Court Interpretations of the Meaning of Self-Insurance

Although there is no agreement on the definition of self-insurance, that definition can be quite important. Several court cases have addressed it. These cases often arise because of conflicts about whether self-insurance is other insurance as defined in insurance policies that affect a claim that is partially self-insured. They also may arise when attempting to trigger insurance guaranty funds after an insurance company providing excess coverage to a self-insured program becomes insolvent. The following sections examine some of the important distinctions made by the courts when defining self-insurance.

One important aspect of self-insurance is this: does it constitute other collectible insurance under the other insurance clause of an insurance policy that affects the same claim? Occasionally, it is beneficial for the self-insured when self-insurance is viewed as other collectible insurance. Sometimes it is not.

There is no universal interpretation on whether self-insurance is other collectible insurance. Several cases illustrate the ways courts have addressed the issue.

The U.S. district court in NME Hospitals, Inc., v. American Casualty Company of Reading, PA, 132 F.3d 1454 (1997), ruled that the other insurance clause of a nurse's individual insurance policy was triggered by a self-insurance layer carried by her hospital employer. In this case, the nurse's insurance policy clearly stated that it was “excess over any other insurance, self-insurance, self-insured retention, or similar programs, whether primary, excess, contingent or on any other basis.” The hospital's $100,000 self-insured layer on the nurse was primary to her individual policy because of the wording of the other insurance clause on the nurse's individual policy.

Similarly, in Odessa School District v. Insurance Company of America, 791 P.2d 237 (1990), the court held that a self-insured retention constituted primary coverage. The court stated here that a deductible or self-insured retention should be considered as primary coverage in interpreting the other insurance clause.

In Air Liquide America Corp. v. Continental Cas . Co ., 217 F.3d 1272 [C.A.10 (Okla.), 2000], the court held that a delivery truck owner's “fronting” a liability policy, whereby the deductible was equal to the policy limits and the insurer acted merely as a surety for the insured's ability to satisfy any judgment covered by the policy, constituted “other collectible insurance.” Thus, the liability policy of the temporary employment agency that provided a driver for the truck provided excess coverage, and the truck owner's decision to self-insure did not relieve it from primary liability simply because the underlying accident was covered by another policy. The court explained that it would be inequitable to allow the self-insurer to receive the double windfall of avoiding significant premium payments and avoiding primary liability for an accident caused by one of its vehicles.

And, in Boatright v. Spiewak , 214 Wis.2d 507 (Wis.App., 1997), the court of appeals of Wisconsin found the self-insurance provided by a rental car lessor was “other collectible insurance” within the meaning of an “other insurance” provision making liability coverage provided by lessee's policy excess over other collectible insurance.

Taking a different view, Florida's First District Court of Appeals determined that self-insurance did not constitute other collectible insurance in State Farm Mutual v. Universal Atlas Cement Company, 406 So. 2d 1184 (1982). In that case, LMV Leasing, Inc. leased an automobile to the United States Steel Corporation for use by its subsidiary company, Universal Atlas Cement. Universal designated its employee, William Henry Parker, as the driver. Parker, in turn, allowed a friend, Geri Dietrichs, to drive the vehicle. While driving the auto, Dietrichs was involved in a collision with a motorcyclist.

The injured motorcyclist sued Universal Atlas Cement Company, United States Steel Corporation, LMV Leasing, Inc., William Henry Parker, and Geri Dietrichs. Dietrichs was insured by State Farm Mutual with a single combined limit of $15,000. As stated for the court record: “The State Farm policy provides primary coverage, but sets out a number of conditions or exceptions to that primary liability. One of the exceptions provides that in the event an insured drives a nonowned automobile, State Farms' liability becomes that of an excess carrier, if other collectible insurance is available.”

United States Steel had purchased excess coverage from the Insurance Company of North America with a deductible of $1 million. The $1 million self-insured portion of any loss was administered by a subsidiary of the Insurance Company of North America. State Farm Mutual contended that United States Steel was primarily responsible for injuries to the cyclist and that the State Farm policy should be excess to the deductible.

