Tag Archives: claim liabilities

Controlling Workers' Compensation Claim Costs: 3 Things Every Self-Insured Should Know

The observed increase in workers' compensation claim liabilities and ultimate losses is partially attributable to external factors — those outside the control of risk management, such as medical inflation. Elizabeth Bart's article, Ever-Increasing Unpaid Claim Liabilities: When Does The Growth Stop? explores such external factors.

This article also explores the topic of increasing workers' compensation claim costs, with a focus on how claims practices can influence claims costs and contribute to the increasing liabilities, and discusses what self-insureds can do to better manage practices in an effort to control costs.

The management of a workers' compensation claim incorporates several key areas, all of which interact and combine to influence the claim's outcome (e.g., initial handling, investigation, reserving, medical management, etc.). It can be challenging to understand whether a workers' compensation claim is well-managed and whether optimal outcomes are being achieved. This is particularly true for self-insured entities, which often delegate claims management responsibilities to an outside third-party claims administrator (TPA).

The result of using TPAs for claims administration is that the self-insured entity itself maintains little if any expertise in the area of sound claims management practices. Moreover, the TPA will often delegate certain functions to other vendors such as case management and medical and legal bill review, further removing the oversight of these services from the self-insured's reach. Finally, many self-insured/TPA contracts focus on the quick resolution of a large volume of smaller dollar claims, with little consideration for the efforts and resources needed to resolve large claims. Therefore, the management of larger claims may not be well understood or outlined in these arrangements.

Improving three often misunderstood or underestimated claims handling areas could result in a significant improvement in claims outcomes and have a material impact on liabilities:

  • Initial activities
  • Information and data collection
  • Change in case reserving practices

Basic knowledge of these essential claims handling activities will enable the self-insured to effectively work with its TPA to avoid common pitfalls and to proactively manage the TPA. This, in turn, will mitigate or avoid unnecessary cost increases.

Initial Activities
Activities undertaken by the claims handler immediately after a claim is reported are often thought of as administrative tasks — no more than an intake exercise whereby the handler runs through a checklist of scripted questions. These activities include assessing immediate medical management needs, making three-point contact (i.e., contact with the employer, the injured worker, and the medical provider), assigning to the appropriate adjuster, taking statements, and gathering documents (e.g., medical authorizations, photos, police reports, and wage statements).

And in truth, activities that occur in the early stages of a claim may not be terribly significant for the large number of reported workers' compensation claims that resolve quickly. However, for that small percentage of claims upon which the majority of the costs are ultimately expended, proper claims management from the outset is crucial to achieving optimal claims outcomes.

For example, a claimant who has had previous injuries or prior surgeries, or who otherwise presents with certain characteristics such as chronic pain, is more likely to require medical management from the outset to ensure optimal medical outcomes, which in turn reduces costs. For a small number of high-severity claims, if the medical aspects are not understood and well controlled at the outset, the claimant often does not improve and the claim can adversely develop into a larger-than-anticipated and larger-than-necessary claim — a lifetime pain management claim perhaps involving multiple surgeries, and costing hundreds of thousands or even millions of dollars without optimal medical outcome or endpoint for the claimant.

Thus, it is important upon receipt of a claim to investigate all prior injuries, surgeries, prescriptions, and comorbidities (i.e., health issues that are not work-related but nonetheless could impact the treatment of the injury). In many cases, the best practice of making three-point contact has devolved in practice into two-point contact (the employer and the injured worker) and in some cases even one-point contact (the employer). This can leave basic medical questions unanswered for weeks or months. For a small percentage of claims that have the potential for developing into the highest-severity losses, these delays could be critical.

Another key initial activity is adjuster assignment. Assignment to the appropriate adjuster can be particularly important for some claims — for example, those where the claimant reports injuries to nonspecific or multiple body parts, such as “neck, shoulder, arm.” These claims present an element of subjectivity, uncertainty, and potential complexity. It is important that the adjuster thoroughly investigate precisely how the injury occurred and communicate with the medical providers about the types of injuries that can result from that activity.

