Controlling Workers Compensation Costs for Employers

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Workers Compensation Claims Reserving: This is a War of Inches

Workers Comp Claim Reserves

"This is a war of inches, and the inches we need to win are everywhere."1.

Probably nowhere is this statement more true than in the world of workers' compensation costs.

Claim Reserves drives up work comp costs

Lower Experience Ratings give employers the competitive advantage.Nothing has a greater impact on the level of premiums which an employer will pay than their Experience Modification Rating (X-MOD). A low X-MOD can give an employer a competitive advantage in the market place. Conversely, a high X-MOD can cause an employer to lose the advantage. It might even put them out of business.

An employer's X-MOD (for all but the largest employers) is the single most important factor in determining what the insurance premium will be. First, it is used as a multiplier against the employer's quoted premium. Someone that has an 89% (low loss history) X-MOD will pay far less for coverage than someone with a 137% (high loss history) X-MOD – in this case, 54% more.

The second way is less tangible, but every bit as important and costly. Just like a low credit score, someone with a high X-MOD is thought to be a higher risk.An employer with a high X-MOD is thought to be a higher risk This means the preferred carriers with the lower filed rates won't quote their business. And, the lesser carriers (that have higher filed rates) are less willing to offer discounts to the employers. It turns out to be a double-hit for employers with poor loss histories. Depending on the circumstances, they might pay as much as twice what an employer with a good loss history and the same work class code and payroll.

How employer loss figures drive up their Experience Rating

The employer's loss figures are calculated as 'Total Incurred'. 'Total Incurred' is a combination of (i) money actually paid out plus (ii) claim reserves based on estimates for future payments. Claims Reserves cause reported losses to be higher In most cases, the claim reserves usually represent 60% or more of the total incurred. This causes reported losses to be higher and that causes the X-MOD to go higher.

Adjuster sets claim reserves

The person that has the most influence over the Experience Rating is the claims adjuster. The adjuster doesn't have control over the injuries that will occur in the work place or the severity of the claims. What the adjuster does control is how the claim reserves are set.

The claims adjuster should (and must) place adequate reserves on a claim to ensure there is sufficient money to pay the claim. But, if the claim reserves are too high – and the claim closes for a lower amount – the employer will wind up paying a higher amount for the insurance policy renewals than they had to.

The largest portion of work place injuries are medical only ( MedOnly ) claims. They usually close after a short period and at a relatively low cost. The balance (just over 20%) are Indemnity claims. They account for approximately 93% of all costs.

Open claims can fall off the mod rate

Indemnity claims, particularly the severe and expensive ones, will usually remain open for two or more years. They are most often reported on Unit Stats as 'Open' for several successive years. Often, by the time an indemnity claim closes, it has fallen off the X-MOD after being reported for three years.

Following claims until they are closed

One of the audits I regularly perform for my clients is to follow claims until they are closed – regardless of how long they take to close. Once the final cost has been established, I recast the prior year's X-MOD to see if the final cost is significantly below the previous reported costs.

Often I find this is the case – the final cost is well below previously reported values. Had the claim costs been reported at the final value, instead of some higher value, the prior X-MODs would have been lower. Sometimes the adjustment to the X-MOD would not have been significant – sometimes the difference is large.

Employers can request re-rating of prior year's X-MODS

The WCIRB does have a process in place that allows an employer to request prior year's X-MODs to be re-rated and adjusted. If the X-MODs are adjusted downward, the employer can apply to the carrier that used the X-MOD as part of their premium calculation for a refund.

The problem with this is the bar to get a re-rate is very high. Not only must an individual claim close at more than 40% below its reported high value, all claims closed for that X-MOD must, cumulatively, close at least 40% less. Often several smaller claims will close as well and, even though a single claim closed below the 40% level, the combined claims don't meet the 40% hurdle.

Over the years, I've had a few occurrences where the employer was successful in getting a re-rate and a refund. More often, the total of the closed claims don't meet the 40% criteria – even though, by using the final costs, the employer's X-MOD would have been adjusted down by several percentage points.

The impact of proper pricing and claims reserving

One good example is an audit I just completed for an employer. All the claims for their Policy Year 2009 are closed. While comparing the final Loss Runs with the latest X-MOD (effective 2012), I found that the total losses for PY 2009 were $100,450 instead of the $134,070 reported on the X-MOD. That means total losses were over-reported (over reserved) by $33,620 – an increase of 33%.

The majority of the difference was in the larger indemnity claims. Since the Rating Procedure on the X-MOD is designed to rate frequency more heavily than severity, the reduction in the X-MOD wasn't as large as one might expect.

Had the claims been properly priced and reserved, the X-MOD would have been three percentage points lower – a 119% X-MOD instead of a 122%. That doesn't seem like much of a difference. But this employer has about $6.5 million in payroll. The expected premium for 2012 is around $500,000. Those three percentage points cost the employer an additional $15,000 for that year.

This $15,000 is for one policy year and possibly for one of three valuations on the X-MOD. Over the life of this policy year, this could amount to $45,000 (more or less). When all three years on the X-MOD, and each individual year, are taken into account, it can mean the possibility of significant savings for an employer.

What can employers do to lower work comp reserves?

Setting claim reserves is not an exact science. It has been my experience that adjusters do the best they can at estimating the future cost of a claim – given the time and resources they have.

It is up to the employer to review the loss runs on a regular basis and work with the claims adjuster

Review Loss Runs

It is up to the employer to review the loss runs on a regular basis and work with the claims adjuster to make sure the claim reserves are reasonable. Insurance carriers are required by law to disclose everything to an employer that will affect their premium. Most employers don't understand this and don't know how to contact the adjuster and work with them.

In theory, a good insurance broker would perform this service for their clients. After all, they are getting a commission of around 10% of the policy premium.

It is easy to see how an investment of time in communicating and working closely with an adjuster will pay off handsomely.  Every small amount reserved on a claim contributes to the increase (or decrease) in the X-MOD.

As I said at the beginning of the article, 'This is a war of inches and the inches we need to win are everywhere.'

Now, go find that Inch!


1. 'This is a war of inches, and the inches we need to win are everywhere." This was a statement made by Al Pacino during a locker room speech in the movie, Any Given Sunday (1999), in which he plays the head coach of a fictional professional football team.

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