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By CYRIL TUOHY, managing editor of Risk & Insurance®

Many companies use third-party administrators (TPAs) to handle their claims management functions. Some, like Administaff Inc., the Kingwood, Texas-based professional employer organization with clients nationwide, have used TPAs for years.

Why delegate to someone else that which companies or their long-time insurance carriers can do themselves?

Well, for one, it amounts to good risk management.

"From a risk manager's standpoint, I like to split my insurance services and products so I'm not beholden to one insurance company and having them necessarily handle the claims," said Ronald M. McGee, senior vice president of property/casualty products and services at Administaff.

McGee knows a thing or two about spreading the risk since his company's risk management department answers to him. He doesn't like putting all his claims administration eggs in one basket. The way McGee sees it, the easier it is to get a second or third opinion on a claim, the better off everyone is.

"The benefit of using a third-party administrator is that it's a check-and-balance system with a third-party administrator that you don't necessarily have with a carrier," he said. "Using a third-party administrator, you have more control over the handling of the claims and you always get a second opinion."

Second opinions are important. In a world where the legal costs of defending even the most mundane of slip-and-fall claims can easily run into the tens of thousands of dollars, in a world where disputes between the insurance carrier and the insured can make for strained business relationships, prudent risk managers agree on the importance of soliciting second opinions.

And as far as risk management is concerned, better get as many opinions before taking action on a claim than to reconsider a course of action after the parties face one another in court.

McGee said that when there is an issue regarding a claim, three parties are always at the table: Administaff, its insurance carrier and its TPA, SRS, the large subsidiary of insurance giant The Hartford.

"The more eyes on the claim and the more brains working in one room, the more likely it is to lead to a better outcome when settling the claim," said McGee.

"When companies try to process their own claims, it's the same notion as attorneys who represent themselves--they have a fool as a client," said Paula Woolworth, senior vice president of account management and managed care for third-party administrator GAB Robins in Parsippany, N.J. "If you're trying to manage your own claims, it may be one of the most foolhardy things to do."

For many companies, it doesn't make any economic sense to administer their own claims because it's too expensive, said Woolworth, the former risk manager for a major apparel manufacturer.

"The reason we have a third-party administrator in place instead of in-house is that we operate in so many jurisdictions that I could not do it as efficient internally," said Mark A. Meyerhoff, senior director, risk management and insurance, for Chicago-based aerospace giant Boeing Co., which has used a TPA for more than a decade. "There are some companies that have a workers' comp staff, but for us it just doesn't make economic sense."

There's even more reason not to manage your own claims because, beginning Jan. 1 of this year, Medicare compliance data-reporting has become even more complex, added Woolworth.

With more than 100 new data fields now required by Medicare, life for claims adjusters and administrators has become more difficult. Companies looking to administer their own claims have to own and operate a top-flight claims system, and that computing firepower doesn't come cheap, Woolworth added. For companies committing reporting errors, the daily fines are stiff.

"So, if I were back in my risk management department, I would think once, twice, thrice about self-administering," said Woodworth. "I would want someone to administer my claims just for data compliance."

Having a TPA manage claims is a sound risk-transfer technique, but it is not without risk. In sum, risk managers looking to rely on a third-party administrator represent companies fundamentally willing to risk unbundling their insurance program from their carrier.

Many companies are not comfortable with that, nor do some employers want to change the structure of their insurance programs for fear of adding to the total cost of risk, according to risk managers.

Adding a third-party administrator to the mix adds another layer to the insured-carrier dynamic, Woolworth added. A third voice weighing in on a claims issue means another party at the table.

"Now there's a lot more back and forth because there's another stakeholder involved," said Woolworth. "It's more work in terms of communication, and it will take more work on the part of the risk manager when you put in a third-party administrator for the first time, or when you change third-party administrator."

CONFLICTS OF INTEREST

There are times when the TPA relationship is deeply conflicted, and it's not clear whether the third-party administrator has its own interest as opposed to its client's best interest in mind.

Conflicts arise when, as part of the engagement, a TPA pays vendors a wholesale price and charges clients a retail price, thereby making money on vendor engagements.

