The workers’ compensation insurer is for many the centerpiece of a mature industry. Injury frequency almost constantly declines. Insurers earn modest but fairly steady returns on equity, with little risk of insolvency. Market shares generally do not change much. Careers are largely very predictable. Within this industry, however, specialized services as an extension of claims management grew since 1990 from about $4 billion in total costs to about $18 billion today. This service universe expanded dramatically and changed repeatedly in products, organization and leadership. Let’s review this evolution and ask if two decades-plus of growth is coming toward an end. Medical bill review, case management, subrogation services, transportation, investigation, pharmacy management – the list of services is long. With annual growth of all specialized services at the 15%-plus level, successful entrepreneurs have been highly rewarded. Like matryoshka dolls, spending on a direct benefit (such as surgeries) requires bill review; inside that, a more specialized review for implants; and then more specialized responses to new state regulation and court decisions. Claims payers account for these services as “loss adjustment expenses,” which divide into “unallocated” and “allocated” categories. Rick Sabetta, a managing principal with Risk Navigation, a claims consultancy, says that as specialized services grew, insurers and third-party administrators began to reposition some costs as “allocated.” As a result, they, but more likely vendors, could charge the services to the claims file. Sabetta told me that some insurers sought to improve the bottom line by reducing or completely removing the unallocated factor, even to the point of insurers' outsourcing their entire claims operation to TPAs. He said, “It is far less expensive to farm the claims out to the TPA than it is to attract, hire, train and manage a claim staff.” To an investment banker, the outsourcing universe is an engagingly complex version of a supply chain management exercise given to MBA students. The entrepreneurs compete through superior information technology, superior management talent and guiding more volume through a scalable structure. Since the 1980s, the supply chain challenge always has reinvented itself into something larger. That’s why the bankers come back often, confident of liquidating their investments in a few years at a profit by selling them to other bankers. The 1980s saw the rise of case management, and national expansion by vendors such as Intracorp, CRA, Genex and Corvel. The 1990s saw the introduction of bill review firms, with their complicated coding systems. State-mandated closed networks started to emerge. So did utilization review. Major state reforms, in Florida in the 1990s and Texas and California in 2004-2005, effectively educated the payer community that it could – and legally had to – commit to using specialized services. In the 2000s, pharmacy benefit management arrived. Regulators rarely demand transparency in the outsourcing universe. For example,  physical therapy is today heavily influenced by proprietary physical rehab networks, but these networks do not share their experience publicly. Pharmacy benefit managers publish about their experience, but only voluntarily. This universe of firms that arrange on behalf of claims payers for physical therapy, dental care, translation, Social Security disability awards, etc., arose from a choice claims payers made to outsource. But would Walmart or Home Depot have outsourced management of their supply chain to vendors to anywhere near this extent? Prospects of double-digit growth in the outsourcing universe may be declining. Frequency of claims continues to decrease. There may not be a new major class of claims operations for payers to outsource. Some large states could lay down mandates that create demand, such as new utilization review or preferred provider organization rules, but the bigger states have mostly done that already. I think we are going to see more of a Walmart culture in how the supply chain is controlled. This article was first published in workcompcentral.

Suicide continues to be among the most stigmatized topics of all human experiences. It is, therefore, characterized by fear, shame and misunderstanding.  Myths include:

• “If we talk about suicide, it’s more likely to occur.” The truth is just the opposite.
• “It will never happen in my circle of friends, family and co-workers.” The truth is: Given the staggering statistics of how many Americans seriously contemplate, plan for and attempt suicide, chances are you know someone who is at serious risk right now.

Fortunately, many progressive and courageous business leaders are beginning to bring this terribly misunderstood topic out of the shadows and into meaningful discussion. This is important not only because the suicide death of an employee has a devastating impact on the workforce and productivity but, more importantly, because leaders are recognizing that the workplace is uniquely positioned to help prevent suicide. As a critical incident response consultant for more than 20 years, and now the clinical director for Crisis Care Network, which responds to more than 1,100 workplace critical incidents a month, with as many as 40 to 50 a month being the suicide of an employee, I have been involved in thousands of employee suicide death responses over the years. I can attest to the shock, sorrow and disruption most employees and organizations feel. I can also attest to the fact that, in most cases, at least one other employee will step forward and say to the consultant on site that, in addition to all the other complex feelings in response to the co-worker’s death, he or she is also frightened by the fact he or she is likewise giving serious consideration to suicide. I was at a workplace response recently where a young female employee, about the same age as the employee who had committed suicide, approached me after a group session to say that she was very scared at how frequently she herself thinks about suicide. She had never told anyone. She knew she probably needed to talk with a professional counselor but always felt ashamed and intimidated by the notion. Fortunately, her employer cared enough to have a comprehensive employee assistance program (EAP) in place that brought in critical incident response services. EAPs, by design, try to remove as many barriers as possible that would prevent employees from receiving effective services. Access is typically 24/7, confidential, at no cost to the employee and available immediately as a telephonic consultation, or as a face-to-face appointment at a convenient location within 72 hours. After further discussion with this employee to determine her level of risk or urgency, we sat together and called the EAP to make an appointment. All employers should be planning now for how they would handle a suicide, so they can be sure to use the opportunity not only to care for employees but to take a proven series of steps that will make future suicides less likely. For the guidebook on what is known as “postvention,” click here.

