June 2012
Maximizing the Value from Loss-Sensitive
Worker’s Compensation Programs
Maximizing the Value from Loss-Sensitive
Workers’ Compensation Programs
When well designed and managed, loss-sensitive programs offer
significant opportunities to optimize cash flow, lower costs,
and improve claims outcomes for a business and its workers.
P. Drew Jones
Senior Vice President,
Risk Management Solutions,
PMA Companies
Kyle Morhardt
Vice President and Chief Underwriting
Officer, Risk Management Solutions,
PMA Companies
With the current economic turmoil and uncertainty, organizations continue to look for ways to reduce costs and save money.
Workers’ compensation costs are one area that a growing number of organizations are giving greater scrutiny.
Organizations with guaranteed-cost workers’ compensation programs—those paying a set premium to transfer their risk to
an insurer—may start to explore loss-sensitive options. With a loss-sensitive product, organizations potentially realize lower
costs by assuming a greater proportion of their risk. Meanwhile, those that are already engaged in a loss-sensitive workers’
compensation approach continue to seek improved financial returns.
After all, a well-designed and managed loss-sensitive program can offer significant benefits—including increasing cash flow,
lowering costs, and improving claims outcomes for a business and its workers. Success requires an effective program structure
combined with an organization’s commitment to fully leverage its insurer’s loss control, claims, medical, and pharmacy
management programs.
At PMA Companies, we work with large organizations with diverse risk management programs—workers’ compensation
programs that typically experience between $1 million and $5 million in losses annually. We see clients realize outstanding
results by using loss-sensitive products to fund their workers’ compensation programs and by embracing our partnership model
with integrated risk control, claims, and managed care services.
Whether you are a beginner or a seasoned professional with regard to loss-sensitive programs, it’s never too late to optimize
your program’s value and achieve stronger results. In this white paper, we’ll examine the three key areas for maximizing the
benefits of loss-sensitive programs: program design, “total cost of risk” concept, and controlling loss costs.
Align the Program’s Design with Your Organization’s Financial Needs
The term “loss-sensitive workers’ compensation program” refers to risk-financing options in which an organization assumes
part of its cost of risk. The buyer has the option to limit its participation (risk it is assuming) on an individual claim or an
aggregate loss basis (or both). Depending on your payment and funding preferences, PMA offers options that include Incurred
Loss Retros, Paid Loss Retros, and Large Deductible and Prefunded Deductible programs.
Some loss-sensitive programs need to be secured by a form of collateral that is acceptable to the insurer. Depending on
an organization’s financial situation, it may choose an option funded by cash, such as Incurred Loss Retro or Prefunded
Deductible, or it may opt for a Paid Loss Retro or Large Deductible product secured by a letter of credit.
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Maximizing the Value from Loss-Sensitive Workers’ Compensation Programs
Indeed, to maximize value, organizations need to first select the right risk-financing solution. A loss-sensitive program’s financial
structure needs to be aligned with an organization’s unique needs. Thus, you, along with your broker and insurance carrier,
should carefully examine your current financial situation and short- and long-term goals when considering a program structure.
Those variables will help guide critical decisions about an appropriate financial structure. Loss-sensitive programs are a
long-term proposition. Decisions made early in the process about such issues as collateral and risk assumption can have
significant financial ramifications for years to come—making it critical for the buyer and agent to truly understand the terms
and conditions of each program’s structure.
Chart 1. Workers’ Compensation Loss-Sensitive Products At-a-Glance
LossSensitive
Product
Incurred
Loss Retro
Product Highlights
Designed to provide premium deferral that increases the financial
flexibility of an insurance program by postponing current payment
obligations to the future.
The ultimate cost of insurance is determined by the actual
incurred loss experience for a specific policy period. The premium
is adjusted annually until all claims are paid and closed. Loss
exposure can be limited to minimize the impact of a large loss or
an excessive aggregation of losses.
Paid Loss
Retro
The ultimate cost of insurance is determined by using the same
retrospective formula as an incurred loss retro. Premiums are
determined utilizing paid loss amounts rather than incurred
(reserved) amounts. Timing of premium and loss payments
(including loss-adjustment expenses) are negotiated prior to
inception, and disbursements (reimbursements) are made as
costs are realized and billed.
