Past wisdom in software development held that the proper sequence of events should start with perfect requirements, followed by perfect design and planning, ending with implementation. The flexibility promised by agile methodologies of software development, according to that view, is as costly as allowing for the possibility that the kitchen in a half-built house is not in the desired location. Besides, what is the meaning of software “architecture” if we allow for shifting designs and evolving features? To answer the criticisms about agile developments, one must examine the underlying concepts supporting traditional, sequential "waterfall" development:

• Perfect planning is possible;
• Change is inevitably costly;
• Architecture must result in unchangeable results

But perfect planning isn’t possible. It is a disservice to the client to require a perfect plan. In the real world, knowledge of the business is dispersed among many stakeholders; concepts suffer from varying degrees of vagueness; and the desired outcome often begins to crystallize only after the work has begun. It is therefore more cost-effective to have  technical talent that can function in an interactive environment with the stakeholder and adapt the work to an evolving plan. Change isn’t always costly. The cost of change can be minimized if enough flexibility was implemented in the first place. Planning must therefore allow for the ability to make changes. The extra initial cost reduces the risk of a higher cost being incurred later. Architecture does not equal rigidity. Proper software architecture makes use of techniques that reduce dependencies, generalize software components and anticipate changes in the design itself. To continue the half-built-house analogy: The ceiling is not resting on too many walls, and the infrastructure for the kitchen is in many places in the house. The practice of writing flat, unidirectional software, based on the theory of the “perfect plan” has resulted in legacy software that is hard to change, maintain or understand. The evolution of the software engineering discipline is in part a response to that problem. The common threads in modern software design concepts indicate that. For example, the concept of encapsulation in object-oriented languages, where the inner workings of a software entity make that entity a black box that can be replaced without having to change its context, directly serves the need for flexible architecture at the lowest level. The concept of “pure functions,” in functional languages, where a function is by definition unable to change its environment (making the function easy to “unplug” and replace), also serves the same end. Proper architecture makes use of established and proven design patterns, selects the right patterns for the task at hand and adapts them when needed based on the specifics. This increases the effectiveness of the planning stage by a) avoiding reinventing the wheel and b) greatly reducing the number of possible paths that need to be explored. It takes a certain attitude to embrace the agile approach: one that thrives on innovation, freedom and work that never stops improving.

Last fall, I wrote about board oversight of cybersecurity and derivative litigation in the wake of cybersecurity breaches.  In this post, I’d like to focus on cybersecurity disclosure and the inevitable advent of securities class actions following cybersecurity breaches.  In all but one instance (Heartland Payment Systems), cybersecurity breaches, even the largest, have not caused a stock drop big enough to trigger a securities class action.  But there appears to be a growing consensus that stock drops are inevitable when the market better understands cybersecurity threats, the cost of breaches and the impact of threats and breaches on companies’ business models.  When the market is better able to analyze these matters, there will be stock drops.  When there are stock drops, the plaintiffs’ bar will be there. When plaintiffs’ lawyers arrive, what will they find?  They will find companies grappling with cybersecurity disclosure.  Understandably, most of the discussion about cybersecurity disclosure focuses on the SEC’s Oct. 13, 2011, “CF Disclosure Guidance: Topic No. 2” (“guidance”) and the notorious failure of companies to disclose much about cybersecurity, which has resulted in a call for further SEC action by Sen. Rockefeller and follow-up by the SEC, including an SEC Cybersecurity Roundtable on March 24, 2014.  But, as the SEC noted in the guidance, and Chair White reiterated in October 2013, the guidance does not define companies’ disclosure obligations.  Instead, disclosure is governed by the general duty not to mislead, along with more specific disclosure obligations that apply to specific types of required disclosures. Indeed, plaintiffs’ lawyers will not even need to mention the guidance to challenge statements allegedly made false or misleading by cybersecurity problems. Various types of statements -- from statements about the company’s business operations (which could be imperiled by inadequate cybersecurity), to statements about the company’s financial metrics (which could be rendered false or misleading by lower revenues and higher costs associated with cybersecurity problems), to internal controls and related CEO and CFO certifications, to risk factors themselves (which could warn against risks that have already materialized) -- could be subject to challenge in the wake of a cybersecurity breach. Plaintiffs will allege that the challenged statements were misleading because they omitted facts about cybersecurity (whether or not subject to disclosure under the guidance). In some cases, this allegation will require little more than coupling a statement with the omitted facts. In cybersecurity cases, plaintiffs will have greater ability to learn the omitted facts than in other cases, as a result of breach notification requirements, privacy litigation and government scrutiny, to name a few avenues. The law, of course, requires more than simply coupling the statement and omitted facts; plaintiffs must explain in detail why the challenged statement was misleading, not just incomplete, and companies can defend the statement in the context of all of their disclosures. But in cybersecurity cases, plaintiffs will have more to work with than in many other types of cases. Pleading scienter likely will be easier for plaintiffs, as well. With increased emphasis on cybersecurity oversight at the senior officer (and board) level, a CEO or CFO will have difficulty (factually and in terms of good governance) suggesting that she didn’t know, at some level, about the omitted facts that made the challenged statements misleading. That doesn’t mean that companies won’t be able to contest scienter. Knowledge of omitted facts isn’t the test for scienter; the test is intent to mislead purchasers of securities. However, this important distinction is often overlooked in practice.  Companies will also be able to argue that they didn’t disclose certain cybersecurity matters because, as the guidance contemplates, some cybersecurity disclosures can compromise cybersecurity. This is a proper argument for a motion to dismiss, as an innocent inference under Tellabs, but it may feel too “factual” for some judges to credit at the motion to dismiss stage. As this analytic overview shows, cybersecurity securities class actions, on the whole, likely will be virulent. Companies, of course, are talking about cybersecurity risks in their boardrooms -- and they should also think about how to discuss those risks with their investors. The best way for companies to lower their risk profile is to start to address this issue now, by thinking about cybersecurity in connection with all of their key disclosures, and enhancing their disclosures as appropriate. Perfection and prescience are not required. Effort matters most. Companies that don’t even try will stand out. As I’ve written in the context of the Reform Act’s Safe Harbor for forward-looking statements, judges are skeptical of companies whose risk factors remain static over time, and look favorably on companies that appear to try to draft meaningful risk factors. I thus construct a defense of forward-looking statements by emphasizing, to the extent I can, ways in which the company’s risk disclosures evolved, and were tailored and focused. I predict that the same approach will prove effective in cybersecurity cases.

