At a Glance
Self-insured healthcare entities should take the following steps to understand, report, and control their exposure to workers’ compensation losses:
- Focus on safety and risk management.
- Maintain a proper retention.
- Create “skin in the game” through an allocation.
- Benchmark the program’s performance.
- Perform frequent analyses and obtain second opinions.
Although medical malpractice is often the top-of-mind risk exposure in a healthcare entity’s self-insurance program, self-insured organizations also should evaluate their workers’ compensation losses. The purpose of workers’ compensation is to compensate an employee injured on the job for lost wages, medical care, and vocational rehabilitation. In exchange, the employee waives the right to sue for negligence. Understanding, reporting, and controlling workers’ compensation risk exposure is the key to effective management of this liability.
Understanding Exposures and Estimating Losses
From the date of loss to the final payment, the development of workers’ compensation losses can extend over a period of a few years on average and up to 40 or 50 years in severe cases. Losses are usually estimated on an occurrence or accident-year basis, which considers when an accident occurs, regardless of when it is reported. Occurrence losses account for losses that are already known, such as payments and case reserves, as well as unknown losses, which are referred to as incurred but not reported (IBNR).
Elements of IBNR. IBNR comprises pure late reportings, case development on known claims, development on reopened claims, and known instances that will be presented as future claims. Case development on known claims and development on reopened claims are significant components of workers’ compensation IBNR.
For example, consider a workers’ compensation back injury. This type of injury usually is reported soon after it occurs but can easily take an adverse course if symptoms reoccur and additional surgeries are needed after a claim is initially closed. In contrast, pure late reportings represent a relatively minor category for workers’ compensation. At the end of any given year, roughly 5 to 15 percent of losses that occurred in that year will still be unknown. This percentage is significantly lower than the corresponding percentage of medical malpractice cases; more than half of malpractice losses are still unknown at the end of a typical year.
Unique characteristics. In developing loss estimations,several considerations unique to workers' compensation should be taken into account:
- The medical inflation component of workers’ compensation losses is increasing at a faster rate than inflation of lost-time claims, and becoming a larger share of payments.
- Healthcare entities can offer treatment to their own workers at a discounted fee.
- The frequency of losses may be affected by the economy and reductions in workforce as some workers try to supplement lost income through workers’ compensation benefits.
- Structured settlements may be used as a mechanism to manage annual payments, especially for a permanent total disability.
- Workers’ Compensation Medicare Set-Aside Arrangements (WCMSAs) typically extend employer liability.a
- Workers’ compensation benefits vary by state.
Actuarial estimates are based on the theory that the past is indicative of the future. When using an actuary, management should communicate to the actuary any program change that affects the timing and valuation of claim payment (e.g., paying or reserving claims quickly and a new level of conservatism versus prior slower, undervalued reserves), claim definition (e.g., when a bandage that might have been excluded previously is coded as a medical-only claim), or claim handling (e.g., changes made by a third-party administrator). In addition, the actuary should be informed of any retention change or mix in the class of workers, such as an increase in nursing exposures. Actuaries will typically give credit to a program’s own development in workers’ compensation, but when incorporating industry information, they should consider the program’s retention to avoid overstating IBNR.
Following Best Practices for Financial Reporting
Some healthcare entities that engage an actuary to estimate IBNR for medical malpractice losses choose to estimate their own workers’ compensation exposures. They may reason that workers’ compensation exposures are not as significant, dollar-wise, as medical malpractice exposures. These entities also may consider workers’ compensation losses predictable because of their “high frequency, low severity” nature. But loss estimates based on IBNR for pure late reportings only, and not also on a consideration of case development and reopened claims, can be misleading. Furthermore, management may be lulled into a false sense of security if an auditor reviews the booked liability and finds that it falls within an acceptable range, not realizing that the acceptable range can vary widely.
Better IBNR estimates may be achieved by engaging an actuary rather than plugging in an “industry standard” figure or using a software program to estimate workers’ compensation losses. In contrast to these other methods, actuarial estimates usually represent a reasonable point estimate that is neither excessive nor inadequate, based on the history of a particular program.
Discounting losses and reserves. As with medical malpractice, discounting losses is permitted but not required, providing that the liability amount and the amount and timing of cash payments (based on the healthcare entity’s specific experience) are fixed or reliably determinable, and that the expected insurance recoveries, if any, are also discounted. Discounting takes into consideration the time value of money of the stream of future payments.
If discounted reserves are presented, the discount must be disclosed. Support for the discount rate may include a risk-free rate, highly rated corporate bonds with maturities matching the average length of a payment, and the ROI used to pay claims projected to be realized over the expected maturity period. Common sources of support include treasury bills; AAA- or BBB-rated corporate, government, or municipal bond portfolios; and historical return on segregated assets in a trust fund.
Adjusting for future expectations. All of these items may require periodic adjustment for future expectations. The entity also may record liabilities and fund for these losses with a contingency margin (e.g., at the 75th percentile) that is selected by management based on the nature and loss experience of the entity.
Workers’ compensation contingency margins are typically smaller than medical malpractice contingency margins because there is less variance in losses. Although many organizations present medical malpractice liabilities on a gross basis, separately reporting any receivable relating to anticipated insurance recoveries (following FASB Accounting Standards Update [ASU] 2010-24, Healthcare Entities [Topic 954]: Presentation of Insurance Claims and Related Insurance Recoveries), this practice is not prevalent for workers’ compensation losses. Nothing in ASU 2010-24 or its technical practice aids, released by the American Institute of CPAs (AICPA), provides for the difference in practice between medical malpractice and workers’ compensation. With the additional AICPA guidance, the same application of ASU 2010-24 to all insurance coverages will become more prevalent. For now, some auditors may be less concerned about grossing up workers’ compensation reserves, likely because the excess losses tend to be smaller than excess medical malpractice losses.