Over the years, I’ve had safety directors or claims managers tell me that workers’ compensation claims move slower than a one-legged dog on tranquilizers. I would say the resolution speed of comp claims more closely resembles that of a three-legged dog on mild muscle relaxants - - but I won’t quibble over how far to take the metaphor. Bottom line: Oftentimes, comp claims do move very slowly. Without dwelling on the obvious, let me suggest three legitimate reasons why comp claims aren’t yet as fast as text-messaging teenagers. 1. Litigation takes time If you have pro se claims (where the claimant does not have an attorney), you’ve undoubtedly noticed that these claims are usually resolved very quickly. Why? You can insert you own joke, but you might consider the old one about how attorneys make good speed bumps. Having fewer attorneys involved removes obstacles and speeds the process. The absence of attorneys also means that there are likely no real issues to resolve. Everyone agrees on everything, so there is nothing to argue about. In disputed claims, though, investigation takes time. Discovery takes time. Getting opinions from expert physicians takes time. Courts take time. Years ago, I had a client tell me: “Brad, I don’t want you to settle any of our comp claims. Take them all to trial.” I did that. . . for a while. After two years of this (and after seeing the defense costs associated with taking every case to trial), the VP of claims called me and said: “Brad, can you start letting me know which claims can be resolved without trial?” It doesn’t take a high level of skill to take every case to trial. It does, however, require skill to know which claims should be settled and which claims should be disputed. 2.  Movement takes willpower Apart from falling down, movement takes willpower and initiative. A new client contacted me in June about taking over the defense of a claim that has been litigated since 2002. I entered my appearance, reviewed the medical records, called the claimant’s attorney and worked out a tentative framework for settlement with three or four phone calls. I am certain that I am not any smarter than the defense attorney I replaced. Some would say he is far smarter - - he was paid to work a file for 12 years, and I was the dope who resolved it with a few phone calls! Self-serving attitudes aside, I had a fresh perspective and wasn’t afraid to throw out ideas to resolve the claim instead of simply throwing out ideas for continued litigation. In an area of the law where the work is often very repetitive, coming up with a new approach is often difficult. 3.  Common sense is mistaken Common sense would seem to indicate that if the claimant’s attorney knows little about workers’ comp law, this places me (as the defense attorney) in a better position to achieve a favorable result for my client. In this instance, common sense is completely wrong. I have always found that claimant’s attorneys who actually know what benefits are payable under the workers' comp law and how to prosecute a workers’ comp claim are far better to work with than the attorneys who handle three comp claims a year and try to handle the claim like a jury trial in circuit court. Knowledge and experience can bring efficiency to a system that rarely seems efficient.

Violent crime, a major and growing problem in this country, is exacerbated by the fact that many crimes go unreported. But there’s a simple fix to the lack of reporting: Make it easier for people to tip off authorities anonymously. Developments in communications technology and in social media can play a decisive role in increasing reporting, especially among young people. Once authorities have more information, they can not only track down more criminals but can develop a fuller picture of where and under what conditions violent crimes occur, and can develop better prevention programs. In California, the Visalia campus of the College of the Sequoias has a program  allowing individuals to report suspicious behavior on campus to local police anonymously via text, voice mail or email. “Our best resource, by far, is the students and faculty right here on campus,” Chief of the Police department Bob Masterson told the student newspaper . “Even if you’re not the victim, you could be a great witness.” Many students said the program, TipNow, keeps them safer; they also consider it a good idea for all campuses. At U.S. hospitals, the violent crime rate per 100 hospital beds rose 25%, from 2.0 incidents in 2012 to 2.5 incidents last year, according to research released by the IHSS Foundation at the International Association for Healthcare Security and Safety (IAHSS). The rate of disorderly conduct incidents experienced the biggest jump, from 28 per 100 hospital beds in 2012 to 39.2 last year (a rise of 40%). A separate IHSS Foundation study found that 89% of the hospitals surveyed had at least one event of workplace violence in the previous 12 months. The federal Bureau of Justice Statistics’ National Crime Victimization Survey reported the following statistics for workplace violence between 1993 and 1999:

• While working or on duty, U.S. residents experienced 1.7 million violent victimizations annually, including 1.3 million simple assaults, 325,000 aggravated assaults, 36,500 rapes and sexual assaults, 70,000 robberies and 900 homicides.
• Workplace violence accounted for 18% of all violent crime.