In case you missed it, saving lives and preventing injuries on the job is now the duty of the human resources department. So is the choice of employee management tactics used to achieve safety. Civility is in; grumpiness is out. Insurers should be concerned, because the shift in responsibility and tactics has grounded the safety ship they worked hard to launch two decades ago. Safety, the social movement The takeover by HR was foretold by Samuel Greengard in his bold 1999 Workforce magazine cover story on zero tolerance. “Saving lives. . . requires careful thought and action—usually spearheaded by HR,” he wrote. Not the safety department. HR. A cursory glance at the organizational charts of mid- to large-size companies confirms the shift. Safety professionals have been dispossessed. Their authority to determine the overall tenor of safety management programs has largely been handed to those who think that relational development between employees is safety’s missing link. The new core belief guiding safety is simple: Unless safety is accomplished civilly—with first priority given to employee management policy—and produces harmony between workers, it is not done properly. As a result, it is no longer sufficient for workers to solely focus on accomplishing traditional safety objectives; they must also dedicate precious energy to ensuring tolerable relationships with each other. As Greengard says, “preventing harassment and avoiding discrimination” share the same priority as “saving lives.” Bottom line? The way workers treat each other in conducting the safety mission has become as important as the mission itself. Safety has become a social change movement. Alarm from safety professionals The change in focus has its detractors. Under the guise of zero-tolerance policies toward what Greengard calls “unacceptable and detrimental behavior,” some wonder if the real purpose of safety is being overlooked. Others express a deep concern that safety has merely become a powerful vehicle through which HR can effect social change. Safety professionals have long been wary of the potentially detrimental influence on risk management that such an emphasis can bring. They are quick to point out that risk control and incident prevention often involve critical, confrontational and sometimes blunt dialogue on the job site—behavior frowned upon by HR. Safety professionals' greatest fear is that there may be a purge of workers whose temperament is vital to risk management but whose behavior is deemed to be uncivil, therefore non-compliant. This includes a large percentage of workers currently employed in safety-sensitive jobs. One report published in Insurance Thought Leadership indicates that three-quarters of skilled and semi-skilled frontline workers exhibit primary personality traits that may be described as crusty or unfriendly. The traits include: task-focused, emotionally withdrawn, hostile and unsympathetic. Airline pilots, surgeons and most professionals whose job includes continuous risk-based decision-making bear the same characteristics. Opening the door for intolerance In research circles closely followed by HR managers, the rhetoric against those inclined to this prickly temperament has increased dramatically. In one study, researchers classify less personable workers as “negative mood” employees who harm the “positive affective states” of “positive mood” individuals. Experts say gruff and grumpy workers easily negate any good generated by people-oriented positive-thinkers. That’s tame compared with the harsh term used in a prestigious 2014 university research report on worker dispositional attitude. In this study, the word used to describe workers whose temperament is typically found in high-risk jobs is "hater," as in the opposite of "liker." Haters tend to initially dislike many things and to focus on tasks rather than people. Considered standoffish, they are not as popular as social-butterfly, anything-goes likers. (Social media is not meant for haters. If so, "dislike" would be their favorite button.) In the wrong hands and for the wrong purposes, "hater" is a derogatory categorization that could be used to isolate, shame or potentially terminate those whose only fault is that they occupy the wrong side of the behavioral spectrum preferred by leaders in the social safety movement. Part 2 of this series explores what insurers can do to stop the slide down this slippery slope.

