February 1, 2009
Article by: ARMC
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. 1
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.
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.
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.
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.
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.
Vascular disease, strokes, shortness of breath, degenerative disc disease, uncontrollable diabetes mellitus, and obesity are easily aggravated, which makes the employer responsible.
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.
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.
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.
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 recession will have a major impact on the cost of workers compensation claims and of course, reserves. As stated, 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.
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