The court disagreed, saying that other collectible insurance only applied when there was “an insurance policy, the proceeds of which are collectible. . . .” The court also cited Southeast Title and Insurance Co. v. Collins, 226 So. 2d 247 (1969), which defined “other valid and collectible insurance” as a “contract in which one party indemnifies another against loss from certain specified perils.” The Florida appeals court stated that “self-insurance, even though administered by someone else, does not fall within . . .” the definition of other collectible insurance.

Putzeys v. Schreiber , 576 So. 2d 563 (1991), reached the same conclusion. In Putzeys, the Court of Appeals of Louisiana, Fourth Circuit, held that a certificate of self-insurance was not a policy for purposes of uninsured motorist coverage.

Another Louisiana case, Provost v. Unger, 949 F.2d 161 (1991), provided a different interpretation. The Provost case arose as the result of a wreck between a car and a truck. The truck was owned by Rex Milling Company and was driven by one of its employees. The car was owned by Budget Rent A Car (Budget). Budget was insured by Columbia Casualty Company on a policy with a $100,000 self-insured retention (SIR). Budget rented the car to Charles Lewis Pump Company (Lewis). At the time of the accident, the car was being driven by Martin Unger, an employee of Lewis and who was at fault. Lewis had coverage with Aetna Life & Casualty, and Unger was insured by Farmers Insurance Company.

Aetna Life & Casualty's policy stated that it was excess over other valid and collectible insurance and Farmers Insurance Company's policy was excess over other collectible insurance. Both insurers contended that Budget and Columbia Casualty Company had to pay first because the Columbia Casualty policy constituted other insurance with a $100,000 deductible. Budget disagreed, claiming it was self-insured for the first $100,000 and, therefore, that layer did not constitute other collectible insurance.

Budget and Lewis' parent company had entered into a Corp-Rate Agreement that covered the rental of vehicles prior to the accident. In its promotional material on the Corp-Rate Agreement, Budget stated that liability insurance in the amount of $100,000 per person, $300,000 per occurrence, and $25,000 property damage would be provided to those renting vehicles under the agreement. Budget told customers that the insurance was primary coverage. However, when the Lewis case occurred, Budgetclaimed it was self-insured for the first $100,000 and, therefore, the Aetna policy should be primary. The court disagreed and stated: “In sum, if it looks like a duck, walks like a duck, and quacks like a duck, it is a duck. Likewise, Budget-New Orleans' Corp-Rate Agreement looks like insurance, functions like insurance, and has settled claims in this litigation like insurance, it is insurance.”

As such, the court ruled that the Aetna and Farmers policies were excess to both the self-insured retention and the Columbia Casualty policy. Therefore, Budget had to pay first and Columbia Casualty Company had to pay second.

The court in Cone Mills Corp. v. Allstate Ins. Co., 114 N.C.App. 684 (N.C.App., 1994) also addressed the question of whether a self-insured retention was the equivalent of primary insurance. The court reasoned that, under a self-insurance scheme, no written insurance policy is issued by another individual or entity nor is a premium paid because a business which is self-insured does not need to pay itself to protect against its own risk of loss. Cone did not issue a policy to itself, nor did it pay a premium for the $250,000.00 SIR. Thus, the court stated, Cone's SIR did not constitute a primary policy.

Also, the court added: “[I]nsurance has been defined as a contract through which one party indemnifies another against loss due to certain specified contingencies, but the term 'self-insurance' has no precise legal meaning.”

It is clear that courts are divided over whether self-insurance constitutes other insurance for purposes of interpreting the other insurance clause in insurance policies. Therefore, the cautious risk manager must research court decisions in jurisdictions under which self-insured operations are contemplated.

It also is very important to review the wording of the other insurance clauses of insurance policies that a risk manager may integrate into an alternative risk financing program. Some other insuranceclauses specifically state that they are excess over insurance and self-insurance; others state that they are excess only over insurance. The specific wording needs to be reviewed when coverage is placed and before losses are incurred.