The question of whether, under the Affordable Care Act (ACA), there will be a physician shortage is not as simple as everyone would like. The most correct answer is yes -- but it depends a great deal on where you live and what kind of care you are trying to access. Based on pre-existing macro economic trends, the shortage was already here -- the ACA adds pressure to the system. The effect of the Baby Boomers The largest trend related to healthcare in the U.S. is the aging of the Baby Boomers. Estimates indicate that more than 10,000 citizens per day will turn 65 for the next 16 or so years. Meanwhile, the ACA is estimated to add an additional 30 million citizens to the ranks of the insured over the next five to 10 years. Between the millions of Baby Boomers heading toward Medicare and the ACA enrolling millions of individuals in the expanded Medicaid plans and state and federal exchanges, there will be challenges to accessing primary care in a timely fashion. Anyone attempting to deflect the reality of these trends is being political. Another macro trend is that nearly half of the 830,000 practicing physicians are currently over age 50; 16% are now age 65 or older; and more than one third of physicians are expected to retire in the next 15 years. Where will all the new physicians come from who are needed to help the millions of new insured individuals and the millions headed toward Medicare? There are even more questions. Today, 30% of physicians are primary-care doctors, and 70% are specialists because that’s where the money has been for the last 30 years. You see, sickness has been the revenue model for the medical treatment system we call healthcare. Like many things in life, the answer is money – what’s the question? Medical schools are incredibly expensive; residency training can take three to seven years; and the entire system has been set up to reward specialist care. Consequently, the ratio of practicing physicians in the U.S. has changed from 70% primary-care physicians and 30% specialists as healthcare has adapted its business model to disease management, prescriptions and treatments of chronic diseases. Where you live also plays a big role in your physician shortage experience. Health Professional Shortage Area maps produced by the government indicate that more than 20% of Americans live in such an area. Affected states include Alabama, Louisiana, Mississippi, Arizona, New Mexico and Wyoming. What does the future of our healthcare system hold? The major change created by the ACA is the beginning of refocusing healthcare from a disease-management to health-promotion model and from a business based on quantity of treatment and fee-for-service to one based on quality of treatment, with compensation bundled and based on outcomes. Today, outcomes have limited financial consequences. Tomorrow, we will pay providers to care about the patient both before and after treatment, to improve outcomes, lower costs and emphasize the prevention of as many claims as possible. The industry is slow to change, and there are many constituencies that prefer evolutionary change, to maximize potential profit margins along the way. We will have more internationally trained physicians entering the U.S. to assist with the shortage. And, as healthcare emphasizes primary care, we will see more nurses, nurse practitioners, pharmacists and physicians assistants handling some of the routine preventive care. Many of these expanded roles for non-physicians will be determined on a state-by-state basis. What are the key challenges of a physician shortage? The challenges for the providers are many. The actual practice of medicine is slowly changing as the incentives are realigned to focus more on the patient and the quality of their outcomes. Hospitals will have to change their old-school business models of the one-stop shop or become obsolete. Many hospitals will go out of business because they are unwilling or unable to change. The specifics will depend on how many competing hospitals are in a particular city, how big the population is and what kind of insurance is paying the bill. Once again, location will play a large part. The ebb and flow of physician availability will be affected by decisions from medical schools, Congress expanding budgets for more training, Medicare revisions and more changes coming from the ACA. On a more personal note, physicians will be influenced by quality-of-life choices, income needs, debt loads from medical school, entrepreneurial spirit, need for security and location. Insured individuals, whether covered with Medicaid, group insurance or an individual policy, all have to change their coverage and, in many cases, their physician. As we will witness over the first three years of the ACA, nearly every insured person will have less coverage if they get sick, as a result of having more "skin in the game." Many previously uninsured individuals will experience the illusion of the low-priced insurance policy, especially if they qualify for subsidies, only to discover that getting sick can be very expensive and that they will likely not receive care from the provider they anticipated. Just as there are no one-size-fits-all healthcare solutions, there is no single answer to the problem of a looming doctor shortage. The experience will depend on where you live, what medical care you need and the kind of insurance plan through which you access your medical care.

On Aug. 5, 2014, the Workers’ Compensation Insurance Rating Bureau of California (WCIRB) released its first-ever “State of the System” report. This was an outstanding, in-depth look at the trends and cost drivers in California workers’ compensation. I encourage you to read the full report here. Given that California now constitutes 25% of the total nationwide workers’ compensation premiums, these issues have a significant impact on larger employers that do business in the state. I have been involved with California’s workers’ compensation system for years, including participating in many discussions on potential legislative reforms. One thing I have always found frustrating is that California has a tendency to evaluate progress on workers’ compensation issues based on its history, alone, without comparing itself to other states. That’s why I found the most compelling information in the report to be the comparative analysis of California to other jurisdictions. This did not paint a pretty picture. According to 2009 data, California ranks eighth in indemnity claim frequency per 1,000 employees, more than 46% higher than the median state. The recent trend makes this even worse because, since 2009, the nationwide trend has been a decrease in frequency rates while California has been increasing. California ranked seventh in 2009 in the percentage of indemnity claims with permanent disability benefits paid – 13% above the median. Once again, the trend makes this much worse as every state that ranked higher than California has passed legislation aimed at reducing workers’ compensation costs. SB 863, passed in California two years ago, increased permanent disability benefits, and there has been a corresponding increase in the percentage of claims receiving these benefits. Finally, California rankedthird in incurred medical benefits per indemnity claim, with costs that were more than 70% higher than the median state. SB 863 focused on reducing frictional costs to the system caused by medical treatment and billing disputes. It did nothing to change the physician behaviors that continue to drive medical costs higher. According to WCRI and CCWC research, nearly half of all pharmacy prescriptions were physician-dispensed, and prescriptions for Schedule II and Schedule III opioid pain medications have continued to rise. Employers looking to open a new manufacturing or distribution facility are looking at comparisons between different state workers’ compensation systems, and other states are using workers’ compensation reform to make their states more attractive to businesses and job growth. My hope is that the WCIRB report serves as a starting point for California to compare itself to other states when evaluating the workers’ compensation system and where reform is needed. We need to move past the thought that things are just done differently in California because that is the way it has always been. Finally, the WCIRB study provides a great lead-in for the California Workers’ Compensation & Risk Conference, which is Sept. 10-12 in Dana Point. You can view the conference agenda here. I will be moderating the opening panel at this conference, which features a variety of stakeholders debating the impact of SB 863 and offering suggestions for improving California’s workers’ compensation system.