Potential
Advantages
Insurer services
Loss limitation can be
provided
■■ Favorable loss experience
reduces ultimate cost
■■ Improved cash flow
(if premium deferral is
offered)
■■
■■
Insurer services
Loss limitation can be
provided
■■ Favorable loss experience
reduces ultimate cost
■■ Improved cash flow
Considerations
Upfront premium
payment minimizes
cash flow
■■ Challenging to budget
■■ Final cost not known
for several years
■■ Adjustment process
■■
Challenging to budget
Final cost not known
for several years
■■ Loss fund may be
required (escrow)
■■ Collateral required
■■
■■
■■
■■
The deferred premium amount is generally collateralized with a
letter of credit. Losses can be limited to minimize the impact of a
large loss or an excessive aggregation of losses.
Large
Deductible
Program
Program functions similar to a paid loss retro. It attempts to
provide increased liquidity and significant deferral of the loss,
loss-based assessments, and the loss-adjustment expense
portion of the ultimate insurance costs. Timing of premium and
loss payments (including loss-adjustment expenses) are made
as costs are realized and billed. Typically, the estimated loss
reimbursements are secured by a letter of credit equal to total
expected losses; however, other methods of collateral are also
available (cash, trust, or a combination).
Prefunded
Deductible
Program
Program functions similar to a traditional large deductible. The
key difference is the method of collateralization. The insured
is required to remit cash in the amount of the estimated loss
reimbursements. This fund is used to secure the estimated
liabilities and acts as a “working fund” to cover monthly
reimbursements. The amount held is evaluated annually and
adjusted according to development factors determined at the
inception of the program.
Insurer services
Favorable loss experience
reduces ultimate cost
■■ Cash flow advantages
greatly improved
■■ Reduced expenses
Challenging to budget
Final cost not known
for several years
■■ Loss fund may be
required (escrow)
■■ Collateral options
include letters of
credit, cash, and
trust accounts
■■
■■
■■
■■
Insurer services
Favorable loss experience
reduces ultimate cost
■■ Easier to administer than a
large deductible program
■■ Upfront discount of
expenses to lower net cost
■■
■■
Final cost not known
for several years
■■ Reduced cash flow
benefits
■■ Estimated losses
prepaid
■■
Just as important as upfront selection, a program needs to be reexamined and modified annually to ensure it is still the best fit
for evolving financial realities and business objectives. At PMA Companies, we review every loss-sensitive program at least once
a year. During this review, we compare the actual loss experience versus what we were expecting and measure that against the
state of the organization’s financials. Of course, other changes, such as mergers and acquisitions, discontinued operations, and
geographic expansion, can all have a material effect on a workers’ compensation program and how it is funded.
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Maximizing the Value from Loss-Sensitive Workers’ Compensation Programs
Focus on the “Total Cost of Risk” Versus Upfront Premium Costs
When maximizing the value of a loss-sensitive workers’ compensation program, it’s important to consider and act according
to the concept of the “total cost of risk.”
The “total cost of risk” is the true cost of a workers’ compensation program and includes significantly more than the upfront
premium. It also includes both the cost of claims and the indirect cost of accidents.
As companies assume a greater proportion of their risk with loss-sensitive programs, they need to be especially vigilant about
containing these costs in order to protect their assets. We view a “total cost of risk” approach as a critical enabler of success
in loss-sensitive programs.
Chart 2. Elements of Total Cost of Risk
Primary
Elements of
the Total
Cost of Risk
What Comprises the Cost
Loss Costs
■■
■■
Loss-adjustment
Expense
Insurance
Company
Expenses
(Retained
Premium)
Cash and
Collateral
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Claims Indemnity Payments
Claims Medical Payments
Allocated Claim Expense (direct file expense, e.g.,
managed care)
■■ Unallocated Claim Expense (file management)
■■
Producer Commission
General Expenses
■■ Risk Control
■■ Excess Premium (specific and aggregate)
■■ Premium Taxes
■■ Information Systems (access to claims information)
■■ Profit
■■
Examples of Savings Opportunities
to Reduce this Cost
Return-to-Work Programs
Accident Prevention Programs (ergonomics,
industrial hygiene, etc.)