This means that the adjuster needs to have the proper background and expertise to ask the right questions. If injuries or body parts are reported that are not medically connected to the work-related injury, the adjuster may only have a short period of time within which to deny those unrelated claims. An inexperienced adjuster may not identify or attempt the valid denial, in which case that injury and all subsequent treatment may be deemed accepted for the duration (perhaps for the life of the claimant), with no further opportunity to deny. In a large number of cases, this missed opportunity will not have a significant impact on the outcome, but for that small population of high-severity claims, such an error will be costly.

As a final example, the initial investigation is important to assess the claimant's ability or motivation to return to work based on one or more subtle aspects of the claim, such as educational level, child support status, disability status of the claimant's spouse, ability of the employer to accommodate the claimant's limitations, proximity of claimant's home to job opportunities, or other factors.

It is important for the handler at the outset of the claim to immediately contact the employer, the injured claimant, witnesses, and medical providers to ask pertinent questions. Equally important is the need for the handler to listen carefully to the answers and follow up on unusual or inconsistent information. Inexperienced claim handlers often appear to be following a list of predetermined questions and may hesitate to go “off script.” Many times, the claims that adversely develop are those that, in retrospect, could have been controlled had certain information been collected and had the investigation been thoroughly completed and thoughtfully assessed early in the life of the claim.

Information And Data Collection
Increasing claim costs are also associated with the inability to easily locate and evaluate the information gathered on the file. A claim may be assigned to an adjuster with the appropriate level of expertise, and that adjuster may undertake a prompt and thorough investigation. However, the pertinent information emanating from that investigation is not captured in discrete data fields in one location in the file system. Rather, that information is buried throughout the “notes” section of the claim system — along with numerous immaterial or administrative entries. This impedes the ability of the self-insured to easily identify claims that have the potential to be large and work with the TPA to effectively control costs.

For example, a large volume of the “notes” section of a claim file may include entries such as the date of a reserve review, an adjuster's failed attempt to contact a party, the payment of a bill, the date a processing decision was made, the scanning of a document into the file, or the receipt of a police report with no substantive commentary. Even entries related to the status of a claim — one that on its face would appear to be highly relevant and current — are often simply “copy/pasted” from prior status entries.

Thus, including in the claim notes pertinent information vital to making prompt and reasonable strategic decisions can lead to inefficiencies and suboptimal outcomes. The amount of stale, outdated, repetitive, and sometimes misleading information makes it exceedingly difficult to identify and assess the pertinent facts, issues, and activities in the file, and impedes the adjuster's (and supervisor's) ability to make informed decisions. In many claim operations, reviewing the file is so time-consuming and difficult that the supervisor is only able to randomly select a small sample to audit at regular intervals. If that supervisor does not by chance select the “right” files, important issues might not be identified and key strategic opportunities might be missed.

The problem is compounded when information is entered incorrectly. Common errors can lead to costly repercussions. For example, assume that the medical records all clearly identify a right shoulder injury. If the handler inadvertently references the “left shoulder” injury in the claim notes, all subsequent actions might be based upon that. A supervisor or newly assigned adjuster may not have the time, or may believe it is unnecessary, to confirm that information by checking the original medical records. Body parts and treatments could be implicitly accepted and additional costs expended for injuries that are not work-related.

Similar types of errors can be made with wage information or rate calculations, and can go unnoticed for long periods of time, resulting in costlier claims. Finally, as more and more claims departments are outsourcing medical bill review functions to third-party vendors, some of that key medical information is not captured in the claim system at all, which can also distort the true picture of the potential exposure.

Thus, it is important that the self-insured verify that the TPA, or other claims-handling entity, develops a system of meaningful data capture, whereby key pieces of information are systematically downloaded or manually entered into consistent discrete fields in as few screens as possible. Many claims systems already have these capabilities, but handlers are not required to enter the data and the fields remain blank. Such a data capture would allow representatives at the self-insured entity the ability to obtain a current and comprehensive snapshot of the development on the claim. Discrete data fields also ensure consistency, facilitate fact-checking, and support the creation of meaningful metrics and management information reports. Self-insureds should ensure that they have full access to the claims system and that they understand all the features of that system.

