Are self-insurers subject to state insurance laws?

General items to consider

Advantages of alternative risk financing techniques

Disadvantages of alternative risk financing techniques

Growth of alternative risk financing techniques

No Single Definition

Some insurance scholars object to the term self-insurance. They believe that the term is a misnomer. They contend that the two requisite insurance components—transfer and pooling—are not included in such a plan. "Insurance," by definition is "a contract whereby one undertakes to indemnify another against loss, damage, or liability arising from a contingent or unknown event." (California Insurance Code § 22) Therefore, technically one cannot be self-insured.

The term self-insurance is criticized for another reason. Some feel that it is not sufficiently broad to cover other types of risk financing techniques, such as captives, risk retention groups, purchasing groups, pools, excess insurance, and cash flow insurance plans. A term that encompasses both self-insurance and the full range of other plans is "alternative risk financing."

Others consider the term to be an oxymoron. Risk managers strive to include only exposures that have predictable losses in their self-insurance programs. Yet, if the losses are predictable, the purists argue, there is no risk about them. Therefore, they need not be insured or self-insured. They need only be funded. Nonetheless, this self-funding of losses is commonly referred to as self-insurance. It falls within the broader category of alternative risk financing.

While there is no general agreement on terminology, alternative risk financing (ARF) generally is used here to refer to self-insurance, excess insurance, captives, risk retention groups, cash flow, and other risk financing plans. An entity may completely self-insure all of its exposures to loss. In essence, an entity that is completely self-insured is truly uninsured.

More often, however, entities combine some elements of self-insurance with elements of traditional insurance to create a diverse alternative risk financing program. Self-insurance will be used in this article only when the topic being examined focuses solely on the technical concept of self-insurance as one of the many ARF techniques available to the risk manager.

 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.

Workers compensation laws allow for the creation of a self-insurance fund to avoid purchasing commercial workers compensation insurance, which was discussed in A & D Development v. Michigan Commercial Ins. Mut., No. 317024, 2014 WL 7338871 (Mich. App. Dec. 23, 2014). A self-insurance fund is administered by an elected board of directors for the purpose of providing workers compensation coverage for a group of private employers in the same industry. The board of trustees is responsible for all operations of the fund, including taking "all necessary precautions to safeguard the assets of the fund." The duties of the fund administrator include providing the board with advice regarding the premiums charged and investing the surplus of monies. The administrative rules provide guidelines for investing surplus premiums.

Some insurance policies contain a provision called a self-insured retention. This self-insured limit is not like a deductible but is in fact self-insurance to the extent of the retained limit. It becomes the primary layer of exposure, with the policy providing excess coverage over the self-retained limit, as discussed in Hampton v. Florida Municipal Ins. Trust, No. 4D13-3659, 2014 WL 7150490 (Fla. App. 4 Dist. Dec. 17, 2014).

Does self-insurance 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 Cas. Co. 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. Of course, her policy, unlike most, said it was excess over self-insurance or a self-insured retention so the issue did not require interpretation.

Similarly, in Odessa School District No. 105 v. Insurance Co. of America, 791 P.2d 237 (Wash. App. 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. Although a self-insured retention can make sense in this analysis, a deductible is a different character as it must only be paid at the end of a case while a self-insured retention must be expended in total before the insurer is required to do anything.

In Air Liquide America Corp. v. Continental Cas. Co., 217 F.3d 1272 (10th Cir. 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.

However, consider Christoffersen v. United Parcel Service, Inc., 747 F.3d 1223 ( 10th Cir. 2014), which noted the issue in Air Liquide was not whether the fronting policy constituted self-insurance but whether it qualified as "other insurance" under the terms of a second policy. The Tenth Circuit's passing reference to the fronting policy as "a form of self-insurance" had no bearing on that issue, for it was simply describing fronting policies as self-insurance in a colloquial sense. Indeed, self-insurance is often defined, as it is in 43 Am.Jur.2d Insurance § 18, as "a term of colloquial currency rather than of precise legal meaning."

Also, consider that insurance shifts the risk of loss from an insured to an insurer. Black's Law Dictionary, 7th Ed., defines "insurance" as "an arrangement by which one party assumes a risk faced by another party in return for a premium payment." As the court stated in Carns v. Smith, No. 01-972H, 2003 WL 22881538 (Ohio Com.Pl. 2003), the fronting policies in General Motors' Program were not insurance policies but were the "antithesis of insurance."

