Many Government contractors have elected to provide coverage for certain risks from their own resources under a program of self-insurance. A decision to self-insure is typically based on a determination that coverage can be provided by self-insurance at a cost not greater than the cost of obtaining equivalent coverage from an insurance company, or in the case of workers compensation, a State fund. That makes some sense. With self-insurance, a contractor is not paying for the insurance company's profits. The larger the company, the more cost effective it is to be self insured since there is a much larger workforce to spread the risks.
Even with self-insurance programs, contractors will carry or maintain various forms of purchased insurance to cover major risks and catastrophic losses. For example, under a self-insured health plan, contractors will usually limit its self-insurance to routine hospital, surgical, and medical expenses and, at the same time, purchase insurance covering life, accidental death and dismemberment, disability income benefits and dreaded disease coverage.
Accounting for self-insurance programs requires a level of precision that is not so easy to estimate. Under a self-insurance program, a contractor must make a charge for each period (i.e. monthly). This charge must represent the projected average loss for that period. How does one project an average loss for a period? Obviously contractor's need good historical data and a sense of what might happen in the future.
Self-insurance charges plus insurance administration expenses may be equal to, but cannot exceed the cost of comparable purchased insurance (see FAR 31.205-19(c)(3)). This is where some contractors run afoul of contract auditors because they don't know, or haven't determined the cost of purchased insurance.
FAR 28.308 requires contractors to submit self-insurance programs to the contracting officer for approval when 50 percent or more of the self-insurance costs to be incurred at a segment will be allocated to negotiated Government contracts and are expected to exceed $200 thousand per year. That same FAR provision includes a list of what is required in the submission for contracting officer approval.
Tomorrow we will look at some of the things a contract auditor might review when it comes to self-insurance costs.