From  1997 through 2009, 335 murders occurred on college campuses, according to data from the U.S. Department of Education (2010).  Three-fifths of campus attacks in a 108-year span occurred in the past two decades. Yet many crimes go unreported to campus authorities. A 1997 study about campus violence by Sloan, Fisher and Cullen found that only 35% of violent crimes on college campuses were reported to authorities. There are various reasons for not reporting crimes. For example, many may regard a crime as too minor a matter to report or may consider it a private matter. Many studies have shown a reluctance to report crimes or other suspicious activities out of fear of the authorities or of criminal retribution. For instance, in February 2009 in San Gabriel, Calif., two gunmen opened fire inside a coffee shop, killing one and wounding six others, but police had trouble finding witnesses to what appeared to be a gang-related attack even though the shop was crowded with at least 40 people. Sheriff's spokesman Steve Whitmore was quoted as saying,  "We know people saw something, and we need them to come forward and help us solve this crime."

Workers’ compensation is widely recognized as one of the most challenging lines of business, suffering years of poor results. Insurance companies are under increasing pressure to achieve profitability by focusing on their operations, such as underwriting and claims. Insurers can no longer count on cycles, where a soft market follows a hard one. The traditional length of a hard or soft market is evolving in a global economy where capital moves faster than ever and competitors are using increasingly sophisticated growth, segmentation and pricing strategies. Insurance executives also cite regulatory and legislative pressures, such as healthcare and tax reform, as inhibitors of growth. Furthermore, medical costs continue to rise, making it particularly difficult to price for risk exposure. The long tail of a workers’ compensation claim means that the cost to treat someone continues to increase as time elapses and becomes a compounding problem. Despite recent improvements in combined ratios, there are still many challenges within workers’ compensation that have to be reconciled. The savviest insurers are evaluating the availability of technologies, advanced data and analytics to more accurately price risk – and ultimately ensure profitability. The ‘Unknown’ in Workers’ Compensation Information asymmetry has made it difficult for insurers to accurately determine who is a high-risk customer and who is low-risk. At the point of new business, a workers’ compensation insurer is likely to have the least amount of information about those they are insuring, and it’s easy to understand why. The insured knows exactly who is on the payroll and what types of duties employees have. Some of that information is relayed to an agent, and then finally to the carrier, but, as in any game of telephone, the final message becomes distorted from the original. This imbalance of information is one reason why fraud is rampant, and why insurers ultimately pay the price. Payroll misclassification – or “premium fraud” – occurs when businesses pay salaries off the books, misrepresent the type of work an employee does or purposely misclassify employees as independent contractors. Some misclassifications are not nefarious. But whatever the cause, they create significant revenue and expense challenges for carriers that rely on self-reporting. The ‘Silent’ Killer Without the right insight or analytical tools, insurance companies have a hard time discerning between their policyholders and making consistent and fair decisions on how much premium to charge on each policy. When an insurer begins to use predictive analytics, competitors that are still catching up run the risk of falling victim to adverse selection. When we hear executives say things like, “The competition has crazy pricing,” it raises a red flag. We immediately begin looking for warning signs of adverse selection, such as losing profitable business and an increasing loss ratio. The problem is that it takes time to recognize that a more sophisticated competitor is stealing your good business by lowering prices while also sending you the worst-performing business. By the time you recognize adverse selection is occurring, you’re falling behind and have to respond quickly. The Power of Actionable Data Fortunately, there are technologies available for insurers of all sizes to make more informed, evidence-based decisions. But when it comes to data, there is still some confusion: Is more data always better? And how can carriers turn data into actionable results? It’s not always about the volume of data that an insurer has; it’s about the business value you can derive from it. If an insurer is just beginning to store, govern and structure its data, it is likely not receiving actionable insights from historic data assets. Accessing a more holistic data set with multiple variables (from states/geography, premium size, hazard groups, class codes, etc.) through a third party or partner can help to avoid selection bias, while encouraging rigorous testing and cataloging of data variables. Having access to a variety of information is key when it comes to making data-driven decisions. The conundrum insurers face when delivering actionable intelligence that underwriters can use is that they only know the business they write. They know very little about business they quote and nothing about business they don’t even see. What complicates this picture is that an insurer’s data is skewed by its specific risk appetite and growth strategies. It’s up to the insurer to fill in the blind spots in its own data set to ensure accurate pricing and risk assessment. As we know, what an insurance company doesn’t know can hurt it. As insurers increasingly turn to advanced data and analytics, the next question that keeps insurers up at night is, “When everything looks good, how do I know what isn’t really good?” One way that Valen Analytics is helping insurers answer that question is by providing companies with a “Risk Score,” a standard measure of risk quality. By tapping into Valen’s contributory database, workers’ compensation underwriters can have better insight into all the policies they write – even historically loss-free policies. In fact, the Risk Score accurately identifies a 30% loss ratio difference between the best- and worst-performing loss-free policies. This is one example of how the power of data can push the industry forward. Despite its many challenges, the workers’ compensation industry is becoming more analytically driven and improving its profitability. A comprehensive data strategy drives pricing accuracy and business growth while allowing insurers to achieve efficiencies in underwriting decision-making. By keeping up with technological advances, insurers can use data and analytics to grow into new markets and areas of business, while also protecting their profitable market share. While NCCI’s annual “State of the Line” report labeled workers’ compensation as “balanced” this year, we may soon see the integration of data and analytics push the industry to be recognized as “innovative.”