■■ Medical Bill Review
■■ Preferred Provider Networks
■■ Pharmacy Program
■■ Case Management (including peer review)
■■
■■
Charge back for access and utilization of Managed
Care Program (percentage of savings)
■■ Fees for claim management and adjudication
(fee per claim or percentage of loss)
■■
■■
■■
Premium Installments
Loss Deposits
■■ Escrow
■■ Letter of Credit
Deferment of premium obligations (improved cash flow)
Premium credits for cash funding of losses (reduction in
upfront premium)
■■ Reimbursement for loss payments based on paid versus
incurred losses (improved cash flow and less exposed to
company reserving practices)
■■ Fee for enacting lines of credit and cash required to secure
line—seek alternatives (reduction in program costs and
improved cash flow)
■■
■■
■■
■■
Maximizing the Value from Loss-Sensitive Workers’ Compensation Programs
Strike a proper balance between risk assumption and
risk transfer (e.g., consider higher deductible and aggregate
limits, lowering excess premium costs)
tAKe control oF loss costs
Loss costs, the direct and indirect cost of accidents and
claims, have a much greater impact on “cost of risk” than
upfront premium. When organizations assume a greater
proportion of their risk, they assume a greater percentage
of these costs. If left unmanaged, loss costs can derail a losssensitive program.
Consider the impact of the following:
workplace Accidents/claims
Employees’ poor judgment or conduct can lead to unsafe
work conditions, loss of productivity, and unnecessary risk.
An organizational commitment to safety and risk control can
yield dividends for most companies, especially those with
more “skin in the game.” Avoiding incidents through effective
safety practices can help significantly reduce costs.
benchmarking
A risk management information system enables organizations
to view and monitor their loss data that could critically impact
their bottom line. Organizations can enhance their operating
performance by understanding their loss experience, types
of injuries, losses by location, and cost-containment
savings. Benchmarking these and other metrics enables an
organization to identify areas of weakness and opportunities
for improvement—and then take corrective action and track
improvements over time.
To protect their assets and financial stability, it is critical
for organizations in loss-sensitive programs to focus on
controlling loss costs. The good news is that there is
much that can be done through proactive, ongoing loss
management techniques.
claims management
How claims are managed has a tremendous impact on
bottom-line workers’ compensation costs. Every claim—no
matter how simple or complex—should be investigated and
actively managed to resolution.
medical costs
Medical costs now represent 50% to 60% of workers’
compensation claims costs. To contain these expenses,
organizations need to fully use their insurer’s managed
care programs, including pharmacy benefits management
programs, that address the rising cost of prescription drugs.
return-to-work Programs
In any kind of workers’ compensation program, a formal
return-to-work process can keep workers productive, help
offset losses, and ultimately result in better outcomes for
all parties. For companies with loss-sensitive programs,
ensuring that workers return to employment as soon as
is medically safe is important from both a cost and
productivity perspective.
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maximizing the Value from loss-sensitive workers’ compensation Programs
Whether you are a
beginner or a seasoned
professional with regard
to loss-sensitive programs,
it’s never too late to optimize
your program’s value and
achieve stronger results.
Are You Maximizing the Value from Your Loss-Sensitive Program?
—Key Questions
Chart 3. CONSIDERATIONS FOR MAXIMIZING THE VALUE OF A LOSS-SENSITIVE WORKERS’ COMPENSATION PROGRAM
Critical Success Factor
Key Questions to Consider
Program Design
Is the size of your retention or deductible appropriate for your operation’s financial situation?
Is the cost benefit of taking a deductible or retention properly reflected in the premium you pay?
Are you taking an appropriate level of risk? What’s the inflection point in your loss analysis where it
pays to transfer some of the risk to the insurance company?
Is your approach aligned with your organization’s current and future financial and strategic goals?
How does your organization need to make its money work—are there better uses for your cash?
Consider a program where reimbursement is based on paid versus incurred losses.