Change In Case Reserving Practices
The onset of conservative case reserving practices can lead to unnecessary increases in ultimate losses. This may not be intuitive. Many people may think that inadequate case reserves lead to increasing ultimate losses, because over time the case reserve (which was initially set “too low”) needs to increase to cover actual payments. While this is true, the ultimate losses may not be affected by the development of inadequate case reserves, because the actuary may have taken the case reserve practices into account in estimating the actuarial reserve.

Thus, even if the case reserves were “too low,” the actuarially estimated additional reserves would have compensated, resulting in a total reserve (case plus actuarial), or “ultimate,” of “just right.” As case reserves increase, actuarial reserves may decrease (all else being equal), and the ultimate will not change. In that way, inadequate case reserves do not necessarily result in increasing ultimate losses.

An important aside: We must remember that inadequate case reserves are not necessarily the result of poor claims handling or intentionally suppressing case reserves. When we say that case reserves are inadequate, we mean that, despite best efforts to set a case reserve that reflects the ultimate value of the claim at any given point in time, there are a few claims that will develop adversely in unanticipated ways (i.e., in ways that could not be foreseen by the claims handler when the prior case reserve was established). That is in part what the actuarial reserve is intended to estimate — the unanticipated development — and is outside the purview of the claims handler.

Changing case reserving practices by making them “higher” or “more conservative,” however, can result in increasing ultimate losses. Consider, hypothetically, a TPA that decides to institute a new practice of establishing a case reserve reflecting the worst case scenario, or adding an arbitrary amount (e.g., 25%) on top of the best estimate of case reserves. That change could result in higher ultimate losses, for two reasons:

  • First, if the actuary is unaware of this change, it will not be incorporated into the actuarial estimates. This could result in higher actuarial estimates. When added to the already increased case reserves, the ultimate losses increase substantially.
  • Second, raising case reserves on a claim can lead to overpayments by the adjuster, a phenomenon commonly referred to as “leakage.” In this case, the additional case reserves are believed, either explicitly or subconsciously, to be available to make payments. Efforts to reduce costs and manage the claim to its optimal result may be tempered by the knowledge that there is “extra” money with which to negotiate. This change in case reserving practices can lead to overpayments and rising claims costs.

In this article, we explored a concept mentioned but not developed in Elizabeth Bart's article, Ever-Increasing Unpaid Claim Liabilities: When Does The Growth Stop? Specifically, we discussed three basic claims practices that could result in increasing workers' compensation costs. Understanding and recognizing the importance of these practices will enable the self-insured to effectively manage the TPA to control increasing costs.

Ever-Increasing Unpaid Claim Liabilities: When Does The Growth Stop?

Large deductible and self-insured workers' compensation programs often face year-over-year increases in their unpaid claim liabilities, even though they are not suffering from adverse claim development, unexpected large losses, or materially changing their risk profile. Why does this keep happening? The increase is the natural result of several external factors, with the biggest drivers being rising indemnity costs and rising medical costs. Why should program managers expect these increases? And how can the inevitability of these rising costs be conveyed to executive management?

The solution starts with recognizing the nature of liability growth and focusing not solely on liabilities but rather on ultimate losses.

How Actuaries Determine Unpaid Claim Liabilities
Actuaries estimate a program's ultimate losses — the amount that will eventually be paid to close all claims that have occurred under the program. For a review as of December 31, 2012, the ultimate losses include all claim payments, current case reserves, and an incurred but not reported (IBNR) provision for any future case reserve development (including reopened claims) and for claims that have occurred but have not been reported as of December 31.

There is one important (non-numerical!) formula that relates to ultimate losses and the resulting reserves called unpaid claim liabilities. The ultimate losses as described above can be shown as follows:

Ultimate Losses

The actuarial report will estimate the total amount to be paid (i.e., ultimate loss) and we know the total amount paid to date from the claim data. The program's remaining obligation is what is left to be paid: the known case reserves and the additional estimated IBNR provision — that is, the remainder of the ultimate loss amount.

Utilizing the estimated ultimate loss and the actual paid losses, we can arrive at the estimated unpaid claim liability:

Estimated Unpaid Claim Liability

Just as the unpaid claim liability is the ultimate losses minus the paid losses, the change in the unpaid claim liability from one evaluation to the next is the change in ultimate losses minus the change in paid losses. The key to understanding the change in the unpaid claim liabilities is to understand the drivers behind the change in the ultimate losses relative to the change in paid amounts. Because, in an ongoing program, both will theoretically increase at each subsequent evaluation. The amount by which the change in ultimate losses outpaces the change in paid amounts will determine the change in the unpaid claim liability.