Do people want faster response by the police to a burglar alarm, or do they want lights they can control remotely? That is a core question that the alarm industry faces as it undergoes seismic changes.

Does the alarm industry sell security, including fast response by police, or does it sell the “connected” home? Many are leaning toward an emphasis on the connected home. That’s why Google bought Nest, known for its smart thermostats, for $3.2 billion in early 2014 and then announced recently that Nest would buy Dropcam for $555 million.

Dropcam uses small cameras to provide security services, though not as the alarm industry is doing. The alarm industry connects cameras to a central station, where feeds are monitored and police notified if there is a break-in. Dropcam uses motion sensors to alert the user to any possible problems; the user then checks the video feed from his phone or computer and, if necessary, contacts the authorities for help.

Whether the alarm industry chooses to emphasize fast police response or follows Google and tries to offer broad home automation solutions, there will be broad ripple effects, including for insurers.

From a risk-management perspective, there are two issues. The first is whether the home automation improves police response and reduces losses. Ultimately, however, the second issue is even more crucial: Do the new home automation services actually introduce new risks and enable high-dollar losses through remote vandalism, including frozen pipes and catastrophic water damage?

Concerning the first issue: At a time when declining budgets are forcing police to reduce the number of officers responding to property crimes, home automation has hijacked a large slice of the alarm industry and is minimizing police response. Catching burglars and reducing property crime has become secondary to lifestyle convenience features and home automation revenue streams. Increasingly, alarm/security is proposed as just one more feature in home automation.

But the new offerings generally use legacy alarm solutions, which have a false alarm rate of 98%. As a result, these alarms are only assigned a priority 3 by law enforcement, so police response is slow, if it happens at all.

By contrast, new alarms – based on monitored video feeds, and with break-ins verified -- are treated like a crime in progress, a priority 1. Responding officers run hot because they expect to make an arrest.

In an effort to confuse the issue and continue to sell legacy alarms, home automation suppliers sell the ability of the homeowner to remotely view cameras in the home as “video verification.” This claim is exploiting a naïve consumer. Home automation cameras are not monitored by the central station, and they do not provide faster police response. Remote viewing by the owner ends up being a glorified nanny cam.

Unfortunately for insurers, home automation has become the primary message of some of the historical burglar alarm companies, which have reengineered their companies. Security companies are now chasing smartphone thermostats and Wi-Fi-based lighting instead of focus on delivering police response to an alarm.

A joint study by the San Bernardino, CA, sheriff and police departments in 2011 found that the arrest rate for a traditional burglar alarm was only 0.08%. A five-year study completed by Pharmacists Mutual in 2013 found that, when police response was less than five minutes, the officers made arrests 21% of the time. This means that the likelihood of an arrest for monitored, video-verified alarms and priority police response is more than 250 times better.

Video-verified alarm systems monitored by a professional central station represent real loss control for the insurer. Video-verified alarms reduce claims. Monitored video alarms actually mitigate losses by delivering faster police response to an actual incident. Police make arrests and prevent the loss itself.

Concerning the second risk-management issue: Home automation introduces new threats for the insurer – catastrophic claims caused by remote vandalism. Imagine the damage to a Minnesota home whose furnace was turned off by malicious hackers while the owners were on a winter vacation. The costs for bursting water pipes and flooding the property for days would make most burglary claims seem paltry in comparison.

The problem is that home automation and the connected home create risks that have not been adequately identified and considered by insurers. Much has been written regarding identity or data theft caused by hackers exploiting weak computer networks for passwords and credit card info. The financial losses from this type of crime have had little impact on traditional property/casualty insurers, but home automation changes the risk exposure because now remote vandals can invade the network and take over the infrastructure and appliances of a homeowner to maximize damage without ever setting foot on the property.

Home automation devices become a Trojan horse for vandals, and the more devices are connected, the larger the risk as each device introduces another potential hole.

The press is finally beginning to educate readers about the issue. A July 30, 2014, article in Computerworld headlined “Home Automation Systems Rife with Holes” explains, “A variety of network-controlled home automation devices lack basic security controls, making it possible for attackers to access their sensitive functions, often from the Internet, according to researchers from security firm Trustwave. Some of these devices are used to control door locks, surveillance cameras, alarm systems, lights and other sensitive systems.”

Security Today published an article on July 16, 2014, about how hacked light bulbs can reveal a homeowner’s Wi-Fi password and actually give the hackers control over the home automation system itself. This excerpt describes the problem: “It’s all the new craze: the connected or smart home, where at the touch of a button on your smartphone you can dim your living room lights, close the garage…. But, with sophisticated technology comes risk if you aren’t vigilant in applying the latest security updates to your smart home. In fact, the latest risk involves LED light bulbs that can be hacked to change the lighting and reveal the homeowner’s Wi-Fi Internet password.”

