professional risk management and claims staff, it is a difficult hurdle for the great majority of employers in the state of Texas. See: Certified Self Insurance; http://www.tdi.texas.gov/wc/si/
The other option is much more realistic for middle market employers throughout the state. Most insurers will offer a negotiated deductible option with a statutory workers’ compensation program. The deductible credit and other terms are negotiated with the insurer, and can represent considerable premium savings with the assumption of a large deductible. The advantage to this option is that the insurer retains the responsibility for providing statutory benefits to Texas workers and that responsibility is further supported by the Texas Property and Casualty Insurance Guaranty Association. The complexity of creating and maintaining a deductible program is much lower than a CSI, and with the addition of an aggregate stop loss, the catastrophic loss potential can be managed effectively. Essentially the insurer pays the worker’s compensation claims directly and then bills the employer for the deductible amounts (or withdraws them from an escrow account). If the employer becomes insolvent, the employees are still protected, which is why insurers typically want a letter of credit from the employer.
Negotiated deductibles are a good option for many employers that want the protection, both for the company and the employees, of the Texas workers’ compensation system along with lower long-term risk costs. Is there anything else that can be done to make this a better option?
The captive insurance/deductible option
Negotiated deductibles can be an attractive alternative for middle market employers with good claims experience, or those who have poor experience that have made an honest commitment to institute effective loss control measures. When an employer combines this option with a captive insurance company whereby the captive issues an insurance policy for deductible reimbursement, this attractive alternative becomes a powerful strategic planning tool.
A captive insurance company is an insurer that has been established to cover the risks of affiliated insureds. A captive can eliminate exclusions, deductibles and retentions in the traditional commercial insurance through the creation of policies designed for the specific insureds and risk exposures. A captive is formed with the permission of various regulatory authorities throughout the world. It is a real insurance company that has a responsibility to its owners, its insureds and multiple jurisdictions. An insurance commissioner monitors the captive’s operations to ensure that certain criteria are met, including solvency and other regulatory parameters. Texas passed captive legislation in 2013, which means that Texas employers no longer must go out of state to form a captive insurance company.
When structured properly by an experienced team of corporate and tax attorneys, and insurance professionals, premiums paid to the captive insurer are tax deductible as are other commercial insurance premiums. The premiums received by the captive insurer are taxed at 0% for federal income taxes. Claim payments from the captive to the employer are taxed at regular C corp. rates since the premiums were tax deductible when paid.
The deductible option described in the previous section uses after-tax money to reserve for claims and then allows for a tax deduction when the claim is paid. By adding a captive, pre-tax funds in the form of deductible premiums are used as reserves in the captive and then taxed when the claims payments are made; often years after the injury occurred. Better yet, underwriting profits of the captive are not taxed at the federal level. When profits are returned to the owners as capital gains or dividends, the capital gains or dividend rates will apply. The employer realizes a tax deferral from the timing of claim payments and a tax reduction on the profits through capital gains. In addition, the captive is a financial institution that can make commercially reasonable loans as an investment.
Finally, we are not suggesting that nonsubscription is wrong or should be avoided. In fact, captive planning fits nicely into a nonsubscriber program as well. We believe that Texas was the only state that actually got it right. We should not force employers or employees to give up cherished constitutional rights. However, a strong workers’ compensation system is critical to the economic stability of Texas and the protection of its citizens. We should encourage willing employers to remain within or come back to the workers’ compensation system through risk assumption, loss control and captive insurance.
Please visit Booth 412 at the IIAT 120th Annual Conference & Trade Show in Fort Worth if you would like to learn more about captive insurance planning for your customers or prospects.
Mr. McNeel is Vice President of Business Development for Capstone Associated Services, Ltd. Lance brings over 30 years of experience in all areas of the insurance industry, including property and casualty insurance, life and health insurance, and reinsurance.