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Workers' Comp Crisis Hits Company Balance Sheets |
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Skyrocketing and unpredictable workers' compensation costs are forcing many self-insured companies and those with large retentions to recalculate their liabilities and, subsequently, to increase their workers' compensation reserves.
When collateral requirements increase, companies have access to fewer financial resources to expand current business or target new markets. Worse yet, as the actuarial loss estimates used to calculate workers' compensation accrual rates become even more complex and historical data becomes less representative, reserve calculations are more prone to error. Sudden spikes in workers' compensation costs can lower earnings, and significant mistakes can even force a restatement. Self-insured companies in a variety of industries, including manufacturing, retail, hospitality, and services, are all affected by this growing trend.
"Last year, for instance, [Jack Ciesielski, publisher of the Analyst's Accounting Observer] found that of Standard & Poor's 100-stock index, 16 included self-insurance liabilities among their 'critical accounting policies' — those crucial areas where incorrect estimates or projections by the company could have a material impact on its finances."
The Wall Street Journal, 3/15/2004
Simply put, Sarbanes-Oxley raised the bar for actuarial assessments as reserve calculations are often considered material. First, the law requires a thorough review and examination of all major risk assessments and processes that could impact accrual calculations. Part of this process includes ensuring that actuarial assumptions are correct and current.
Second, Sarbanes-Oxley requires that an assessment and monitoring process be put in place so that if underlying assumptions change — for example, if average disability awards escalate — the information will be captured and used immediately. If these compliance issues have not been addressed, immediate attention is required.
A key driver behind this reserve calculation crisis is escalating workers' compensation costs, which have doubled nationwide over the last two to three years. Today, employers contribute almost twice as much to workers' compensation as they do to Medicare. At this rate, by 2010 employers will contribute more to workers' compensation than they do to Social Security.
The statistics are revealing:
- Average medical costs per lost-time claim rose 27 percent in the last four years, according to Marsh data.
- While the number of workers' compensation claims declined nationally, the Bureau of Labor Statistics reports that injured employees are spending more time away from work.
- The number of workers' compensation claims involving more than 30 days away from work rose by 15 percent over the last four years, according to the Bureau of Labor Statistics.
"As social and economic environment changes are reflected in the claims experience, actuaries have adjusted prior projections — which has impacted the loss reserve estimates. It is essential to continuously monitor emerging workers' comp claims experience for evidence of changing trends, and to evaluate their implications. These trends will not always match prior expectations."
Best's Review, 3/2004
Workers' compensation losses are no longer as predictable as they once were. Previously, companies could calculate their reserve requirements based on claim history. But as costs surge and vary more widely, historical data may not provide the right information from which to estimate future liabilities. Building an accurate picture of all outstanding liabilities, estimating future costs, and calculating reserve requirements is more complicated than ever.
Another driver in the acceleration of overall costs is the growing number of chronic illness cases as a larger percentage of total claims. Chronic workers' compensation cases are often characterized by unexpected, long-term medical expenses and the increased likelihood of a disability award. Predicting the ultimate or fully developed costs of a chronic case is inherently difficult. There is a greater chance that initial reserve calculations will be insufficient, as the high cost nature is only revealed after substantial treatment over a considerable period of time.
Executives who are concerned about rising workers' compensation costs and self-insured reserve requirements should ask themselves the following questions:
- Does our workers' compensation history mirror what is happening in the company today?
- Have our workers' compensation losses risen dramatically in the last few years? Do our reserves reflect that change?
- Do we have a high number of open claims, which are often a key driver of rising costs?
- Have our disability awards increased dramatically?
- Have we adjusted our earnings in response to rising workers' compensation costs or reserve requirements? Could it happen in the future?
"Rising premiums for workers' compensation coverage have been difficult for many employers to handle. However, equally difficult have been the significant, mandatory increases in the self-insured retentions most underwriters are requiring. While a number of factors, including the concern about concentration of values (i.e., large office and manufacturing facilities), double-digit medical cost inflation, increased cost of drugs, etc., have caused this situation, there appears to be little hope of improving it in the short run."
Rough Notes, 2/28/2004
Number crunching is the last thing a company should do prior to a collateral reduction or to setting reserves based on accruals. First, companies need to make sure that their current reserves are appropriate before beginning their annual quantitative analysis. At least three months before posting reserve calculations, a thorough review of all outstanding claim files will determine if reserve strengthening or reserve reductions are appropriate. It is here that an aggressive claim-closure strategy will begin to pay off. Not only will it help lower overall workers' compensation costs, but fewer open claims can lead to lower, collateral requirements.
Lowering reserves may free up capital to expand current lines of business, target new markets, and/or grow the company. It may also help present a more favorable loss picture when marketing the insurance program. With more aggressive accounting standards, boosting reserves in today's market may not be perceived as entirely negative, as long as actions are timely and there is an accurate and complete picture of a company's accruals and reserve requirements.
Self-insured companies with a financially material amount of posted reserves should regularly complete the following projects:
- The accuracy and adequacy of reserves should be reviewed on the basis of sound actuarial principles.
- Open reserved files should be reviewed regularly to identify those that are ready for closure.
- Closed reserved files should be reviewed to quantify lost opportunities for savings by comparing what the files would reflect with optimal loss control, claims management, and cost containment strategies.
To help understand, quantify, and manage workers' compensation risks more aggressively, executives should consider:
Strategic Reserve Evaluation (SRE) — Helps ensure that reserve estimates for outstanding claims are appropriate and liabilities are mitigated while also helping companies meet and comply with Sarbanes-Oxley regulations. Combining actuarial and claims consulting capabilities, SRE determines the adequacy of current reserves and potential charges and/or releases. The program focuses on reducing the capital and expense requirements going forward. Services may include a claim inventory workout, actuarial evaluation, and a closed file review. Results include the following: validation of the correctness of reserves; an efficiently linked claim closure project; and a cost-savings report specific to the employer.
For more information about how Marsh can help your business address workers' compensation reserves issues, please contact us.
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