(Part I of this series focused on how to identify high-exposure claims and on the factors that drive cost and duration. Part II focuses on approaches to establish the value of a case, to determine if it is a good candidate to settle.)
Three numbers are critical in the valuation and determination of whether a case is a good candidate for settlement: future value, present value and settlement value.
The analysis of future valuation provides, by reserve category, a value for the indemnity, medical and expenses projected for the future of the case.
The indemnity exposure is driven by statutory requirements for both permanent partial and permanent total disability. Typically, permanent partial disability is a fixed number of weeks multiplied by a weekly benefit. Likewise, permanent total disability benefits are calculated at a fixed rate; however, in most instances the benefit is payable for the life of the injured worker. A complication is that each jurisdiction views permanent partial and permanent total disability differently.
Determining the future medical exposure can be even more complicated. In many instances, a calculation will be made based on the average spending on the case over the past three years, but a more thoughtful analysis is necessary to determine the true future value. The analysis should be calculated based on the normal, expected treatment that an injured worker will need over the course of the claim but also consider the irregular treatment modalities necessary or requested by the physician. These may be surgeries, replacement of motorized wheelchairs, conversion vans, etc., which occur on an irregular basis; for example, a replacement van would be required every eight to 10 years, or a motorized wheelchair may need to be replaced every five to seven years. By parsing out these items, a much more accurate and appropriate analysis will be developed.
Even once you understand the future exposure and the present value of a case, you still should consider other factors, such as co-morbidity and the reduction in the life expectancy of an injured worker because of both industrial and non-industrial conditions (factors discussed in Part I: Settlement of High-Exposure Claims Part I).
Co-morbidity factors can indicate whether an injured worker’s life expectancy suggests there will be a need for, perhaps, a second knee surgery (at the 30-year mark). Will the injured worker’s condition deteriorate to either create a need or expand the existing exposure for home/attendant care?
The most significant costs in high-exposure claims typically are medical, and a calculation of settlement value should also take into account that great savings can be achieved. In many instances, savings can be realized through turning the Medicare Set Aside, presuming one is necessary, into an annuity. Assessing non-Medicare type items such as home/attendant care and “off label” medications can also produce savings.
Expenses are also sometimes difficult to quantify. Allocated expenses such as legal fees and record subpoena services may diminish over time as issues begin to resolve. Depending on the jurisdiction, continuing litigation costs may be incurred if a defendant denies a treatment modality or procedure. In addition, consideration should be given to “other” medical expenses such as bill review, utilization review and nurse case management services. These typically continue through the life of the claim and may cost thousands, if not tens of thousands, of dollars.
When analyzing the present value (also referred to as a discounted value) of benefits, it is important to understand the time value of money and current internal rates of returns on investments. The typical internal rate of return for annuities is currently approximately 4%. This rate varies, primarily based on interest rates. Carriers and self-insured employers have greater buying power, so they might expect a return of 6% to 7%.
Determining present value is a straightforward calculation based on whatever the right discount rate is but requires a detailed understanding of likely expenses. Is the injured worker only entitled to benefits for a specific number of remaining weeks? Or, is the benefit payable for life? Determining the present value of the consistent medical generally is a matter of calculating the average annual cost and applying the appropriate discount rate. With irregular costs, it is necessary to understand the specific items in question and the estimated frequency of each. If an injured worker needs knee replacements and will require two over her lifetime, an estimate is needed as to when those will occur (for example, in 15 years and again in 30 years) and the anticipated cost of the surgery. The present value of the surgeries can be calculated based on how many years off they are.
Discounting expenses associated with a case is typically handled much like the medical discounting. For the regular, consistent costs, an annual amount can be calculated and discounted for present value. If intermittent litigation and other expenses may occur, estimates are created and discounted for present value.
It is safe to say there is some art associated with determining present value. Variances in the discount rate used, the manner in which exposure is calculated and other factors can greatly affect the calculation. Understanding these variables and analyzing them correctly is imperative to reaching a solid present value calculation.
The nature and type of insurance program (primary vs. self-insured) as well as the manner in which the defendant has analyzed his exposure will greatly affect the settlement value of a case. Understanding the differences between the future exposure and present value calculations aid in determining the amount of money that a party is willing to spend to bring closure to a file.
Lacking a crystal ball, reserving practices have always had an aspect of “art” to them; thus the future value will have some variation over time based on changes in treatment course, deterioration in condition and other factors. Present value calculations are estimations or approximations based upon the changes in value of money over time.
Likewise, the settlement value of a case is the best estimate of where the future needs of the injured worker will be, with consideration of the time value of money and degree of desire to extinguish the exposure now—before there is any further potential for expansion or deterioration in the condition, creating a greater degree of expense and exposure in the future.
A discussion of settlement value should consider that a settlement of the case-in-chief not only ends direct expenses such as litigation, utilization review and nurse case management but also brings to an end the time and energy expended to adjust the claim. Time and energy are usually disproportionately great in high-exposure cases because of the complexities.
A settlement also helps the carrier/self-insured employer by possibly allowing it to recover reserves set aside for a case and by reducing exposure to any expansion of the claim as the years go by.
Ultimately, the objective is to bring these high-exposure cases to resolution as promptly and cost-effectively as possible because, for carriers and self-insured employers, this small percentage of cases drive the majority of costs associated with a workers’ compensation program.
Part III of this series will cover Negotiation and Resolution.