Several cases have arisen in which the definition of self-insurance has been the focal point for determining whether guaranty fund coverage is available to self-insureds when an excess carrier becomes insolvent. The first major case, decided in 1974, was Zinke-Smith, Incorporated v. Florida Insurance Guaranty Association Incorporated, 304 So. 2d 507 (1974). It focused on the right of an individual self-insured employer to collect from the Florida Insurance Guaranty Association Incorporated (Association) when its excess carrier became insolvent. Zinke-Smith Incorporated (Zinke) self-insured its workers compensation exposure and purchased excess coverage from Home Owners Insurance Company (Home).

Zinke incurred losses that exceeded its self-insured retention and was unable to recover the additional losses under its excess policy because Home had become insolvent. Zinke attempted to collect from the Association but was not successful. The Association claimed that the excess coverage afforded Zinke was not direct insurance but, rather, reinsurance. Since the Florida guaranty fund statute excluded reinsurance claims, the contention by the Association that the coverage was not direct insurance barred Zinke from recovering. A trial court agreed with the Association.

The appellate court focused upon whether self-insurance was insurance. If self-insurance were equivalent to insurance, Zinke could not recover from the guaranty fund because the excess coverage would be reinsurance. If the self-insurance were not insurance, the excess coverage would be direct insurance and Zinke could recover. Direct insurance was not defined in Florida guaranty association legislation, so the court interpreted the word direct in its plain, every day meaning as: “…an insurance contract between the insured and the insurer which has accepted the risk of a designated loss to such insured, which relationship is direct and uninterrupted by the presence of another insurer.”

The appellate court decided that the insurance policy involved in this case met that simple test. Thus, Zinke's retention below the excess limits was nothing more than a deductible and did not constitute insurance. This made the excess policy direct insurance and not reinsurance. Therefore, Zinke was entitled to make a claim against the Association.

In Iowa Contractors Workers Compensation Group v. Iowa Insurance Guaranty Association, 437 N.W.2d 909 (1989), a case similar to Zinke, the Iowa Supreme Court also ruled that excess coverage provided to a self-insured group was direct insurance, not reinsurance. The major difference between this case and Zinke is that the Iowa insured was a self-insured group, not a self-insured individual, but the court ruled there was no significant difference between a single self-insured employer and a group of self-insured employers.

In Levi Strauss & Company v. New Mexico Property & Casualty Insurance Guaranty Association , 816 P.2d 502 (1991), the Supreme Court of New Mexico was faced with a case similar to Zinke. Citing Zinke as precedent, the Supreme Court of New Mexico held that excess coverage for workers compensation losses is direct insurance and that Levi Strauss was entitled to coverage by the guaranty association.

In a recent decision by the Supreme Court of Connecticut, the Connecticut Insurance Guaranty Association appealed a decision of the workers compensation review board ordering the Association to reimburse the defendant employer for the portion of the benefits that the employer otherwise would have been able to obtain from an insolvent insurer. See Esposito v Simkins Industries, Inc. , 286 Conn. 319 (Conn., 2008). The claimant, the wife of the deceased, agreed to settle a workers compensation claim with the employer. In accordance with the commissioner apportionment of responsibility amongst the insurers during the employee's employment, including the employer as a self-insurer, the employer sought reimbursement from the other insurers.

The issue before the court was whether, under the Connecticut Insurance Guaranty Association Act, a self-insured employer that was initially liable for a workers compensation claim as the last insurer on the risk was permitted to seek apportionment against the Association for an insolvent insurance carrier's share of workers compensation benefits.

In affirming the judgment of the board, the supreme court held that the employer, who had been self-insured at one time, could seek reimbursement from the Association for the insolvent insurer's apportioned share of the workers compensation claim. The court further concluded that the Act did not impose an exhaustion requirement on the employer, as it had no rights under an insurance policy with any insurers that were not satisfied.