The entire home automation system is only as secure as its weakest link or device – devices that need to be kept updated with security patches as flaws are discovered. Unfortunately, many of these connected home devices are static and not even capable of being updated with new software patches. The connected home is now the Wild West of home security, and property/casualty insurers are likely going to be the ones left paying the bill.

The bottom line is that the home automation industry introduces threats that run counter to the risk mitigation insurers have traditionally found by using discounts to promote monitored alarm systems.

In analyzing these risks, David Bryan, Trustwave researcher, states, "Anybody could have turned off my lights, turned on and off my thermostat, changed settings or [done] all sorts of things that I would expect to require some sort of authorization.”

The proliferation of devices, protocols, apps and portals mean that the problem is getting more complex instead of calming down. It is time for insurance companies to review their “alarm discount” and make sure that the discount encourages behavior that actually reduces claims. The alarm industry is promoting home automation to the consumer, but the features and benefits don’t actually reduce risk.

Underwriters can reduce risk and minimize losses by encouraging their policy holders to install monitored, video-verified alarm systems that deliver faster police response. Any insurance policy that offers discounts for home automation systems is encouraging new and unexplored risks posed by remote vandalism, and possibly worse.

Insurance companies, agencies and vendors really like animals. We like them partly because we insure them. But mostly we like them because, in an industry that struggles to translate its core values to tangible brand attributes, a cute and fuzzy or large, strong animal can help convey the right message and generate attention. These 12 brands, while completely different in size and essence, found the perfect animal to communicate their offerings and stand out from the herd (or pack or pride or. . . ).

1. Aflac Duck

2. Bolt Horse

3. Car Insurance Gorilla

4. Elephant Auto Insurance Elephant (What Else?)

5. Geico Camel

6. Geico Gecko

7. Geico Pig

8. Giraffe Professional Insurance Agency -

Giraffe

9. Hartford Stag

10. ING Lion

11. MetLife Snoopy

12. The Zebra - Zebra

Catastrophe models from third-party vendors have established themselves as essential tools in the armory of risk managers and other practitioners wanting to understand insurance risk relating to natural catastrophes. This is a welcome trend. Catastrophe models are perhaps the best way of understanding the risks posed by natural perils—they use a huge amount of information to link extreme or systemic external  events to an economic loss and, in turn, to an insured (or reinsured) loss. But no model is perfect, and a certain kind of overreliance on the output from catastrophe models can have egregious effects. This article provides a brief overview of the kinds of traps and pitfalls associated with catastrophe modeling. We expect that this list is already familiar to most catastrophe modelers. It is by no means intended to be exhaustive. The pitfalls could be categorized in many different ways, but this list might trigger internal lines of inquiry that lead to improved risk processes. In the brave new world of enterprise risk management, and ever-increasing scrutiny from stakeholders, that can only be a good thing. 1. Understand what the model is modeling…and what it is not modeling! This is probably not a surprising "No. 1" issue. In recent years, the number and variety of loss-generating natural catastrophes around the world has reminded companies and their risk committees that catastrophe models do not, and probably never will, capture the entire universe of natural perils; far from it. This is no criticism of modeling companies, simply a statement of fact that needs to remain at the front of every risk-taker’s mind. The usual suspects—such as U.S. wind, European wind and Japanese earthquake—are "bread and butter" peril/territory combinations. However, other combinations are either modeled to a far more limited extent, or not at all. European flood models, for example, remain limited in territorial scope (although certain imminent releases from third-party vendors may well rectify this). Tsunami risk, too, may not be modeled even though it tends to go hand-in-hand with earthquake risk (as evidenced by the devastating 2011 Tohoku earthquake and tsunami in Japan). Underwriters often refer to natural peril "hot" and "cold" spots, where a hot spot means a type of natural catastrophe that is particularly severe in terms of insurance loss and is (relatively) frequent. This focus of modeling companies on the hot spots is right and proper but means that cold spots are potentially somewhat overlooked. Indeed, the worldwide experience in 2011 and 2012 (including, among other events, a Thailand flood, an Australian flood and a New Zealand earthquake) reminded companies that so-called cold spots are very capable of aggregating up to some significant levels of insured loss. The severity of the recurrent earthquakes in Christchurch, and associated insurance losses, demonstrates the uncertainty and subjectivity associated with the cold spot/ hot spot distinction. There are all sorts of alternative ways of managing the natural focus of catastrophe models on hot spots (exclusions, named perils within policy wordings, maximum total exposure, etc.) but so-called cold spots do need to remain on insurance companies’ risk radars, and insurers also need to remain aware of the possibility, and possible impact, of other, non-modeled risks. 2. Remember that the model is only a fuzzy version of the truth. It is human nature to take the path of least resistance; that is, to rely on model output and assume that the model is getting you pretty close to the right answer. After all, we have the best people and modelers in the business! But even were that to be true, there can be a kind of vicious circle in which model output is treated with most suspicion by the modeler, with rather less concern by the next layer of management and so on, until summarized output reaches the board and is deemed absolute truth. We are all very aware that data is never complete, and there can be surprising variations of data completeness across territories. For example, there may not be a defined post or zip code system for identifying locations, or original insured values may not be captured within the data. The building codes assigned to a particular risk may also be quite subjective, and there can be a number of "heroic" assumptions made during the modeling process in classifying and preparing the modeling data set. At the very least, these assumptions should be articulated and challenged. There can also be a "key person" risk, where data preparation has traditionally resided with one critical data processor, or a small team.  If knowledge is not shared, then there is clear vulnerability to that person or team leaving. But there is also a risk of undue and unquestioning reliance being placed upon that individual or team, reliance that might be due more to their unique position than to any proven expertise. What kind of model has been run? A detailed, risk-by-risk model or an aggregate model? Certain people in the decision-making chain may not even understand that this could be an issue and simply consider that "a model is a model." It is worth highlighting how this fuzzy version of the truth has emerged both retrospectively and prospectively. Retrospectively, actual loss levels have on occasion far exceeded modeled loss levels: the breaching of the levies protecting New Orleans, for example, during Hurricane Katrina in 2005. Prospectively, new releases or revisions of catastrophe models have caused modeled results to move, sometimes materially, even when there is no change to the actual underlying insurance portfolio. 3. Employ additional risk monitoring tools beyond the catastrophe model(s).  Catastrophe models are a great tool, but it is dangerous to rely on them as the only source of risk management information, even when an insurer has access to more than one proprietary modelling package. Other risk management tools and techniques available include:

• Monitoring total sum insured (TSI) by peril and territory
• Stress and scenario testing
• Simple internal validation models
• Experience analysis

Stress and scenario testing, in particular, can be very instructive because a scenario yields intuitive and understandable insight into how a given portfolio might respond to a specific event (or small group of events). It enjoys, therefore, a natural complementarity with the hundreds of thousands of events underlying a catastrophe model. Furthermore, it is possible to construct scenarios to investigate areas where the catastrophe model may be especially weak, such as consideration of cross-class clash risk. Experience analysis might, at first glance, appear to be an inferior tool for assessing catastrophe loss. Indeed, at the most extreme end of the scale, it will normally provide only limited insight. But catastrophe models are themselves built and given parameters from historical data and historical events. This means that a quick assessment of how a portfolio has performed against the usual suspects, such as, for U.S. exposures, hurricanes Ivan (2004), Katrina (2005), Rita (2005), Wilma (2005), Ike (2008) and Sandy (2012), can provide some very interesting independent views on the shape of the modeled distribution. In this regard, it is essential to tap into the underwriting expertise and qualitative insight that the property underwriters can bring to risk assessment. 4. Communicate the modeling uncertainty. In light of the inherent uncertainties that exist around modeled risk, it is always worth discussing how to load explicitly for model and parameter risk when reporting return-period exposures, and their movements, to senior management. Pointing out the need for model risk buffers, and highlighting that they are material, can trigger helpful discussions in the relevant decision-making forums. Indeed, finding the most effective way of communicating the weaknesses of catastrophe modeling, without losing the headline messages in the detail and complexity of the modeling steps, and without senior management dismissing the models as too flawed to be of any use, is sometimes as important for the business as the original modeling process. The decisions that emerge from these internal debates should ultimately protect the risk carrier from surprise or outsize losses. When they happen, such surprises have a tendency to cause rapid loss of credibility from outside analysts, rating agencies or capital providers.

In a popular article published earlier this year, Mark Walls examines the complex relationship between the Affordable Care Act (ACA or PPACA) and workers’ compensation. While I recommend the entire article, today I want to focus on one point that Mark highlights. In preparing for the effects of the fully implemented ACA, Mark advises that employers should: "Carefully manage the approach to healthcare premium rebates, which could affect how payroll is calculated under workers' compensation." I’ll be honest – until I read Mark’s article, I was happily leaving all of Zywave’s ACA discussions to our own Erica Storm, an attorney who’s been monitoring and writing about healthcare reform for several years. But the words payroll and workers’ compensation jumped out at me. If workers’ comp payroll can be affected by the rebates, then so can experience mods and workers’ compensation premium. How much impact are we talking about? With Erica’s help on the ACA side of things, I delved deeper into the topic. Premium rebates introduced by healthcare reform The concept of health insurance premiums affecting workers’ compensation payroll is not new, but ACA-mandated rebates, which began in 2012, have introduced a new level of complexity in the accounting. ACA requires insurers with a certain medical loss ratio (MLR) to issue a rebate to employers. Guidance to employers on rebate options is vague, but options may include

• passing along MLR rebates to employees,
• applying rebates to future premiums, or
• applying rebates to benefit enhancements.

