"Our rates had been so low for so many years that they never hit the radar

screen," says Roland Vaughan, president and chairman of Sherlock, Smith. "All of a sudden this was a major business concern."

The firm couldn't locate any better deals, in part because workers' comp has

become anathema to many insurers. "We've just been bleeding carriers here,"

he says. So Sherlock, Smith joined a self-insured group fund "at a cost much closer to my historic rates," Vaughan boasts.

Proliferating Pools

His experience is not unique. Self-insured group funds are proliferating at small

and large companies after years of eclipse. (Workers' comp insurers were so hungry for business when rates were soft that many even waived the

deductible.) "We wrote $1 million in new business in the month of July alone, by

far the largest amount of premium written in a single month since the group

funds we administer were formed 20 years ago," says Tim Hanna, president of Regency Insurance Group. The Okemos, Mich.-based company administers

four funds that insure 1,300 companies–including more than 100 that joined in July.

The Alabama Self-Insured Workers Compensation Fund wrote $11 million in

new business last year for its 3,000 members, roughly one-sixth of its $67 million overall premium volume, and anticipates another $15 million in new

business this year. "This indicates a rather large exodus from the commercial workers' compensation insurance market," says Freda Bacon, administrator of

the 23-year-old Birmingham-based fund.

Self-insured group funds were created in the 1960s to benefit middle-market

companies that could not afford to establish stand-alone self-insurance programs. Today, 34 states permit their incorporation. About 95% of the funds

are homogenous, meaning their members come from a common industry, according to the Self-Insurance Institute of America, a Santa Ana,

Calif.-based trade association.

The funds are essentially mutual insurance companies whose members receive

premium dividends during good loss years and pay premium assessments in the bad ones. They also get to share the investment income accrued on premiums.

"Why let an insurer keep this when it's your capital in the first place

generating the income?" asks Felix Kloman, a veteran risk management consultant

based in Lyme, Conn. "Most of the profits historically generated [in

the insurance industry] have come from investment income on loss reserves."

The Alabama Self-Insured Fund has returned more than $81 million in

premiums to its members over the last 10 years, according to Bacon.

Lower Cost, Lower Losses

Other advantages to group self-insurance are that funds don't pay taxes on

premiums received (unlike commercial underwriters) and have low overhead. They also are exempt from contributing to insurance guaranty funds in most

states, although they sometimes have to meet excess insurance requirements. "There is no question that self-insured group funds are the least expensive

method of delivering workers' compensation insurance," says William L. Shores, whose eponymous accounting firm in Orlando, Fla., has conducted

more than 1,000 audits of self-insured group funds over the past 25 years. "Basically, you're purchasing insurance at cost."

Kloman says self-insured groups also boast better loss records than companies

with commercial insurance. "You have a better knowledge of loss exposures given the experience of your peers, and then you have the peer pressure to

improve safety and loss control," he says. "You respect this information because it's from your peers, rather than suspect it, as you would if it came

from some remote insurance company selling other lines."

Improved risk management factored into the decision by Wendy's of Michigan

to join the Michigan Restaurant and Lodging Fund this past July. "Our rates jumped 20% at our last policy renewal with our commercial insurer, and we

were very frustrated with the products the commercial marketplace was showing us," says Cindi Romanowski, risk manager at the $40 million, Grand

Rapids, Mich.-based owner of 40 Wendy's International franchises. "I wanted more control over the system."

Romanowski now expects to have more input into claims administration and

health-provider choice. She is particularly eager to use accident reports tailored to the needs of the Restaurant and Lodging Fund's 800

members–and she expects to receive a premium give-back reflecting her chain's true

loss experience. (The Wendy's franchise initially is paying about

the same premium as for commercial workers' comp, since the group bases its assessment on the company's historical loss experience.)

Proponents of funds say that they are insulated from the wild gyrations of the

commercial insurance industry because of their members' common experience. "You're not going to see workers' comp rates rise 50% to 100%

and more in a single year like they have in California for many companies," says Vincent Capaldi, an account executive at Self-Funded Alternatives,

Langhorne, Pa., which brokers excess workers' compensation to self-insured companies.

He concedes that excess insurance for groups has risen by about 10% in the

past 12 months–about the same as for commercial excess lines. Shores says too many funds are tempted to forgo the excess coverage. He recalls the

tough battle he had dissuading one client from switching to a limit of $5 million

from unlimited coverage after it calculated that it could save $75,000 in excess

insurance premiums annually. "I kept harping that all it would take is one big

loss to blow through that limit," he says. "Lo and behold, the next year one

fund member had a single accident in which 50 workers were injured and the total bill came to $50 million. They would have been on the hook for more than

$45 million."

United They Fall

If a principal virtue of self-insured group funds is their members' shared risk

profiles, sharing is also their chief vice, say representatives of commercial insurers. Members with good loss experiences can suffer substantial setbacks

if their co-members falter.

"Funds present joint and several liability," explains Robert

Hartwig, chief economist at the New York-based Insurance Information Institute. "If one

member gets caught with a couple of repetitive-stress claims…which can run

into the hundreds of thousands of dollars, that cost is spread across all members of the group, even if their losses are nothing."

Some funds have folded under this pressure. Four self-insured workers'

compensation group funds in Illinois went into receivership in the past year, the

most recent being the Illinois Environmental Services Workers Compensation

Trust. "Had these companies bought traditional insurance, which completely transfers the risk of loss to a third party, they wouldn't have these ongoing

liabilities," says Hartwig.

He also says that the homogeneity of most funds create risk, citing failed

workers' comp insurer Fremont Insurance. "[Fremont's] no different than the

funds, which, by and large, don't sell anything other than workers' comp,"

Hartwig says, adding that self-funded insurers at least have government guaranties that are unavailable if a fund goes bust.

Kloman says the comparison is odious. "Joint and several liability exists for

both self-insured groups and insurance companies–it's the same thing," he says."In both, you're paying for the losses of other people via the premium you

plunk down. Insurers can underwrite badly for years and then leave people in the lurch with markedly higher premiums. It's happening again right now."

Therapeutic Tips

Even advocates of funds warn that potential participants must do substantial

due diligence before ditching their private policies. Excess insurance coverage cost must be considered, just like the dollar level at which a fund's insurance

attaches, they say. Other important issues are the expertise of the group fund's administrator, the prescribed underwriting guidelines (if any) and

membership eligibility criteria.

Paul H. Moore, president of Brooke Insurance, a Shreveport, La.-based

consulting firm specializing in self-insurance, says funds should have both per claim and aggregate excess insurance protection. "Find out the name of the

excess carrier, its length of time in business and its rating," Moore advises.

"You also want to know how much risk members bear before the excess kicks in, and if there is a financial limit to this catastrophic coverage."

Shores says potential pool participants should look for funds with long track

records to determine how they weather the ups and down of the marketplace and of government safety regulations. He also suggests asking a group fund

for its underwriting criteria and membership eligibility requirements for analysis

by an agent or broker. Members' experience modifiers, which indicate companies' past loss histories, also are useful since they

are assigned by

outside workers compensation rating bureaus, he says.