By Christopher Flatt and Claude Yoder
Workers' compensation is often the single largest insurance expenditure for employers. As such, it's not surprising that reducing workers' comp costs is a top priority for employers -- especially in today's challenging insurance marketplace.
Regardless of whether an employer purchases a guaranteed cost or a loss sensitive program, an integrated strategy to managing workers' comp can help reduce the total cost of risk.
Simply defined, an integrated approach is a strategy that examines workers' comp costs across the spectrum of its component parts -- including workplace safety, claims administration and risk transfer -- and then develops customized quantitative solutions based on sound analytics.
In their quest to find the causes of and solutions for spiraling workers' comp costs, too many employers treat workplace safety, pre- and post-loss strategies, claims administration, risk transfer, and accompanying data and analytics as isolated and unrelated functions.
A more effective approach integrates workers' comp cost containment strategies into a single risk management platform. Such an effort should be built on solid analytical footing that examines not only the fixed costs -- such as an insured's risk transfer premium, capital charges, collateral costs and claims management expenses -- but also the variable costs of risk including retained losses, claims handling charges and claims handling performance.
An integrated approach leads to a thorough understanding of an insured's risk appetite, helping to structure an optimal workers' comp program. The key components to this increasingly more technical approach include:
* Identifying the unique loss cost drivers in a workers' comp program and focusing on strategies to reduce them;
* Managing claims effectively;
* Benchmarking performance metrics against peers;
* Predicting reported loss development and forecasting losses at specified retention levels;
* Analyzing a full range of risk transfer options;
* Making necessary adjustments to priorities and cost containment measures to achieve the maximum benefits; and
* Developing targeted solutions.
The common thread of these efforts is analytics with the ultimate goal of reducing workers' comp total cost of risk.
IDENTIFYING COST DRIVERS
The first step in an integrated approach is to identify the company's unique workers' comp cost drivers and focus on how best to reduce them. Loss control, occupational health and safety, claims management, injury management, and employment practices and processes all need to be reviewed.
The starting point is to examine the facts around the company's historical loss activity and determine whether the losses are the result of exposures inherent in a particular industry or of a controllable trend within the company.
Once the root causes of loss have been determined, companies can focus on implementing the best strategies to reduce them. Existing loss control programs should be reviewed to determine whether changes can be made to mitigate controllable losses.
Companies also should consider implementing behavior modification and ergonomic measures designed to help improve the company's health and safety performance. Not only do such steps help reduce the frequency of workers' comp claims, but employees appreciate it when their employers invest in improving their workplace.
Managing claims effectively and efficiently is an important component of integrated cost containment. It is crucial to keep an eye on the medical component of claims and understand unique jurisdictional claims issues, especially as medical costs have been rising faster than wages.
Some argue that medical costs now represent more than 60 percent of every workers' comp claim dollar. By employing such strategies as bill review, medical case management and pharmacy-benefit management, employers can put themselves in a better position to manage claim costs.
An aggressive claim closure strategy to settle legacy claims can help lower an organization's claims costs and collateral requirements, and reduce long-term balance sheet volatility. For example, claims closed within the first six months generally cost roughly one-third of the total value of claims that take six to 12 months to close. And the story gets worse as claims age: Claims that close two to three years after opening typically are more than four times as expensive as claims that close within one year.
The bottom line is that claims get more expensive as duration to closure increases. Strategies that help shorten claim durations can potentially create significant cost savings. A well-designed return-to-work program also can have a big impact on claims management and ultimate cost. Employees recovering from work-related illnesses and injuries who return to the workplace in a modified capacity typically have a faster recovery than those who remain out of work longer.
A proper analysis of claims administration fees can yield savings for employers. Vendor comparisons are commonly based on unit costs, such as claim handling fees, bill review fees and other administrative fees. These costs, however, make up only a small percentage of the variable costs associated with claims.
By incorporating into the analysis variable costs, such as actual loss costs, employers can compare and choose claims administrators, managed care providers and risk management information system (RMIS) providers, based on claim value outcomes -- actual claims handling performance -- and ultimately lower their program costs.
The use of benchmarking tools and predictive models are important components to managing workers' comp costs and should be included in an integrated approach. For example, by benchmarking how a company's actual loss performance compares to that of its peers, it can differentiate itself to underwriters, which is critical in today's transitioning market. Some key metrics to benchmark include average paid and incurred loss costs, and claim closure and reopening rates.
In addition to benchmarking, an integrated approach includes the use of predictive modeling. This is an evolving area that is changing the way decisions around workers' comp pricing and claims management are made. The key is to develop a strategic direction through the use of analytical tools built with a significant amount of aggregated and credible data.
Insurers have used predictive models for years to determine which risks are more likely to have losses and have charged premiums accordingly. In workers' comp, predicting the ultimate value of reported claims is challenging. This is critical, especially for insureds with significant retained loss amounts.
Predictive models can help take out some of the guesswork in estimating ultimate claim values by looking at the unique information available for a given claim. Data points -- such as cause of loss, attorney involvement, which vertebrae was injured in a back claim, the use of prescribed narcotics and pre-existing conditions -- all may prove predictive of ultimate values, how best to administer treatment of the injury and help keep the claim value as low as possible.
For example, back fusion cases are one of the most expensive types of workers' comp claims. If an employer can identify the warning signs, such as a deviation of accepted medical treatment protocols, early in the life of a claim, it can work to ensure the individual receives appropriate and cost effective care early on, possibly avoiding surgery and increasing the chances of getting the injured employee back to work sooner.
An effective integrated approach to managing workers' comp costs also depends on the proper management of insurance and retention levels. Although a particular workers' comp insurance structure may have made sense when it was initially transacted, companies and their risk appetites and insurance need change over time. It is advisable to challenge legacy assumptions to determine if a change in structure may be warranted.
The effective use of state-of-the-art analytical tools -- for example, multivariate loss projections, insurance program optimization or predictive modeling -- can help to confirm that an existing insurance structure is optimal. Just as importantly, it can provide well thought out supporting technical evidence as to why an alternative structure or risk financing mechanism may be better suited to achieve an employer's workers' comp risk management objectives.
For example, a better understanding of a company's projected workers' comp losses and the volatility around these losses within its retained and placed layers of insurance may lead a risk manager to make changes to retention levels. A company with a $500,000 retention whose annual loss costs historically fall well within their retained layer may be better served to increase its deductible and save on premium costs.
Determining the most effective program structure for an individual employer is a dynamic process that involves analyzing insurance prices at different retention levels, measuring the cost and benefit of changes, and having a thorough understanding of the insured's expected claim count, and paid and incurred loss distribution by layer. All of this must then be overlaid on the insured's risk tolerance to measure the program efficiency.
The cost of a workers' comp program can be better controlled by using the right tools and applying them through an integrated program. To achieve the maximum benefits, employers need to take action, beginning by working to ensure that their workplaces are as safe as possible. They must also ensure that their workers' comp buying decisions are based on the most effective analytics available for their business and industry. Doing so will help to maintain the expected initial cost reduction gains from an integrated approach as a sustained benefit rather than a one-time bonus.
CHRISTOPHER FLATT is Workers' Compensation Center of Excellence leader and CLAUDE YODER is head of Global Analytics at Marsh Inc. They can be reached at firstname.lastname@example.org.
November 1, 2012
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