maximizing the value from loss sensitive workers ... · pdf file3 maximizing the value from...

June 2012

Maximizing the Value from Loss-Sensitive Workers' Compensation Programs

2 Maximizing the Value from Loss-Sensitive Workers’ Compensation Programs

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.

P. Drew JonesSenior Vice President,Risk Management Solutions,PMA Companies

Kyle morhardt Vice President and Chief Underwriting Officer, Risk Management Solutions, PMA Companies

maximizing the Value from loss-sensitive workers’ compensation Programswhen 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.


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.

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.

chArt 1. worKers’ comPensAtion loss-sensitiVe ProDucts At-A-glAnce

loss-sensitiVe ProDuct

ProDuct highlights PotentiAl ADVAntAges consiDerAtions

incurreD loss retro

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.

■■ Insurer services■■ Loss limitation can beprovided

■■ Favorable loss experiencereduces ultimate cost

■■ Improved cash flow(if premium deferral isoffered)

■■ Upfront premiumpayment minimizescash flow

■■ Challenging to budget■■ Final cost not knownfor several years

■■ Adjustment process

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.

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.

■■ Insurer services■■ Loss limitation can beprovided

■■ Favorable loss experiencereduces ultimate cost

■■ Improved cash flow


■■ Loss fund may berequired (escrow)

■■ Collateral required

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).

■■ Insurer services■■ Favorable loss experiencereduces ultimate cost

■■ Cash flow advantagesgreatly improved

■■ Reduced expenses


■■ Loss fund may berequired (escrow)

■■ Collateral optionsinclude letters ofcredit, cash, andtrust accounts

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 experiencereduces ultimate cost

■■ Easier to administer than alarge deductible program

■■ Upfront discount ofexpenses to lower net cost

■■ Final cost not knownfor several years

■■ Reduced cash flowbenefits

■■ Estimated lossesprepaid


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 exAmPles oF sAVings oPPortunities to reDuce this cost

loss costs ■■ Claims Indemnity Payments■■ Claims Medical Payments

■■ Return-to-Work Programs■■ Accident Prevention Programs (ergonomics,industrial hygiene, etc.)

■■ Medical Bill Review■■ Preferred Provider Networks■■ Pharmacy Program■■ Case Management (including peer review)

loss-ADJustment exPense

■■ Allocated Claim Expense (direct file expense, e.g.,managed care)

■■ Unallocated Claim Expense (file management)

■■ Charge back for access and utilization of ManagedCare Program (percentage of savings)

■■ Fees for claim management and adjudication(fee per claim or percentage of loss)

insurAnce comPAnY exPenses (retAineD Premium)

■■ Producer Commission■■ General Expenses■■ Risk Control■■ Excess Premium (specific and aggregate)■■ Premium Taxes■■ Information Systems (access to claims information)■■ Profit

■■ Strike a proper balance between risk assumption andrisk transfer (e.g., consider higher deductible and aggregatelimits, lowering excess premium costs)

cAsh AnD collAterAl

■■ Premium Installments■■ Loss Deposits■■ Escrow■■ Letter of Credit

■■ Deferment of premium obligations (improved cash flow)■■ Premium credits for cash funding of losses (reduction inupfront premium)

■■ Reimbursement for loss payments based on paid versusincurred losses (improved cash flow and less exposed tocompany reserving practices)

■■ Fee for enacting lines of credit and cash required to secureline—seek alternatives (reduction in program costs andimproved cash flow)

5 maximizing the Value from loss-sensitive workers’ compensation Programs

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 loss-sensitive program.

Consider the impact of the following:

workplace Accidents/claimsEmployees’ 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 signifi cantly reduce costs.

claims managementHow 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 costsMedical 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 benefi ts management programs, that address the rising cost of prescription drugs.

return-to-work ProgramsIn 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.

benchmarkingA 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 fi nancial stability, it is criticalfor 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.

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?

conclusionWell-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.


About PmA companiesPMA 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.

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 commercialproperty & casualty insurance products

■ PmA management corp. and PmA managementcorp. of new england, providing results-drivenTPA and Risk Services specializing in workers’compensation and liability

About the AuthorP. Drew Jones is Senior Vice President, Risk ManagementSolutions, PMA Companies. He leads PMA Companies’ RiskManagement Solutions (RMS) business segment, whichprovides primary and excess insurance programs and riskmanagement services to organizations whose cost of risk inworkers’ compensation and primary casualty is $500,000and above.

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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