Risk Control
Has your carrier built risk control hours into the cost of your program? Are the hours being used to address
your organization’s safety and loss prevention needs?
Has your insurance company established an appropriate action plan to mitigate your loss exposures?
Claims
Is your carrier proactive in managing claims? Do they have registered nurses involved in claims management?
When a claim occurs, does your carrier manage it effectively? Is your carrier adhering to best practices?
Do they communicate with you frequently?
Are you getting the benefits of a financial product that has a service component behind it?
Medical Management
Today, approximately 50 to 60 cents of every workers’ compensation loss dollar goes to medical care.
How effective is your carrier’s managed care program?
Pharmacy Benefit
Management
Of the 50 to 60 cents going to medical costs, 19% of the medical costs are for pharmacy costs.
How effective is the carrier’s pharmacy benefits management program in controlling these costs?
What is your carrier’s approach to narcotics management?
Best Practices-Based
Approach
In PMA’s experience, organizations that execute best practices—such as prompt reporting of claims and formal
return-to-work programs—tend to have better outcomes. How is your carrier helping you identify
and implement a best practices-based approach?
Carrier
Collaboration
With a loss-sensitive product, an insurance carrier needs to be a true partner. Is your carrier actively collaborating
with you to ensure that you are deriving the maximum value from your workers’ compensation program?
Does your carrier provide a risk management information system that offers a comprehensive and in-depth
view of your claims activity? Does the system facilitate easy and effective report generation?
Conclusion
Well-designed and managed loss-sensitive workers’ compensation programs offer significant benefits—
including maximizing cash flow, lowering costs and improving claims outcomes. To achieve success
in these programs, you need to execute the critical success factors: embrace the “total cost of risk”
concept, choose a program design wisely, and fully engage in your loss management programs.
By doing so, you have a tremendous opportunity to achieve strong financial rewards.
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Maximizing the Value from Loss-Sensitive Workers’ Compensation Programs
About PMA Companies
About the Author
PMA Companies (www.pmacompanies.com) provides
risk management solutions and services in the U.S.,
specializing in workers’ compensation and offering
property and casualty insurance. A member of Old Republic
Companies, PMA Companies is headquartered
in Blue Bell, PA.
P. Drew Jones is Senior Vice President, Risk Management
Solutions, PMA Companies. He leads PMA Companies’ Risk
Management Solutions (RMS) business segment, which
provides primary and excess insurance programs and risk
management services to organizations whose cost of risk in
workers’ compensation and primary casualty is $500,000
and above.
Old Republic International Corporation (NYSE: ORI) is one of
the nation’s 50 largest publicly held insurance organizations.
PMA Companies includes:
■
■
PMA Insurance Group, specializing in workers’
compensation, and providing other commercial
property & casualty insurance products
PMA Management Corp. and PMA Management
Corp. of New England, providing results-driven
TPA and Risk Services specializing in workers’
compensation and liability
An accomplished executive, Mr. Jones joined PMA
Companies in 1992 and has subsequently held positions
of increasing responsibility, including Vice President of
Brokerage and Agency Management, and Vice President
and Senior Regional Executive for PMA’s Southeast Region.
During his 30-year insurance career, Mr. Jones has developed
in-depth expertise in workers’ compensation, large account
underwriting, and risk-financing and program design. He is a
graduate of the University of Delaware with a Bachelor of Arts
degree in Economics and serves on the Insurance Society of
Philadelphia Board.
Kyle Morhardt is Vice President and Chief Underwriting
Officer, Risk Management Solutions, PMA Companies. He
is responsible for the underwriting operation of PMA’s RMS
business segment.
With over 25 years of risk management and insurance
experience, Mr. Morhardt is an expert in risk-financing and
program design for large accounts with complex insurance
needs. He has successfully led the development of risk
management solutions for PMA clients in diverse industries,
including major health care systems, large universities,
national manufacturers, and global retailers.
Mr. Morhardt has a Master’s degree from the University of
Hartford and a Bachelor of Science degree from Marquette
University. His previous white paper is entitled, “Workers’
Compensation: 10 Considerations for Recessionary Times.”
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Maximizing the Value from Loss-Sensitive Workers’ Compensation Programs