Workers Compensation Reserves—Dollars and Sense
February 2009
Workers compensation reserves can have a
major impact on insurers and employers, and should be monitored closely to
ensure they represent the ultimate cost of the claims.
by William Quinn Jr., CPCU, ARM, ALCM
Albert Risk Management
Consultants
Improper loss reserving can affect an insurer's profitability and even its
very survival. More than one-third of the 1,000 property/casualty insurance
company failures during the past 4 decades were due to inadequate reserves.
During the mid-1980s, I negotiated contracts to administer 11 of them. One
of the failing companies was actually increasing reserves daily to cover the
payments to be made that very day! How could they have possibly expected to
accrue the funds necessary to cover their ultimate liabilities with this
sort of reserving practice?
Employers are not immune from the financial
effects of an insurer's or third-party administrator's improper reserving.
Reserves Can Be Too High
The second worst thing that can happen to
an employer is to have workers compensation reserves that are too high. This
is likely a surprising concept to the many that make it their mission to
keep reserves as low as possible. When they are too low, they develop
rapidly and can create an unfunded future financial crisis. Risk managers
who fought long and hard to keep reserves in check or reduce them have been
fired when the reserves ultimately exploded. I know a risk manager who fits
this description who had to seek permission from the CEO to borrow a huge
sum of money to pay for a retrospective adjustment in a year in which the
company had a red bottom line.
Admittedly, the establishment of reserves
is more of an art than a science, but they are not the result of a guess.
Accurate reserves depend for accuracy on the experience of the adjuster, the
quality of the investigation, a good claims control program, and most of all
the impact of the injury on the employee.
One dangerous result of
inadequate reserves is the lack of management oversight. Early intervention,
by experienced claims people, is necessary to control the cost of claims
that are likely to develop into very expensive ones. Inadequate reserves
allow high exposure claims to "fall below the radar" of claims managers
which can delay the application of necessary case management controls until
they are too late to affect the outcome of the claim.
The Unlucky 7
Inexperienced adjusters tend to minimize reserves because they have not
experienced a sufficient number of claims that tend to develop into very
expensive ones, such as the unlucky 7. Click here for Figure 1: The Unlucky
7.
Back Injury—Middle Aged Employees
This is especially true with
respect to laborers without transferrable skills. Many years of constant
stress and normal aging means extended medical care, possible surgery, and
doubtful return to work.
Vascular Injury—Older Employees
Injuries
to the lower extremities are a good example. People with preexisting
peripheral vascular conditions are commonly found to suffer from diabetes,
hypertension, and high cholesterol so as to be candidates for strokes, heart
attacks, and amputations.
Unrelated Physical Conditions
Vascular
disease, strokes, shortness of breath, degenerative disc disease,
uncontrollable diabetes mellitus, and obesity are easily aggravated, which
makes the employer responsible.
WC Payment Approximates Net Income
Consider a family with two working parents. If one of the parents receives
workers compensation benefits, and there is no longer a need to pay for
childcare, the net family income may actually be greater than when both
work.
Disability Near Retirement
Mentally, employees that are
nearing retirement have prepared themselves for leaving the workforce.
Enjoying tax-free income is an added benefit at that point and will be
difficult to discontinue.
Seasonal Employees
Construction workers
and farm laborers are typical seasonal employees. My long claims career
exposed me to an inordinate number of employees who took advantage of the
workers compensation system to get them through the winter—I even had some
repeaters.
Plant or Business about To Close or Downsize
Even a
hint of layoffs can cause a rash of new claims. In my early days of handling
workers compensation claims, I had several plant closings where more than 50
percent of the employees filed occupational disease and or back claims.
The Current Economy
The current recession will have a major impact
on the cost of workers compensation claims and of course, reserves. As
stated above, huge layoffs (or just the threat of job loss) will spawn a
substantial number of fraudulent claims and a much larger number of
prolonged expensive claims. With no opportunity to return to work, employees
will hang onto the workers compensation "lifeline."
Because of the impact
of experience modifications, even so-called guaranteed cost plans are loss
sensitive. Retrospective, large deductibles, and self-insurance plans are
even more loss sensitive. All of the plans will have a direct impact on the
profitability of individual work locations as well as the overall
profitability of the corporation.
Employers with charge back programs need
to be especially diligent to make sure that current reserves fairly
represent the workers compensation exposure at individual profit centers.
Some profit center managers will do their utmost to minimize reserves.
Widespread layoffs will cut payroll costs, but claims by laid off workers
will certainly increase, the costs will escalate, and you can be sure that
reserves will explode. Risk managers should be prepared for this and advise
upper management of the exposure.
No longer can insurers rely on the stock
market to bail them out of deficit underwriting. Catastrophes aside, 2008
investment losses were the primary cause of the poor financial performance
of most property/casualty underwriters. They should carefully monitor claims
reserves—and their customers would be wise to do the same.
*The Albert Risk
Management Consultants claims management team (Glenn Brown, Lisa
Hartman, William Quinn, Jr., and David A. Tweedy) contributes articles on
claims topics. You can reach William Quinn at
bquinn@albertrisk.com.
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