It is a fact of doing business in the U.S.: Lawsuits happen! Regardless of whether the action has any merit, lawsuits are expensive to deal with, damaging to reputations and draining to a business and its management. Small to mid-sized private companies can specifically attest—litigation is never a small or inconsequential matter. Any business, regardless of the sector it is in (manufacturing, service, agricultural, transportation, energy, technology), can find itself embroiled in a dispute. Disputes can arise from relationships gone sour with shareholders, competitors, regulators, creditors, or even a random third party. Directors, officers and company (“D&O”) liability insurance for privately held companies can be a lifesaver in the event an unexpected lawsuit or dispute arises. When a business and its management team are placed in an adversary’s crosshairs, a D&O policy can step in to respond right off the bat. This response would include providing a defense, including the engagement of skilled legal counsel who will guide the D&Os through the process. In addition, when coverage applies, the D&O policy would fund the settlement of a lawsuit, or pay a judgment if the case were to go to trial. Originally, D&O coverage was designed to protect only the individual directors and officers from lawsuits brought by outside shareholders who are not involved in the management of the company. However, D&O products have evolved considerably over the past 20 years and now cover the entity as well as the D&Os for a wide range of management decisions and claims from shareholders, as well as clients, competitors, vendors and creditors. A disturbing fact for members of the company’s board of directors is that D&Os can, and usually do, get personally named in a lawsuit asserted against the company. The claim seeks personal liability against the D&Os. The more closely held a company is, the fewer owners/D&Os there are to sue, so the exposure to the personal assets of those principals is even more pronounced. D&Os know that, in most states, a corporation is required to indemnify its D&Os for personal liability, if it arose from the execution of their corporate duties. If the corporation is on financially sound footing, the D&Os' personal assets will usually be protected. However, situations often arise where the company cannot or will not defend a D or O, compelling them to defend themselves. Such cases can be when the company is not on solid financial footing or when it becomes insolvent. As troubling as it may sound, in tough financial times, the D&Os could find themselves paying for their own defense and settlement of a lawsuit out of their own pockets. When a lawsuit hits, the financial advantages of having D&O coverage is readily apparent. What isn’t evident from reviewing policies is something we’ve witnessed over the course of many D&O claims. When serious accusations of wrongdoing are leveled at a member of management and there’s no D&O coverage to fall back on to fund the claim, the financial burden of a dispute can tear a management team apart. For example, suppose you are the officer who is the target of certain allegations. How quickly do you think your colleagues will rally around you when your alleged error or omission is the cause of significant financial hardship to the company? Without D&O insurance in place to shoulder the financial and legal burden of a claim, infighting can erupt rather quickly when the company’s financial resources are placed in peril. When accusations fly, and salaries and bonuses might be affected, such situations often change the way people behave toward one another. As opposed to circling the wagons, executives may play the blame game. In contrast, if D&O insurance is in place, there may not be such a panic, and finger pointing may not be as fierce or important. Accordingly, we believe that one of the great hidden benefits of D&O insurance is that it tends to defuse internal turmoil and helps maintain management cohesiveness during what is surely a trying time. When D&O insurance is in place and coverage has been accepted, the management team will be able to easily maintain a “stick together” attitude and an “us against them” mentality. To summarize: We believe D&O insurance is imperative to carry for private companies and their principals.  D&O coverage acts as a solid backstop to mitigate or solve what could be the devastating financial impact of unforeseen business litigation. Litigation can happen at any time from within or from outside any organization.  In a society as litigious as ours, not having D&O insurance creates a serious exposure to the business itself, as well as every member of a company's management team personally. Make sure your private company customers, no matter what size or industry, carefully consider the purchase of D&O insurance to ensure that the company, as well as their personal assets, are protected.