When unpaid claim liabilities are increasing, it is really because the ultimate loss estimates for each new accident year are increasing faster than the losses are paid during the calendar year. So what causes the ultimate loss estimates to increase?

Many risk managers are concerned that executive management will perceive increasing ultimate losses and increasing unpaid claim liabilities as a reflection of an underperforming current risk management program as well as claim management practices. However, there are many factors completely unrelated to risk management that influence the unpaid claim liabilities.

Changing risk management practices such as claim reserving methods and claim payment speed, or shifting the type of work performed or injuries incurred, will influence actuarial studies, but we're going to focus on external trends that influence programs and cannot be controlled by risk management. These factors, even with keeping all aspects of the program's risk management consistent from year to year, cause the natural tendency of ultimate losses to grow each year.

An Illustrative Example — Without Trend
While actuaries and risk managers are fluent in the actuarial terms of ultimate losses and unpaid losses as described so far, when describing the cash flows to executive management at a high level it may be easier to think in terms of buying a house and making annual payments on it. If a $250,000 house is purchased, it's clear that ultimately the full $250,000 will be paid. Until then, the remaining unpaid portion is equivalent to the actuarial unpaid claim liability.

Let's say a $250,000 house is purchased and $50,000 payments are made every year for five years to pay it off. An additional house is purchased every year. The first house is purchased in 2012 and, at the end of the year, $50,000 is paid. The unpaid amount is $200,000 ($250,000 – $50,000). In 2013, another house is purchased and a $50,000 payment will be made on each house this year.

At the end of 2013, we know that ultimately $500,000 for both houses is owed and that $50,000 was paid in 2012 for house #1 and $100,000 in 2013 for both houses. The unpaid liability as of December 31, 2013, the remainder left to be paid, is $350,000 ($500,000 – $150,000) — which is an increase of 75% over the prior year end.

Unpaid Liabilities

If the same thing is done in 2013 as 2012 (buying a $250,000 house and making $50,000 payments on each), why does the liability go up? It's because the change in ultimate losses (another $250,000) is much larger than the additional $100,000 payments in 2013. In 2013, the ultimate increased by $250,000 for the new year's exposure of an additional house and the payments increased by $100,000 for the two $50,000 payments made on the two houses. The prior liability of $200,000 plus the change in ultimate losses of $250,000 minus the change in payments of $100,000 equals a new liability of $350,000 at the end of 2013.

For the next four years, the liabilities will keep increasing. The liability will go unchanged only when the payments made in the calendar year are equal to the new exposure brought on with the purchase of a new house. When five (or more) $250,000 houses are owned, $250,000 in payments will be made each year, offsetting the additional $250,000 in liability picked up with each new house purchased, as shown in Figure 2 below.

Liabilities with Multiple Houses - No Trend in Housing Cost

Many executive managers (and some risk managers) feel that their programs are in this “steady state” and do not expect to see increases in the liability. However, in the real world of large deductible and self-insured workers' compensation programs, the ultimate losses for each new exposure year are heavily influenced (and increased) by rising medical and indemnity costs. The injuries that cost $250,000 in 2012 dollars will cost more in the future.

An Annual Occurrence?
It is very important that executive management is aware that unpaid workers' compensation claim liabilities are expected to increase each year. And that the increases will be more than inflation (as represented by the consumer price index, or CPI). While other balance sheet items may be subject to inflation only, unpaid claim liabilities are subject to inflation, severity trends, and frequency trends. The 2012 State of the Line annual presentation by the National Council on Compensation Insurance (NCCI) shows a five-year indemnity trend of 2.9% from 2006 to its projection for 2011, with a medical trend of 4.4%, noting that the negative frequency trends that had been offsetting the rising indemnity and medical severity trends are beginning to flatten out.

This means that as business continues into the future, and even if all other variables remain the same, each new year of additional workers' compensation exposure is expected to cost more than the prior year by the aggregate trend. This is analogous to buying the same house every year in a housing market that's rising.

