Plans that seem attractive at the beginning of a policy term may turn into nightmares for companies that are unable to really manage claims frequency and severity.

Regardless of all else, claims drive the ultimate cost of any workers' compensation program. Preventing workers' comp claims and managing those that occur are the ultimate successful plan for all companies, regardless of size or complexity.

Workers' compensation is a statutory requirement, which means that insurance covering this exposure mirrors a state's legal requirements for employers falling within the law, as stated in Part I of this article last month.

Self-insured programs follow the same course. They provide medical and wage-loss benefits to employees covered by the workers' comp law of the state in which they work.

The beauty of guaranteed cost is its predictability and ease of implementation. However, incentives to keep claims from occurring and to actively manage those that do occur diminish in a guaranteed cost program. Ultimately a business relying on guaranteed cost coverage may experience more employee injuries because there is no incentive to work to actively prevent them. This can lead to a higher modification factor and thus fewer insurers willing to offer guaranteed cost coverage.

Dividend plans basically are guaranteed cost plans that offer the potential for a dividend reward if the business has better than expected claims experience. Dividend plans typically base claim experience on the losses of a particular group to which the insured belongs or to the individual insured business.

And since they have an up-side in the potential for a dividend but no down side in the form of the client having to pay in additional funds if claims are higher than expected, dividend plans typically are reserved for those businesses that have better than average claim experience.

Thus, a company that is written on a guaranteed cost plan that actively manages its loss prevention and claims may eventually qualify for a dividend plan. Dividends are not guaranteed and are paid only if declared by the carrier's board of directors, but typically they will be paid to companies that have good claims experience.

Incurred loss retrospective rating plans are one step further toward self-insurance. They reward companies that have better than expected loss experience and penalize those with worse than expected loss experience during the retrospective term.

Under a retro, the insured business pays the policy premium to the insurance company at the beginning of the term. As time elapses, the premium is adjusted upwards or downwards as claims develop and mature. This continues until all claims are closed, a time frame that may stretch for years into the future. Typically, the premium is adjusted based on the financial measure of incurred losses, which include claims that have been paid as well as the amounts set aside, or reserved, to pay future claims.

Large deductible plans are similar to retro plans except that they bill the insured as claims are paid. Claim reserves typically are used to establish the amount of collateral that is required to secure the program. The initial amount that a business with a large-deductible plan pays in typically is substantially less than the full estimated standard premium, which is collected under an incurred loss retro program.

However, the business that's insured on a large deductible plan must post collateral—typically an irrevocable letter of credit and/or surety bond—for the difference between the amount deposited up front and the standard premium. The company also sets up an account out of which claims are paid.

The business must replenish the claims account as claims are paid so that it is maintained at a certain pre-determined level. Collateral is based on estimated losses and the insured's financial condition—a safeguard against a company walking away from paying claims that may exist years into the future.

Some companies may find the collateral requirements burdensome, especially since collateral is required year after year, with letters of credit frequently stacking atop each other.

Self-insurers also must post collateral and bonds to guarantee the payment of future claims. Getting back to the five areas of review, frequently –cited upsides to these types of plan are the enhanced cash flow and decreased fixed costs.

There are many variations on each type of financial plan, depending on market conditions, business conditions, and claims-management expertise. Regardless of what a financial plan is called, however, companies should take time to compare each of the five factors with the plans that are available to better determine the best type for their operations.

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When reviewing financial plans, businesses should concentrate on five basic areas:

• Amount of insurance purchased

• Cash flow arrangements

• Fixed costs

• Amount of risk transferred to the insurance company

• Amount and form of collateral required to guarantee that claims will be paid.

With this list, a company can determine that a guaranteed cost program provides 100 percent insurance coverage, no cash flow opportunity unless installment billings are offered, the highest fixed costs, 100 percent of the risk transferred to the insurance company, and no required collateral. Such plans are typically offered to smaller businesses that have average or above average past claim experience or to types of businesses that statistically have fewer worker injuries, such as office exposures.

Diana Reitz, CPCU, is managing editor of FC&S Online, the National Underwriter Company's online source for coverage interpretation and analysis.