One case that is in direct opposition to many of the cases involving guaranty funds was South Carolina Property and Casualty Insurance Guaranty Association v. Carolinas Roofing and Sheet Metal Contractor's Association, Hosea Foster, and Cannon Roofing Company, 446 S.E. 2d 422 (S.C. 1994)). In this case, the court ruled that the South Carolina Property and Casualty Insurance Guaranty Association did not have to pay the excess workers compensation claims owed by an insolvent excess insurer to the Carolinas Roofing and Sheet Metal Contractor's Association self-insured group workers compensation fund. The court said that the fund was an insurer and therefore, the excess coverage was reinsurance.

In the South Carolina case, the court differentiated between a single-employer self-insured and a group self-insured. With a group self-insured, the court reasoned, individual risk is transferred to the group. This transfer of risk, the court stated, is what constitutes the group as an insurer.

Some states have guaranty funds for specific types of self-insurance, such as workers compensation. These targeted funds eliminate concerns over protection under general guaranty funds.

The guaranty fund cases cited above focused on the relationship between the insured and the insurer. What has not been considered is the wording of excess insurance policies themselves. Occasionally, an insurer will title an excess policy, “Excess Reinsurance Coverage.” The use of the term reinsurance in the title of the policy could affect the ability of a self-insured firm to collect from a guaranty fund. Risk managers should be certain that excess policies state clearly that they are excess or stop loss coverage—not excess reinsurance or reinsurance coverage.

Are Self-Insurers Subject to State Insurance Laws?

Self-insurance has developed to the point that most states have specific regulations for self-insurance operations. For example, all of the states that permit employers to self-insure workers compensation have requirements that self-insurers must meet. This is because workers compensation is a statutory coverage, and states want to be sure that funds are available to pay injured workers, even in cases in which excess insurers become insolvent.

Occasionally self-insurers also must adhere to regulations and laws imposed upon insurance companies. Two California cases illustrate the problems that can arise.

In Richardson v. G.A.B. Business Services, Inc, 161 Cal. App. 3d 519 (1984), a California trial court held that a self-insurer was not subject to state statutes dealing with insurance companies. Richardson was injured in a Safeway Store. He sued the company and won. Then he filed suit against G.A.B. (an independent adjusting firm) under Section 790.03 (h) of the California Insurance Code, contending that the claim was not handled properly. Section 790.03 (h) covered the proper handling of claims of insured individuals. The Fifth District Court of Appeal ruled that, since Safeway was a self-insurer, its adjuster could not be held to the standards applied to insurers. The key in the case was that Safeway self-insured its own liability.

In a subsequent case, Nathanson v. Hertz Corporation, 183 Cal.App.3d 78 (1986), Hertz Corporation, a self-insurer, was found to be subject to the same standard of care in settling claims as insurance companies. The court ruled Hertz Corporation was subject to the same section of the insurance code (Section 790.03 (h)) which G.A.B. had not been subject to in the Richardson case. The difference was that Hertz sold third-party liability coverage to customers renting cars and self-insured the exposure. Hertz self-insured another party's liability rather than self-insuring its own liability exposure.

This difference between self-insuring one's own risk and self-insuring coverage sold to the public not only was important in the California decisions, but it is also important in self-insurance cases involving uninsured motorists coverage.

Two of the cases revolving around uninsured motorists coverage are Hebard v. Michael Dillon, Regional Transit Authority , 699 So. 2d 497 (1997) and Gutman v. Worldwide Insurance Co ., 630 A.2d 1263 (1993). Both of these cases concluded that self-insurers were not subject to state insurance laws in the matter of uninsured motorists coverage. Gutman, however, was superseded by an amendment to the Pennsylvania Motor Vehicle Financial Responsibility Law that added language regarding rejection of UM benefits [as stated in Smith v. Enterprise Leasing Co., 833 A.2d 751 (Pa.Super., 2003)].