Whatever option is chosen, the plan sponsor must follow the fiduciary duties of prudence, impartiality and acting for the exclusive benefit of plan participants. When employers pass along any portion of the rebates to employees, such rebates must be counted as payroll for the purposes of workers’ comp. Note that this rule applies as long as the rebate to the employee is through the employer and not directly from the insurance provider. The rule also applies regardless of whether the rebate distribution is taxable or non-taxable. Payroll rules in more detail Payroll for the purposes of workers’ compensation is defined in the applicable bureau manual; the majority of states use NCCI’s Basic Manual for Workers Compensation and Employers Liability Insurance. Rule 2-B-1 lists payment types included and rule 2-B-2 lists payment types excluded for the purposes of calculating workers’ compensation payroll. But most helpful with regards to rebates is a separate NCCI article, The Patient Protection and Affordable Care Act and Workers Compensation Premium Determination. Be sure to check out the handy tables to make sense of how both insurance premiums and rebates can be included or excluded from payroll. A sample scenario An employer’s decision on what to do with a rebate can be complex, depending on the type of group health plan and whether the rebate is considered a plan asset.  The workers’ compensation aspect is admittedly almost an aside. Yet as we all know, even small impacts add up. For an employer that passes along a rebate to its employees, how much impact might that employer experience on its mod and premium as a result? To answer that question, it’s first important to note that the state and insurer matter. In many states, the average rebate paid in 2013 (for 2012 premiums) was less than $100 per family. Clearly, for many employers, that isn’t going to significantly affect payroll through rebates. However, in some states and for some plans, the average rebate was much higher. According to government data on 2012 premium rebates, 10 states (excluding territories) had large group rebates averaging from $340 to more than $1,250; eight states had small group averages of $300 or more. Using that information as a rough model, I constructed a sample “high rebate” scenario to test its effects on workers' comp premium. I imagined:

• a 100-employee manufacturing business in Illinois
• an average hourly wage, including most benefits, of $35.00 (roughly based on June 2013 Employer Costs for Employee Compensation data for goods-producing occupations from the Bureau of Labor and Statistics). For simplicity’s sake, I’ve assumed that all costs are reportable for workers’ compensation purposes.
• 80% of the workers in payroll code 2797 – manufacturing
• 20% of the workers in payroll code 8810 – office work
• a relatively high level of losses that has driven the company’s mod to 1.20, while the minimum mod, based on zero losses, is 0.61 (these values were determined using ModMaster)
• two rebate levels to analyze, assuming for each that the full amount is returned to employees:
  • a high but not unrealistic $1,000 rebate
  • a probably unrealistic $3,500 rebate

First let’s take a look at the calculation of this sample company’s manual premium, followed by its final premium at various mod levels. Before any health insurance rebates, our sample company has a mod of 1.20 and associated premium of more than $800,000. Note how low the minimum mod and premium could be. When a $1,000 rebate is introduced, the manual premium is increased by the same percentage as the effective total payroll increase – in this case 1.4%. But what I was very curious to see was whether, in the mod calculation, the increase in payroll was enough to increase expected losses and thus lower the mod, thereby offsetting some of the manual premium increase. As you can see below, this was not the case. Although expected losses (not shown) did increase, they didn’t increase enough to actually change the minimum mod or current debit mod values. A $1,000 per employee rebate edges up payroll, but not enough to significantly change the mod calculation. The effective rate of the payroll increase therefore applies to the final workers’ comp premium regardless of the mod value. So how large would rebates need to be to actually affect the mod as well as the premium? I experimented with several rebate levels and for this payroll scenario found that the magic number was somewhere around $3,500: A $3,500 per employee rebate affects payroll enough to change both the current and minimum mod values. That mod decrease in turn mitigates the overall premium increase. When $3,500 is added to each employee’s salary, the resulting increase in expected losses in the mod formula is enough to drop the minimum mod by 0.01 and the current debit mod by 0.02. For this example, that offsets the 4.8% payroll and premium increase to only 3.1%. In summary The above example is considerably simplified; in reality, the included/excluded payroll calculation would be more complex, and additional premium credits and debits would likely apply. Results could vary greatly with company size, as well. Nevertheless, the example suggests:

• As a rule of thumb for employers considering their rebate options, it seems reasonable to use the total amount being rebated to employees divided by the original included payroll as an approximation of the employers’ workers' comp premium increase. The actual increase may vary when accounting for a change in the mod value or effects of other premium debits and credits.
• Even a rebate of less than 1% may, if returned to employees, add up to thousands of dollars of premium expense for all but the smallest employers, in addition to the administrative costs of processing the rebate.
• While relatively high-dollar rebates may be rare, employers should be especially sensitive to their increased impact on premium.

Employers should also keep in mind that, per NCCI, “an employer is required to keep records of information needed to compute premium. In addition, the employer must provide those records to the carrier, when requested, for the purpose of auditing the employer’s workers compensation policy.” While some insurance professionals suggest that rebates may diminish with time and premium stabilization, others disagree. There’s also been discussion in the press of possible policy endorsement or other changes to protect employers from additional premium charges as a result of rebate distributions. The one thing we can all agree on is that the “bigger picture” relationship between ACA and workers’ compensation is a blurry image that will take years to fully develop. Have you or your clients experienced a mod or workers’ compensation premium increase because of distributing a MLR rebate to plan participants? I’d love to hear your experience in the comments below.