Historically, the insurance industry has assessed its competition by looking at those companies within the industry that directly compete and sell in the same market segments, offer similar products, use the same distribution channels or have similar market size. But in today’s fast-changing digital economy, this approach has become outdated, and insurers are being blindsided by new challengers and competitors from outside the industry. The new challengers may not compete directly by offering and underwriting insurance, but they are competing in new ways to capture customer relationship, pocketbook and much more through innovative offerings and business models. Where are all of these coming from? This new breed of competitors is coming out of the technology and Silicon Valley companies. There have been numerous articles and blogs regarding the potential of companies like Google, Apple, Amazon, eBay and other technology companies entering the insurance space, fueling speculation and, for some, even fear. Centuries-old industries and the companies within them are feeling the pressure to reimagine themselves, and insurance is one of them. Most of these new challengers have emerged in the last 15 years, many in the last 5 to 10 years. But the impact of these technology and Silicon Valley companies is only beginning. Why? Because of the massive numbers of users they have as engaged and loyal customers. Insurance companies pale in contrast. This contrast illustrates why these technology and Silicon Valley companies pose a competitive threat to insurance. The growth and influence by these industry challengers has greatly accelerated in the last three years. Adding fuel is their drive and commitment to emerging technologies and innovation. The insurance industry is one of tradition, based on decades, even centuries, of business assumptions and models that have changed little within a culture of risk aversion – yet insurance is now operating within a world changing rapidly, creating businesses and new customer engagement models and embracing new and emerging technologies. The insurance industry, like so many other industries, is feeling the tremors of a coming quake of seismic change that will redefine competitive boundaries and customer loyalty. We have identified and discussed key business attributes that detail the differences between these technology companies and insurers. The contrasts could not be more stark. The strategic vision of these organizations reflect the shifts and challenges of the new digital economy. The technology companies' focus is:

• Customers rather than products
• External rather than internal
• Customer power rather than company control
• Connecting people to an ecosystem rather than connecting people to the company
• Pulling and engaging rather than pushing and informing
• Selling an outcome rather than selling a product
• Creating an experience rather than processing a transaction

Insurance is just beginning to experience the implications. As with other industries, this overwhelming change requires insurers to go back to the fundamentals and discuss: who we are, what we do, what we offer and how we offer it in this new digital era. Will we be a product manufacturer, an underwriter of products, a distributor of products, a provider of services or all of the above? And how will we leverage new and emerging technologies and redefine the customer experience? Disruption, convergence, change, technology adoption and the digital world are unfolding more rapidly than anyone realized, and many are unprepared. To be just viable, not to mention successful, in the new digital, customer-driven world, insurers must first leverage their deep expertise by providing risk transfer products and risk management services that meet the needs of customers. Second, insurers must decide if they will manage an ecosystem of partners to provide services to repair, reimburse and restore after loss events. Third and most transformative, insurers must decide if they are going to broaden their offerings beyond insurance to own and manage the customer relationship. Today, many insurers are accustomed to asking, “What products and services do we manufacture, and what channels do we use to sell them to grow the company profitably?” The insurance leaders of tomorrow will be asking, “How can we connect, educate and enhance our customer’s lives or businesses through innovative offerings that provide meaningful value in helping to manage risk in a changing world?” For the full research brief, "The Shifting Competitive Landscape: A New Breed of Industry Challengers," click here. 