All of these cases point to the fact that afirm considering self-insurance should carefully examine case law in the states in which it operates to determine the difference in its responsibility between self-insuring third-party liability and self-insuring its own risks.

General Items to Consider

As shown, courts have applied other insurance clauses, as well as state guaranty association funding, divergently in different cases. Some of the general areas that should be reviewed in designing programs that use self-insurance, deductibles, and self-insured retentions, include:

1. Did the excess insurer pay premium taxes on the policy? This would point to the insurance being direct insurance.

2. Does the excess insurer categorize the policy as reinsurance or direct excess insurance?

3. Does the applicable state law define direct insurance?

4. Does the self-insurer assume the risk of others, or is it merely retaining its own risk?

5. Does the excess insurer have a direct relationship with the insured, or does another insurer stand between them?

Advantages of Alternative Risk Financing Techniques

There are several reasons why a firm would implement and use ARF for certain types of business risks. The motives vary depending on the size and financial strength of the firm considering the option. Some of the reasons include:

1. Cost savings;

2. Cost stability;

3. Improved claims control;

4. Flexibility in structuring programs;

5. An inability to obtain coverage or a desire to broaden the available coverage; and

6. Program ownership, which encourages safety programs, supports loss control efforts, and emphasizes good claims management.

In addition, firms sometimes self-insure because they are unaware of a particular exposure to loss and thus inadvertently retain the risk. There often are very good reasons to select partial or total self-insurance of an exposure. However, a corporation should not find itself self-insured by default. Risk exposures should be assessed and appropriate action taken to either insure or retain those risks.

Disadvantages of Alternative Risk Financing Techniques

While alternative risk financing techniques can be both less expensive and more efficient than traditional insurance, they also can embody a number of disadvantages for the firm. Many of these drawbacks are the reverse side of the advantages of alternative risk financing discussed above. They include:

1. Unexpected variations in cash flow;

2. Adverse employee or customer relations;

3. Administrative problems;

4. Increased income taxes; and

5. A difficulty in moving back to traditional insurance or a different type of ARF program once a program has been in place for a period of time.

Each of these potential stumbling blocks needs to be examined carefully by any firm considering the adoption of an ARF program.

Growth of Alternative Risk Financing Techniques

In spite of these disadvantages, the use of alternative risk financing grew significantly during the past. Not unexpectedly, the use of these techniques increased when property and casualty insurance markets were hard, as was seen in the late 1970s and mid-1980s. What is unusual is that the use of ARF techniques has continued in the property and casualty area since the soft market there began in 1986, and that new types of ARF programs are being developed. One area of growth in the use of ARF techniques has been employee benefits, because of the continuing increase in the cost of health-related insurance.

According to a National Employer Health Insurance Survey conducted by the Centers for Disease Control and Prevention, National Center for Health Statistics, among the 3.2 million private-sector establishments that offered health insurance to their employees in 1993 in the U.S., 21 percent self-insured at least one health plan. Because self-insuring companies tend to be large employers, their employees accounted for half of the workforce employed by the companies that offered health insurance. Less than 5 percent of establishments that belong to firms with less than fifty employees self-insured, while 85 percent of establishments in firms with 1,000 or more employees did so. Other company characteristics that often accompany large firms also resulted in having higher proportions of establishments that self-insure than the national mean of 21 percent: corporations (24 percent), companies that existed for 25 years or more (33 percent), multistate firms (61 percent), and companies that have unionized employees (57 percent).

Estimates in the property and casualty area show that alternative risk financing there has grown in like fashion. Swiss Re's 2003 study, “The Picture of ART,” showed global commercial lines direct premium volume written by traditional carriers was about $ 370 billion in 2001, while the premium volume for various types of ART carriers was about $88 billion. Self insurance (with $44 billion in gross premiums written) accounted for the largest ART segment, followed by captives ($38 billion), U.S. state pools ($5 billion) and risk retention groups ($1 billion). The study noted that while captives were global phenomena, self-insurance and RRGs are U.S-specific products.