In Atchison, Topeka & Santa Fe Ry. Co. v. Stonewall Ins. Co., 71 P.3d 1097 (Kan. 2003) the Kansas Supreme Court noted that among the courts that have decided whether self-insurance is insurance, it appears that a slight majority have decided it is not. Sound policy and fairness reasons have been articulated for deciding that self-insurance is insurance. In addition, excess insurance coverage, as insurers provided to Santa Fe, generally assumes that there is primary insurance coverage. To hold otherwise allows the insured to "manipulate the source of its recovery and avoid the consequences of its decision to become self-insured," conduct the Kansas Supreme Court found unacceptable. As the self-insured retentions had to be exhausted before looking to the insurers for coverage.

In Boatright v. Spiewak, 570 N.W.2d 897 (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 Auto. Ins. Co. v. Universal Atlas Cement Co., 406 So. 2d 1184 (Fla. App. 1981). 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. The court record stated: "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 applied only when there was "an insurance policy, the proceeds of which are collectible." The court also cited Southeast Title and Ins. Co. v. Collins, 226 So. 2d 247 (Fla. App. 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 if administered by someone else, did not fall within the definition of "other collectible insurance."

Putzeys v. Schreiber, 576 So. 2d 563 (La. App. 1991) reached the same conclusion. In Putzeys, the court 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 (5th Cir. 1991), provided a different interpretation. The 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 was insured by Columbia Casualty Company on a policy with a $100,000 self-insured retention. Budget rented the car to Charles Lewis Pump Company. 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 were required 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, Budget claimed 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 was required to pay first and Columbia Casualty Company second.

The court in Cone Mills Corp. v. Allstate Ins. Co., 443 S.E.2d 357 (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 that 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.

The court also 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." Whatever the precise meaning of "self-insurance" is, it is not—nor could it be—insurance since there is no promise of payment of indemnity for another.

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, and, preferably, seek the advice and counsel of an experienced insurance coverage lawyer in the jurisdiction to properly evaluate the exposure and whether it is appropriate and financially feasible to self-insure.

It also is 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 insurance  clauses 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, directly and with the assistance of local insurance coverage counsel, 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, Inc. v. Florida Ins. Guaranty Ass'n, Inc., 304 So. 2d 507 (Fla. App. 1974). It focused on the right of an individual self-insured employer to collect from the Florida Insurance Guaranty Association Incorporated when its excess carrier became insolvent. Zinke-Smith Incorporated self-insured its workers compensation exposure and purchased excess coverage from Home Owners Insurance Company.

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 on 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 for sums in excess of its deductible or self-insured retention.

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 In re Mission Ins. Co., 816 P.2d 502 (N.M 1991), the court was faced with a case similar to Zinke. Citing Zinke as precedent, the court held that excess coverage for workers compensation losses is direct insurance and that Levi Strauss was entitled to coverage by the guaranty association.

In Esposito v. Simkins Industries, Inc., 943 A.2d 456 (Conn. 2008), the Supreme Court of Connecticut was faced with an appeal from the Connecticut Insurance Guaranty Association because the workers compensation review board ordered he 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. The claimant, the wife of the deceased, agreed to settle a workers compensation claim with the employer. In accordance with the commissioner's 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 is South Carolina Property and Cas. Ins. Guar. Ass'n v. Carolinas Roofing and Sheet Metal Contractor's Association, 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.

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 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 call 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 and not excess reinsurance or reinsurance coverage.

As always, it is imperative that insurance policies must be read before they are acquired and any deductibles, self-insured retentions, or other varieties of self-insurance discussed with knowledgeable risk managers or local insurance coverage counsel.

 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 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 Corp., 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 cases revolving around uninsured motorists coverage are Hebard v. Dillon, 699 So. 2d 497 (La. App. 1997) and Gutman v. Worldwide Ins. Co., 630 A.2d 1263 (Pa. Super. 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 inSmith v. Enterprise Leasing Co., 833 A.2d 751 (Pa. Super.. 2003)].

All of these cases point to the fact that a firm 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. Unless the firm considering self-insurance is knowledgeable about insurance law in the jurisdiction, it would be prudent for the firm to seek the advice and counsel of a competent local insurance coverage lawyer before making a decision to self-insure.

 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 the following:

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
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 can also embody a number of disadvantages for the firm. Many of these drawbacks are the reverse side of the advantages of alternative risk financing discussed previously. They include:

1.  Unexpected variations in cash flow
2. Adverse employee or customer relations
3. Insufficient experience to deal with tort claims
4. Lack of experience in managing lawyers to defend the firm
5. Administrative problems
6. Increased income taxes
7. 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