The Reserve Funding Analysis is one of the most important documents that an insurance provider can have for a property it covers. A Reserve Funding Analysis is a formal evaluation of the physical condition of a property and the expected future expenses that will be needed to keep the property in a viable state of repair. Having this funding statement out in the open on Day One discloses to the owner, the insurance company, financial institution and all other stakeholders the real cost of preserving the asset that everyone is vested in. For the insurance carrier, the analysis establishes the baseline property condition, helps ensure responsible operation of the property and provides the actual numbers that support appropriate pooling of the risks and accurate pricing of the insurance product. This is not trivial. Where there is an absence of knowledge and inadequate reserve funding, there is little incentive for the operators to mitigate major system exposures. Many times, market conditions such as “curb appeal,” trend-setting landscaping, new exterior paint or other highly visible amenity may receive disproportionately higher funding priority than the hidden major building system peril such as a potable water system rupture, building envelope failure, venting or water drainage intrusion. This situation represents a severe moral hazard.  The insurer becomes the de facto major system reserve fund. This is especially the case when the owner can claim no knowledge of imminent failure or will attribute the failure to one or more lesser contributing factors. While this is not quite as scandalous as TV crime dramas where the crook sets a building ablaze to collect the insurance money, owners are still making insurers unfairly responsible for more subtle perils such as catastrophic water system failures and building envelope failures such as roofs, water rot and foundation decay. These conditions are often difficult to see until there is a major failure. Or, they may be exacerbated, but not caused, by a storm, earthquake or natural risk. Piping systems corrode from the inside, becoming weaker while showing little or no indication of a problem until water is cascading down 12 floors of luxury condominiums. Building envelope water intrusions can go unnoticed until toxic mold appears in the venting or a deck collapses. Certain concrete cracks can allow water to enter invisible places, undermining the purpose of the foundation. Many of these perils are easily avoided with routine maintenance, assuming the owner is aware of and has budgeted for them. The most typical Reserve Study available on the market is a common tool for condominiums. The purpose is to protect mortgage holders and shared asset community members and to help set homeowners association (HOA) dues fairly and comparably (vs. alternate properties) while avoiding the need for imposing special assessments on the owners. Think about it. These are exactly the same business functions as the insurance carrier! Therefore, a specialized Reserve Study that meets the needs of the insurance carrier should be considered essential in any significant building, facility or property. The Building Condition Assessment The first step is to perform a comprehensive Property Condition Assessment by a registered professional engineer knowledgeable in the ASTM E2018-08 standard. No law exists that requires a professional engineer or architect to perform the inspection, but one is highly recommended by most attorneys in the event that the findings are legally challenged. The ASTM E2018-08 standard will provide visibility to major systems and components that are due to be replaced, that are failing or that are operationally sub-standard or outdated. The Condition Assessment can also reveal how a building is “aging.” For example, a 10-year-old building can reveal what the next 40 years will be like much better than a new building can. A quarter inch of settling after 10 years can be re-measured after 20 years. Corrosion or rot on the north side, but not on the south side, can tell an important story for the future. A good engineer can see these trends and predict future conditions with surprising clarity. Hiring a Consultant It is imperative that a licensed, professional, civil or mechanical engineer perform the assessment and reserves estimate. Many engineers closely align themselves with architects and other engineers, so it is important to inquire about their professional network. There are many Certified Inspection Professionals who are qualified to perform inspections, but the science of engineering can quickly become an integral part of the process. Water chemistry, corrosion science, water vapor diffusion and hydrocarbon compatibility, electronic logic controllers, etc., are the domain of engineering. Further, only the engineer would be qualified to allocate other engineers where needed -- the lineage should remain intact wherever possible because only engineers can come up with the numbers that fit the actuarial tables and can be upheld in court. Initial Project Review Once the responsible engineer has been retained, he will require a set of initial information about the build, property or facility. This will include:

• As-built drawings and architectural specifications
• The declaration and description
• Reciprocal cost-sharing agreements
• Previous reserve fund studies
• The most recent audited financial statements
• What the current annual contribution to the reserve fund is
• Inspection of the current maintenance and repair record
• A summary of (end-user) problems and concerns

The Process

• The engineer is provided the above information. The as-built drawings and specifications are prior to visiting the site in order for the engineer to become familiar with the overall design and construction schemes. If they are absent or deficient, this is a red flag.
• Site inspection is performed.  Problem areas are reviewed and documented.
• The report is prepared. The drawings are used to “take-off” quantities such as roofing, exterior wall cladding, asphalt, hallway finishes, etc. that will assist in preparing the replacement/repair cost budgets.
• The engineer presents a draft report to the insurer prior to its being finalized.
• Upon receiving direction from the investors, the Reserve Fund Study is finalized and submitted.

The Report Format Every engineer may have a slightly different format, but, in general, the Reserve Funding Analysis has two main components: physical analysis and financial analysis. The analysis includes:

• Inspection Report. Based on the results of the site inspection, the report will provide an itemized overview of the major common elements. This will include general condition, the need and timing for remedial work or replacement and any other information that the stakeholders should be aware of.
• Information Tables. There is typically a table that summarizes the common elements in terms of current age, life expectancy, remaining service life and current and future cost budgets.
• Expenditure Tables. The data from the information tables is summarized to show when the itemized common element repair/replacements are estimated to take place. For each year, these expenditures are summed. The annual projections must be a minimum of 30 years commencing in the year the study (and updates) is prepared.
• Cash Flow Tables. Based on the estimated expenditures, different contribution plans can be provided. Often, one plan includes the contribution level currently being used as a form of comparison with other scenarios.

The Funding Plan As part of the Financial Analysis, the study must have a recommended funding plan projected over 30 years from the date of the study. The plan must show:

• The estimated cost of major repairs and replacements based on current costs.
• The same costs adjusted to account for an assumed inflation rate. The inflation rate must be stated in the study.
• The opening balance of the reserve fund.
• The recommended amount of contributions to the reserve fund determined on a cash flow basis that are required to offset adequately the expected cost in the year of the expected major repair or replacement common elements and assets.
• An estimate of the interest earned on the reserve fund contributions based on an assumed interest. The study should state the assumed interest rate.
• The percentage increase in annual contributions to the reserve fund for each year of the 30-year study.
• The estimated closing balance of the reserve fund for each year.

Conclusion It may be surprising to know that much of this due diligence is already being performed by the owners, management firm, bank, attorneys, accountants, real estate brokers, etc.  However, it is the insurance carrier that must have the clearest probabilistic view of the property. The insurance carrier must be assured that due diligence has been performed by the right professionals, at the right time, and articulated in the right numerical form that serves the calculations of insurer, not just the calculations of the insured.

Policymakers in many states increasingly enact medical fee schedules in the quest to limit the growth of hospital costs. They often seek a reference point or benchmark to which they can tie reimbursement rates. Usually, that benchmark is either Medicare rates in the state or some measure of historic charges by the hospitals. Medicare rates are usually seen by healthcare providers as unreasonably low; charge-based fee schedules are often seen by payers as unnecessarily high.