Complying with state requirements. Workers’ compensation reserves may be heavily scrutinized by states’ departments of insurance. For workers’ compensation losses, some states require a certified actuarial opinion, the definition of which may vary from an actuarial report to a true, official actuarial statement of opinion. As of 2012, self-insured workers’ compensation losses in California must be evaluated by a qualified actuary for the purpose of collateral, as stated in California Senate Bill 863. Other states have similar provisions.
Even with a well-managed insurance program, workers’ compensation losses can accumulate to an amount that significantly affects the bottom line. The following management steps can help control workers’ compensation costs.
Focus on safety and risk management. A safety analysis should be conducted to identify the main loss drivers. Such an analysis might disclose, for example, that patient lifting, needle sticks, infectious diseases, and blood-borne pathogens are leading causes of workers’ compensation claims, or that the late-night nursing shift has a high proportion of losses. A plan can then be enacted to better control, if not eliminate, these risks.
An organization may decide to focus on the safety initiatives with the highest dollar impact or those that can be implemented most quickly. Safety is most effective when the organization creates a culture of safety and takes the approach that all accidents, injuries, and occupational illnesses can be prevented. Employee safety should be just as important as patient safety. A cost-benefit analysis might show that a patient-lifting device pays for itself many times over when compared with the cost of workplace accidents that result from lifting heavy patients.
Risk managers should routinely monitor activity on reported claims and encourage the adoption of return-to-work programs. Both direct and indirect costs of workers’ compensation incidents, such as damage to equipment and lost production and training time, can be reduced through effective risk management.
Maintain a proper retention. Often the first step in selecting a retention is recognizing “working layer” losses (i.e., losses that are relatively predictable). A retention—the amount specified in a liability insurance policy that the insured must pay before the insurance policy will respond to a loss—is usually selected to contain all the working layer losses; insurance is usually purchased for losses that may exceed the working layer. Retention depends on several factors, including the availability and capacity of commercial markets, the cost of expected retained losses versus commercial insurance, the variability and predictability of retained losses versus the stability of commercial insurance, and risk tolerance levels. Commercial insurance is loaded for the insurer’s profit, contingency, and expenses. Although a higher retention would save on premium costs, these savings should be weighed against risk tolerance and additional variability in losses. Larger entities may be better candidates to consider a larger retention and are often better equipped to handle cash flow swings, from a financial standpoint, than smaller entities are. Proper retention, which can be attained through a detailed analysis, helps avoid trading dollars with an insurance company.
Create “skin in the game” through an allocation. A well-designed allocation structure encourages and increases employee responsibility. An allocation structure should be designed to be understandable, easy to communicate, easy to administer, and stable over time. An allocation is more stable if more weight in the formula is given to exposures and a longer experience period of losses is included. The structure may incorporate a cap on losses, such as not penalizing for random large losses. Alternatively, the structure may be designed to be responsive to current experience, which will cause more fluctuation from one year to the next. Employees should be informed about the allocation formula up front.
Benchmark the program’s performance. Industry sources such as the National Council on Compensation Insurance, the Workers Compensation Research Institute, and the Occupational Safety and Health Administration are commonly used to benchmark workers’ compensation. Benchmarks may need to be adjusted for development, trends, exposures, and retentions so they align with a program’s current characteristics for an “apples-to-apples” comparison. Common benchmarks include:
- Frequency (number of claims divided by the number of exposures)
- Severity (losses divided by the number of claims)
- Loss costs (losses divided by the number of exposures)
Statistics may be customized to monitor concerns such as the claim closure rate (i.e., the number of closed claims divided by the number of reported claims). If benchmarking comparisons suggest that a program is not performing as well as it should, creating intelligence about the program can provide a basis to support requests for additional funds to invest in risk management to reduce future losses. The benchmarking process also can draw more attention to the insurance program from divisions, management, brokers, and commercial insurers, leading to lower insurance costs down the road.
Perform frequent analyses and obtain second opinions. Any interim or additional look at a program creates an opportunity to spot adverse trends and respond to current problems, potentially leading to fewer year-end “surprises.” Depending on program size and staff capacity, it may be reasonable to conduct monthly or quarterly analyses or even to have weekly conversations. At the very least, an outside look, or second opinion by a qualified actuary, will provide an unbiased, independent view and may confirm the appropriateness of current results or generate productive discussion toward understanding differences.
Reaping the Benefits of the Actuarial Report
The actuarial report is a powerful document that should be reviewed thoroughly by management. Management may require full transparency and maintain analysis appropriate to the program needs. A proper analysis can provide added benefits, including support for letters of credit and a basis for lowering excess insurance, allocating losses, benchmarking program performance, gaining insight into safety, and maintaining adequate reserves and funding.
Richard C. Frese, FCAS, MAAA, is a consulting actuary, Milliman, Chicago.
a. The Centers for Medicare & Medicaid Services (CMS) defines a WCMSA as " a financial agreement that allocates a portion of a workers' compensation settlement to pay for future medical services related to the workers' compensation injury, illness or disease." CMS also notes, " These funds must be depleted before Medicare will pay for the treatment related to the workers' compensation injury, illness or disease."
Publication Date: Thursday, August 01, 2013