As discussed in Part 1 of this series, business succession and exit planning for an owner of a successful business is crucial yet challenging. A comprehensive plan considers the central role that the business plays in an owner’s overall financial, retirement and estate plan. This presents opportunities for the business owner and advisers to address:

1. Business continuation. Transferring control to a family member, key employee or third party.
2. Key talent retention. Ensuring continued success of the business through retention of key employees using special benefits (golden handcuffs).
3. Retirement. Securing a comfortable retirement (which may not be primarily dependent on the business).
4. Legacy issues. Preserving the business for family members or realizing its value to provide financial security for surviving family members while treating heirs fairly.

This article, the second in a four-part series, addresses how an owner can:

• Attract, reward and retain key employees; and,
• Protect the value of the business upon the eventual departure of a key employee.

Business owners, especially those who have lost a key employee to a competitor, know first-hand how hard it is to attract and retain good talent. Not only does the departure of a key employee hurt the bottom line, but valuable time must be spent to find and train a suitable replacement. If the executive was a possible successor to the business, the owner may have to consider other, less appealing options. Indeed, for many businesses owners, the most important assets of the company are the key employees and executives. They drive revenue and are important to business perpetuation.  But in today’s economy, key employees are less loyal and might be tempted to leave for even slightly greener pastures. Executive Compensation One way a company can retain and attract top people is to reward them with additional executive compensation. A supplemental executive retirement plan (SERP) is a viable option to provide special compensation for special people. Highly compensated employees are typically not able to put away enough through the company’s 401(k) and profit sharing plans to adequately replace the executive’s pre-retirement income. With a SERP, the company agrees to provide a benefit to an executive based on satisfaction of terms and conditions such as sales goals, performance and longevity. The business owner chooses who participates, the level of benefits, the types of benefits and the plan provisions. Benefits typically include retirement income, survivor benefits and disability payments and are subject to the company’s creditors. By offering valuable benefits like these, business owners will attract more top talent, increase their productivity and make it more difficult for them to consider leaving the company. Family Business Applications A SERP can be especially useful in a family-owned business setting where a key employee, such as a CFO, is not a family member. Because these employees are unlikely to receive equity in the company as a benefit of employment, they can be provided with “equity-like” benefits through a SERP so they will stay with the organization and perform, especially as the business is transferred from one generation to the next. Informal Funding Most businesses earmark assets and current cash flow to pay future SERP liabilities. Otherwise, the “pay when due” approach may put too much financial pressure on the business. When the promise to pay isn't backed by assets, a slowdown in business can mean a slowdown in benefits paid out, as well. To avoid these pitfalls, most organizations choose to informally fund SERPs with taxable investments, such as equities, or with tax-favored corporate-owned life insurance (COLI). Both offer attractive, growth-oriented investment opportunities. Assuming the executive can medically qualify for the coverage, COLI can provide additional tax advantages: tax-free gains on investment earnings in the policy, tax-free access to cash values through policy withdrawals and loans and an income tax-free death benefit at the passing of the executive. In a rising tax environment, the benefits of tax-favored COLI can make it an even more compelling option. The coverage can be even designed to allow a company to eventually recover all or a portion of its SERP costs, including benefit payments and policy premiums. An Example Suppose a company has a key employee it wants to retain. A SERP could be established with a COLI policy on the executive’s life that is sufficient to provide the future benefits outlined in the agreement, such as a retirement income benefit of $100,000 a year for 15 years. The business would own the policy, pay the premiums and serve as beneficiary. In specific cases, a business may be in a position to borrow some or all of the premiums and make interest payments to a lender rather than premium payments to an insurance company. At the executive’s retirement, the company would access policy cash values to provide the agreed-upon income benefit to the executive. The retirement benefit would be taxable to the executive and deductible to the company. When the executive eventually passes away, the company receives the tax-free death benefit proceeds as a mechanism for cost recovery. If the executive dies before retirement, the death benefits are paid income tax-free to the company. The business can then provide the benefits promised to the executive’s beneficiaries and use the excess funds to recover the cost of the plan and protect the business from the loss of the executive. If the executive decides to leave before retirement or meeting the terms of the SERP agreement, the executive may forfeit some or all of the promised benefits, which should make him think twice about departing. Even if the employee leaves, the company still owns the policy and can use it as source of funds to hire a replacement. Although the premium payments are not tax-deductible to the business, using COLI can be extremely tax-efficient because: Cash values grow tax-deferred and can be accessed tax-free via policy loans and withdrawals; payments to the key employee (or employee’s heirs) are tax-deducible to the company; and death benefits are paid income tax-free. Next Steps It is comforting for a business owner to know that, with a SERP, there is a tool at her disposal to efficiently recruit, retain and reward the industry’s top talent. Consulting with a corporate attorney and a knowledgeable life insurance professional, who is experienced in designing COLI products, is the place to start. Part 3 of this four-part series will address business owner retirement, to ensure the business owners and their families maximize the value of the businesses they worked so hard to create.