This study examines an alternative benchmark for workers’ compensation fee schedules—prices paid by group health insurers. In concept, this benchmark has certain advantages. Unlike Medicare, the group health rates are not the result of political decisions driven by the exigencies of the federal budget. Rather, these rates are the result of negotiations between the payers and the providers. Unlike a charge-based benchmark, group health rates are what is actually paid to providers. This is important given the growing public attention to the arbitrariness of many hospital charges.

The major limitation of using group health prices paid as a benchmark for workers’ compensation fee schedules is that these prices are seen by group health insurers as proprietary. However, one state, Montana, has adopted a fee schedule based on group health prices paid and implemented relatively straightforward processes to balance the need for a fee schedule and the need to protect the proprietary information of the group health insurers.

This article does the following: (1) describes the major findings of the study, (2) suggests a framework for thinking about whether prices paid by workers’ compensation payers are too high or too low, and (3) discusses the Montana approach.

Major Findings

What do we find when we compare the prices paid to hospital outpatient departments by group health and workers’ compensation payers? Among the major findings of this study are:

• In many study states, workers’ compensation hospital outpatient payments for common surgical episodes were higher, and often much higher, than those paid by group health. For example, in half of the study states, workers’ compensation paid at least $2,000 (43%) more for a common shoulder surgery (see Figures 1a and 1b).
• The amount by which workers’ compensation payments exceeded group health payments (“the workers’ compensation premium”) was highest in the study states with either no fee schedule or a charge-based fee schedule (Tables 1a and 1b).

    Are Prices Paid By Workers’ Compensation Payers Too Low or Too High?

The comparison of workers’ compensation and group health hospital outpatient payments raises the question in many states as to whether workers’ compensation hospital outpatient rates are higher than necessary to ensure injured workers access to good quality care. For example, in Indiana, hospital outpatient services associated with shoulder surgery were, on average, reimbursed $9,183 by workers’ compensation as compared with $7,302 by group health. Is this differential of $1,881 necessary to induce hospital outpatient departments to provide facilities, supplies and staff to treat injured workers in an appropriate and timely manner?

Consider the following framework for analyzing the question. If hospital outpatient departments were willing to provide timely and good-quality care to group health patients at the prices paid by group health insurers, then two questions should be answered by policymakers:

• What is the rationale for requiring workers’ compensation payers to pay more to hospital outpatient departments than group health insurers pay for the same treatments?
• If there is such rationale for higher payment, is a large price differential necessary to get hospital outpatient departments to treat injured workers?

In addressing the first question, let’s say that the hospital outpatient department provided identical treatment for a group health patient and a workers’ compensation patient. If the care was identical—same facilities, supplies and staff—and workers’ compensation imposed no unique added costs on the hospital outpatient department, then there is little rationale for workers’ compensation payers to pay more than the group health payers.

Healthcare providers often cite a special “hassle factor” in workers’ compensation that does not exist in treating or billing for the group health patient. Common examples of the alleged hassle factor include longer payment delays, higher nonpayment rates (where the compensability was contested or where care given was not deemed appropriate), more paperwork, more missed appointments, lower patient compliance with provider instructions and so on. If these hassles are unique to workers’ compensation patients, then this forms a potential rationale for workers’ compensation paying higher prices than group health, for the same care. Let’s assume that this accurately describes the real world.

Then the question becomes: Are the unique costs imposed on hospital outpatient departments large enough to justify workers’ compensation payers having to pay $2,000-$4,000 more per surgical episode than group health payers pay for the same care? If the costs of these hassles total less than, say, $2,000, then workers’ compensation fee schedules could be lowered without adverse effects on access to care for injured workers. In other words, the large price differentials observed in this study can only be justified by the large costs of these hassles that are unique to workers’ compensation.

In applying this framework to different types of providers, where these hassles exist, some types will be larger for some kinds of providers than for others. For example, the first doctor who treats may be more exposed to nonpayment risk than other providers who treat later in the claim; or the hospital outpatient departments’ use of the operating and recovery rooms would be less affected by paperwork but exposed to payment delays. Because the majority of payments to hospital outpatient departments are for physical facilities (e.g., recovery room), equipment (e.g., the MRI machine but not the radiologists’ professional services) and supplies (e.g., crutches), it is more likely that hospital outpatient departments are more exposed to billing delays, nonpayment risk (at emergency rooms for initial care) or canceled appointments and less exposed to time-consuming paperwork hassles or patient compliance issues.

Moreover, if the additional burden that the workers’ compensation system places on hospital providers (e.g., additional paperwork, delays and uncertainty in reimbursements, formal adjudication and special focus on timely return to work) is sizable, policymakers have two choices. The first is to adopt a higher-than-typical fee schedule that embraces large costs for the hassle factor. The alternative is to identify and remediate the causes of the larger-than-typical hassles -- especially where these are rooted in statutory or regulatory requirements.

