Most buyers of commercial property and casualty insurance policies have an inadequate grasp of the differences between a self-insured retention (SIR) and a deductible. Even more regrettably, few sellers of these policies appreciate the differences.
I want to focus here on the significance of Oklahoma's allowance of limited uncollateralized SIRs for the new Oklahoma option (OKO) from a surety standpoint. This focused perspective will shorten the discussion below, but readers who need more general background information on the deductible/SIR distinction should consult this great article written by Donald Malecki.
In the world of workers' compensation (WC), deductible policies are far more common than SIRs. The primary reason for this is that states prefer financially stable insurance carriers to provide the surety that injured workers' claims will be paid. Don't forget that "lifetime medical benefits" is a potential multi-million dollar liability for any injured worker. States don't want to trust employers--who may be on the verge of insolvency at a moment's notice--to bear that burden. Consequently, each state's WC system is set up to shift that burden to financially stable insurance carriers. Standard WC policies are not the only solutions states allow, but alternatives are usually more onerous for employers. When insureds decide to take on some of their own risk (e.g., by buying loss sensitive policies), the system ushers them toward deductibles. The major reason for this is that even though the carrier and insured may establish terms on how that deductible will work, the carrier is still on the hook for a loss (in case it doesn't work). This conservative proclivity has been inherent in WC for decades. For example, if an insured agreed to pay the first $250,000 on a catastrophic loss but goes bankrupt before paying that out, the carrier is still responsible. Hence, carriers (not states) frequently require collateral from insureds when setting up a deductible. Regardless of any such arrangement, the states look at WC carriers to provide the ultimate safety net for their respective WC systems.
SIRs are quite different in this respect. When a carrier and insured set up an SIR, the carrier typically has no responsibility until the SIR has been satisfied. For example, sticking with WC, if an insured carries a $250,000 SIR (leaving the carrier to handle all exposures beyond that threshold) and the insured can't pay that full amount--for whatever reason--the carrier doesn't have to pay anything. Because of this technical difference between deductibles and SIRs, states (not carriers) lead the way in requiring collateral from SIR employers to ensure they can meet their fiduciary obligations. Once these obligations are met, the ultimate safety net of financially solvent insurance carriers is in place.
Now let's leave traditional WC.
One of the most amazing aspects of Texas nonsubscription is the complete lack of collateralization of SIRs. The state does not police this area AT ALL. And carriers, for the most part, don't really care if insureds (employers) can't provide any type of financial warranty that an SIR can be met. It is my opinion that this discrepancy--the lack of surety for injured workers--is the worst component of an otherwise phenomenal alternative to WC in the Lone Star State.
Enter the Oklahoma option. Oklahoma is trying to thread the needle here. Employers who choose to opt out of traditional WC have some unique options when it comes to setting up a loss sensitive program. The Oklahoma Insurance Department is allowing a "safe harbor" for all employers who choose an SIR up to $25,000. This means that any employer in the state who wants to take advantage of the OKO--even if that employer is on the verge of bankruptcy--is able to carry up to a $25,000 SIR without providing any surety that such a financial commitment can be met. There are other options above that $25,000 threshold, but just think about that opportunity for a moment.
The most expensive dollars to insure for any loss are the first dollars. The first $25,000 worth of exposure for any loss is far more expensive to insure than the $25,001-$50,000 layer. And, actuarially speaking, insureds pay less (dollar for dollar) for all retained losses than they would if they outsourced those losses by buying insurance from a bulky carrier with lots of overhead. So OKO employers can make a serious impact on their insurance costs by bearing the most costly dollars--the first ones--of their risks without going through the time, energy and costs of offering collateral. An ameliorative effect of such a structure is that employers are then incentivized to get more serious about loss prevention. Of course, the least expensive loss is the one that never happens.
How is this magic accomplished? Well, keep in mind that we're talking about a relatively small corridor of potential trouble. Unlike Texas, where anything goes, Oklahoma is still policing this relatively small SIR area and relying on financially solvent carriers to provide the safety net for the OKO system. The state is simply offering a little wiggle room. If the employer fails to meet its financial obligations within its retention (say the last $12,345 of its $25,000 commitment), then Section 205 of the new WC law comes to the rescue. That section created the Oklahoma Option Self-insured Guaranty Fund, which is funded, effectively, by two sources: a) fees paid by carriers doing business in the state; and b) assessments on self-insureds collectively.
So the first effort to clear the SIR hurdle belongs to the employer who established the SIR to begin with. After that, it is left to the Self-insured Guaranty Fund to fulfill an SIR obligation (say the last $12,345 of the employer's $25,000 commitment). Again, in order for the carrier to provide the ultimate surety on any given claim, the SIR simply needs to be met. The vast majority of employers can meet the financial obligations of the vast majority of workplace injury claims. If an OKO employer can't meet its financial obligation, then the Oklahoma Option Self-insured Guaranty Fund helps bridge that gap to put the ultimate responsibility where it can best be handled: in the financially solvent carrier's lap.
This is just another unique solution afforded by an unprecedented law, drafted by a state legislature and enacted by a governor who are determined to put Oklahoma at the forefront of innovation in workplace accidents.