"When you look at that, most people say, 'Well, everybody does that,' " said Joe Boures, president of SRS, which manages the equivalent of about $2.5 billion worth of clients' funds annually through claims-handling. "The difference in this case is that the third-party administrators are making money using their customers' money. It's difficult to honestly represent a client's best interest if the third-party administrator is making money with most vendor relationships."

(SRS doesn't participate in any of these arrangements, according to Boures.)

For risk managers like McGee and Meyerhoff, and former risk managers like Woolworth, going through the effort to hire a third-party administrator is well worth the risk of running into potential conflicts of interest given the complexity of the claims process and the penalties for making mistakes.

Other companies have unique requirements or business models, and it only makes sense for them to hire a TPA.

Take David Jewell, director of risk management for PetSmart Inc., for example. The company, with more than 15,000 claims a year in 2007 and $35 million in loss payments on self-insured or retained losses, has just begun its second year with Sedgwick CMS, the Memphis-based third-party administrator.

Jewell's challenges were unique in that so many of his claims were animal-related. In some cases, a small bite could develop into a workers' comp claim costing several hundred thousand dollars.

"Of the 80 percent of the loss costs due to workers' comp claims, about half of this amount is spent due to injuries involving animal interaction," he said.

"We needed a focused claims management effort, and the only way we were going to get it was to partner with a third-party claims administrator that understood the business and was able to adapt to our needs," he also said.

Sedgwick offered PetSmart and Jewell a high degree of customization, and the result has been one of "huge cost efficiencies," as fewer claims come though the door, said Jewell.

"Our store managers are not calling in as many nonwork-related incidents as before, and the reporting process is streamlined and easier for our stores to work with," said Jewell. "Visibility of the entire program among our stakeholders is vastly improved."

PetSmart, which has a retention of $1 million per claim on the workers' comp side and $500,000 per claim on liability side, stayed with its insurance carrier for the rest of PetSmart's insurance program when it decided to use Sedgwick Claims Management Services to manage its claims, said Jewell.

"Why people use a third-party administrator, and how they select it, depends on what it is the client is trying to achieve," said Dave North, CEO of Sedgwick. Hiring a good TPA, he said, is more than just an economic issue. It's, in effect, a cultural one as well.

"You want the TPA to understand your expectations because you are in effect talking about future events," said North.

Indeed, for Jewell, unlike for Meyerhoff at Boeing, the cost calculus was not paramount in moving to a third-party administrator. For Jewell and PetSmart, taking control of the claims process was more important.

"It wasn't the expense of claims-handling fees that was driving us," he said. "We knew we needed control over the entire claims management process, allowing us to focus on the conditions internally that were driving the claim counts, both frequency and severity."

Using a TPA has allowed PetSmart, headquartered in Phoenix, to do that, and as it turns out, to do it more efficiently too. Using a third-party administrator was a "huge win for us," said Jewell.

Looking back, bringing in a TPA was somewhat of a gamble for Jewell and his team. No one knew whether PetSmart's insurance carrier's claims unit would complete "the handoff" to Sedgwick without a major glitch.

"The biggest risk was the hand-off and when we actually pulled the trigger," Jewell recalled. "There are lots of unknowns and you plan for contingencies, but there are always things that evolve that you don't anticipate."

With 1,149 pet stores and 161 animal boarding facilities in the United States and Canada, there was no guarantee that corporate announcements signaling big changes in the way claims were reported and filed would ever trickle down to the managers at the retail level, often busy dealing with owners passionate about their pets.

As a result, for the first two months with Sedgwick, the change in incident reporting was at times "a bit rocky," according to Jewell.

But once a claim was reported into the TPA, PetSmart never had to worry whether the claim was properly recorded and filed.

"In over a year, I can't think of one case we have received where a customer complained that no one has contacted them regarding their claim in a timely basis," added Jewell. "This is a great improvement over what we had seen in the past."

In hindsight, PetSmart's decision to hire a third-party administrator was a good one. It doesn't always turn out that way, of course, and the courts are filled with lawsuits pitting clients against their TPAs for services not rendered. Nor is every risk manager sold on hiring a third-party administrator, preferring to stay with the bundled claims arrangement offered by carriers.

"In speaking with my peers and others about the use of third-party administrators and whether they plan to use one, it's about 50-50," said Jewell. "There are a lot of companies that choose a bundled arrangement and don't want a third-party administrator."

February 1, 2010

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