In this next example, the houses bought are 3% more expensive every year. All the houses have similar characteristics from year to year — square footage, tax rates, school districts, etc. — just as from year to year, many companies' workers' compensation exposure stays similar, as far as the number of employees, the mix of NCCI class codes, the location of employees, and the retention limit of the insurance program.

Adding Trend
Continuing from Figures 1 and 2, if a 3% housing increase trend is used, the change in liability will now increase each year and will continue to increase by the 3% trend. In our first example, a constant liability was achieved because the total calendar year payments ($50,000 on each of the five houses with a mortgage at any one time) lowered the liability the same amount as the new house raised the liability each year.

In the 3% trend example below, payments are made on less expensive houses while the incoming houses are the most expensive. In 2018, the first trended house is purchased for $257,500 ($250,000 × 1.03). The first of five payments is made on this house for $51,500. Each of the other four outstanding mortgages is still being paid at $50,000 each, so in 2018 a total of $251,500 is paid. But this is $6,000 short of the $257,500 change made to the ultimates when the new house was purchased.

Recognizing that the majority of payments are being made on mortgages (or claims) in earlier, “cheaper” years, while more expensive, trend-influenced mortgages/claims are being brought onto the program's liabilities, is the key to accepting the natural rise in liabilities over time.

Long-Term Liabilities with Multiple Houses - 3% Annual Trend in Housing Cost

Large deductible and self-insured workers' compensation programs face liability increases that are due to cost trends every year. In order for a program's liabilities to stay at the same level or decrease, the program would have to overcome these trends. But inflation, severity, and frequency trends aren't the only variables out there.

What To Watch For In The Future
As the economy recovers and workforces grow, this will increase the future additional costs applied to the program's liabilities. As a workforce increases by 1%, 3%, or 5%, so too do the anticipated ultimate losses for the next year. It would be comparable to buying a house with 1%, 3%, or 5% more square footage at the same cost per square foot.

Additionally, as the insurance market slowly hardens, programs may begin raising their retention levels. As the retention levels rise, so do the oncoming liabilities. Retention level increases will have a much larger impact than trend increases, as retention levels can increase by substantial amounts. In this example, a workers' compensation retention increase from $250,000 to $500,000 is similar to suddenly buying more expensive houses. While a 3% trend will raise the house price from $250,000 to almost $300,000 over six years (and raise liabilities by 3% each year), a jump to buying $500,000 houses will noticeably increase the liability with the addition of $500,000 mortgages, while most payments on the houses are in the range of $250,000 to $300,000.

In these examples, a very even payment pattern was used, but it is also important to note that the timing of payments influences the unpaid claim liabilities. In real life, workers' compensation payments may not be this regular, and large claims can have sudden payouts due to judgments or settlements.

As shown in the earlier formula, unpaid claim liabilities are equal to the ultimate losses minus the paid amount to date. Let's say that a decision is made to fully pay one of the mortgages on these houses. An additional payment of $250,000 would decrease the liabilities by $250,000. And while this large payment will decrease the liability, it does not have an effect on what is paid in total — the ultimate payments will remain the same — they just have to be paid sooner. And the decrease in the liabilities came from an equal decrease in the assets, which will offset on the financial statements.

Your actuary can explain and quantify the trend effects on your insurance program in detail and how any other changes in your program (to retention levels, employment levels, etc.) will affect the liabilities going forward. Internally, the actuarial report should be reviewed for its information on the change in the program's ultimate losses, which is a better reflection of the program's performance over time than the change in liabilities over time that is due to their sensitivity to payment timing.

Risk managers who need to manage executive management's expectations on unpaid claim liability growth can explain the external factors that play a large role in changing liabilities over time. If liabilities are increasing with the increasing trends, that's to be expected. If liabilities are increasing less than trend, staying flat, or decreasing, that's great. If liabilities are increasing by more than trend, ask your actuary for some suggestions.

A safety analysis can help identify which kinds of injuries make up the majority of the loss dollars, the program's retentions and allocation methodology can be reviewed, or for a thorough review of claims, predictive analysis can zero in on loss drivers.

An actuary can't make external trends disappear but can help explain them to executive management and make other suggestions on finding solutions in your data.