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By MICHAEL KIM, the loss portfolio product manager for Safety National, a provider of alternative risk funding solutions for the self-insured community since 1942

In a time of economic uncertainty, a tool exists in most jurisdictions that allows a self-insured employer or group to divest itself of claims that are dragging its balance sheet down: the loss portfolio transfer, or LPT.

In its simplest form, an LPT is the transfer of a book of liabilities from an entity to a carrier or reinsurer. An LPT has no minimum or maximum size, but the transaction must be both financially reasonable to the transferring entity and also provide adequate protection to address the carrier's or reinsurer's concerns regarding adverse claims development.

In the workers' compensation alternative markets, such as self-insurance, the most important benefit of an LPT can be the elimination or reduction of a collateral requirement by the state, or states, where that entity is self-insured. With continuing credit challenges facing some self-insured organizations, an LPT may allow for the reduction of a state's held collateral by providing for the removal of liabilities from the self-insured's balance sheet.

There are many stories of entities in the self-insured community using LPTs with great success. We recently worked with a self-insured employer wishing to dissolve its status as a qualified self-insured. The transferring entity had $1.4 million in outstanding reserves and, through an LPT, received a return of collateral totaling $6.6 million from the jurisdiction in which that collateral was held. This type of collateral relief is available to an entity wishing to remain a qualified self-insured, but still wanting to transfer liabilities from a prior occurrence period.

The transferring self-insured entity can also benefit by:

-- Providing and converting a fixed payment for all known and unknown liabilities.

-- Eliminating the variability and volatility of long-tail liabilities.

-- Securing relief for, and potential strengthening of, its balance sheet by removing accumulated historical liability.

-- Eliminating joint and several liability in a group or association scenario.

-- Achieving administrative cost-savings by reducing or eliminating claims administration responsibilities.

While self-insurance has proven to be the most straightforward environment for the application of an LPT (and the area mainly discussed here), the positive effects of this type of agreement can be realized in other situations as well. If an entity is currently insured under a large deductible program, for example, an LPT may be a solution if that insured entity's carrier approves the transfer.

In addition, any time a merger or acquisition takes place, an LPT can eliminate any existing claims on the acquired entity's books, which can make it easier for such a transaction to take place.

Also, an insurance carrier wishing to discontinue certain lines of business can use an LPT as a solution for transferring existing liabilities within those lines.

GAINING LPT PROPOSAL

In order to receive approval for an LPT, the transaction will need to satisfy three important criteria to most jurisdictions. First, the transfer must include all known and unknown liabilities, defined as not only development on existing claims but also incurred but not reported (IBNR) liabilities.

Second, the transfer cannot be cancelled by either the seller or buyer of the transfer. This prevents any of the liability from being returned to the self-insured entity.

Third, the policy format must meet the unique requirements of each jurisdiction. For example, the state of California has its own special excess policy form that must be used to execute an LPT in the state.

In addition to meeting jurisdictional requirements, a due-diligence process takes place to evaluate the feasibility of an LPT. Key components of the due-diligence process for an LPT can include:

-- A fair and accurate assessment of all liabilities subject to the LPT. This assessment typically involves a review of the subject liabilities by claims professionals, including the self-insured's third-party administrator (TPA) when applicable.

-- A clear understanding of the insurance structure to be included in the transfer, including self-insured retentions and historical excess coverage, by both the seller and buyer.

-- An audit may be used by the carrier or reinsurer to determine the adequacy of reserve values for all known liabilities to be included in the transfer, given that an actuarial analysis will be utilized to project claims development and IBNR.

Clearly, communication and cooperation between the seller and the buyer of the LPT are fundamental to a successful LPT.

Given the low frictional costs associated with this type of transaction, a transfer of claims liabilities through an LPT can create financial flexibility through the release of collateral, a cleaner balance sheet and the reduction of long-tail claims payment requirements.

Finally, finding a financially strong, admitted and rated carrier or reinsurer with experience executing LPTs is important to streamlining the process and making the transaction efficient and successful.

Read more at the WORKERSCOMP Forum^TM homepage.

April 21, 2010

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