The Montana Approach

The major limitation of group health as a benchmark for workers’ compensation is that the group health rates are the proprietary competitive information of commercial insurers. The Montana legislature found a way to use group health prices as a benchmark for its workers’ compensation fee schedule while respecting the confidentiality of the commercial insurers’ price information. The approach used is to obtain the price information (conversion factor) from each of the five largest commercial insurers and group health third-party administrators (TPAs) in the state and compute an average. The average masks the prices paid by any individual commercial insurer or TPA. In addition, the statute guarantees the confidentiality of the individual insurers’ information.

Conclusion

This study raises a number of concerns about whether fee schedules are too high or too low. There are two key pieces of information needed to address this -- (1) how much other payers in the state are paying, and (2) whether there is a unique workers’ compensation hassle factor.

This study addresses the first question for common surgeries done at hospital outpatient departments. A related WCRI study does the same for professional fees paid to surgeons and primary-care physicians.

Quantifying the presence and magnitude of any unique workers’ compensation hassle factor remains to be done. However, in some states, these studies show that workers’ compensation prices were below those paid by group health. For those states, policymakers may want to inquire about access-to-care concerns, especially for primary care. For other states, the workers’ compensation prices paid were so much higher than prices paid by group health insurers that policymakers should ask if the large differences are really necessary to ensure quality care to injured workers.

One way of framing that question using the results of the WCRI studies is as follows: “Workers’ compensation pays $10,000 to hospital outpatient departments for a shoulder surgery on an injured worker, and group health pays $6,000 for the same services. Does it make sense that if workers’ compensation paid $9,000 that hospital outpatient departments would no longer treat injured workers—preferring to treat group health patients at $6,000, or Medicare patients at a fraction of the group health price, or Medicaid patients at prices lower than Medicare?”

Another study sponsored by Liberty Mutual concludes that early magnetic resonance imaging for diagnosis of back pain leads to higher costs and poorer outcomes. The study, published in the August issue of the medical journal Spine, showed that when back pain patients went through MRI scans within the first month after injury, they were between 18 to 55 times as likely as the reference group to receive more diagnostic and invasive procedures. Glenn Pransky, a co-author of the study and director of the Liberty Mutual Center for Disability Research, said that MRIs can put patients in a mindset of trying to find a specific problem in their back and then seeking to fix it. “People get hung up on thinking, ‘Oh, I’ve got this ruptured disc. That must be the problem. I won’t be well until somebody fixes that ruptured disc,’” Pransky said. As many of us know, herniated discs and other spinal "abnormalities" are actually quite common. Pain is complex, and the cause of pain is often illusive. In an Aug. 20 webinar from managed care company Paradigm Outcomes, two physicians pointed out that pain can come from many places. "When you look at somebody’s pain, they have the pain sensation -- there could be nerve pain, there could be soft tissue-muscle-tendon pain," said Steven Moskowitz, senior medical director of Paradigm’s pain program. "They could have pain because they’re deconditioned and out of shape and stiff, and so it hurts to be stiff and to move when you’re stiff. And then they can have. . .  emotional components."

Bowzer's pain started bending over for his cigar.

  In his most recent book, Living Abled and Healthy, Christopher Brigham, MD, no stranger to workers' compensation and lead editor to the AMA 6th Ed. Guide for Rating Permanent Disability, examines people who have had catastrophic injuries or who grew up "less than able" but overcame these difficulties, and compares them with folks who can't seem to surmount such obstacles. [Disclosure -- Brigham is a friend, and I contributed a small part to the book.] Brigham argues that our mind-body connections are surprisingly strong and that people in general discount the effect our emotions, psychology, feelings and perceptions have on our physical being. "If we believe something is helping us we will likely feel better," Brigham says. "If we believe something is hurting us, we will likely feel worse. Our attitudes define who we are, and the choices we make determine our destinies." Robert Aurbach, an attorney, researcher and international workers' comp expert now consulting in Australia, has noted that neuroplasticity -- the brain's ability to reorganize itself by forming new neural connections -- can play a big role in one's perception of ability versus disability. Essentially, continued "training" to be disabled, rather than abled, forms neural connections that reinforce negative associations with pain. The extent to which early MRIs contribute to the perception and emotion of disability has yet to be fully quantified, but the Liberty Mutual study suggests the connection it is not insignificant. According to a 2013 report from the Bureau of Labor Statistics, sprains, strains and tears made up 38% of work-related injuries in 2012, making those the most common source of claims. In that category, the back was the most-often injured body part, making up 36% of sprains, strains and tears. Essentially that means that 1/6th of all work injury claims are related to back pain. How many of those end up worse because of diagnosis and treatment fostered by early MRI findings and might have otherwise been adequately (and perhaps more effectively and efficiently) treated conservatively isn't known, but I suspect the number is considerable. The authors of the Liberty Mutual study found that MRI use for patients with lower back pain wasn’t distributed evenly across the U.S., and they hope to continue the study to determine whether certain states are more prone to improper use of the scans. I think it would also be interesting and beneficial to correlate that study with information about disability rates; my guess is that we (the grand collective "we") make people more disabled than they otherwise would be in our zeal to use medical technology and attempt to find easy answers to complex problems, like pain and disability.