Ratios, Rates, Risk Allocation and Benefits Delivery

In June the Workers' Compensation Insurance Rating Bureau (WCIRB) released its overall combined ratio analysis for carriers in California. The ratio had climbed from 117% for years 2009 and 2010 to 122% in 2011.

As you likely know, the combined ratio is how much goes out the door for every premium dollar taken in - so in the case of 2011 a carriers paid out twenty two cents more than they took in.

The combined ratio is a very broad measurement that is useful for at least trend spotting, but is very susceptible to misinterpretation because it is greatly affected by outliers - companies whose ratios that are included in the overall number that have either very high or very low individual ratios.

In general for California, while the present number itself is high, a negative combined ratio is not abnormal. Most of the time there is sufficient investment income to still make a profit despite more expense dollars going out than premium dollars coming in.

There have been some years, most notably 2005 through 2007, where the combined ratio was positive and carriers were able to make an underwriting profit in addition to investment income.

And there are years like 2012 where there is insufficient investment income, insufficient payroll base, insufficient premium ... Which takes us to rates.

The published insurance rates are an interesting phenomenon in workers' compensation because they are the product of available risk allocation resources - in other words what the size of the market's total payroll is. In the latest filing, for every $100 in payroll, the WCIRB seeks $2.68 as the basis for determining the employer's obligation.

When the economy is in the doldrums, and unemployment remains stubbornly high (Bureau of Labor Statistics reported California's July unemployment at 10.7%, still the third worst in the country), there is quite simply less wage against which to charge premium, so each unit of risk allocation resource, i.e. a wage dollar, must carry more of the risk.

Consequently carriers seek higher rates because the risk allocation part of the insurance teeter-totter was getting outweighed by the benefit delivery side. But this isn't necessarily because the benefit delivery system got heavier. Part of the problem is that the risk allocation system got lighter.

Another part of insurance fundamentals is expenses, and more directly, loss and loss adjustment expenses. These can come in either at the benefit delivery side or at the risk allocation side.

Loss is basically how much medical costs and how much indemnity is paid out.

California medical losses paid in 2011 were $4.4 billion and accounted for 60% of total payments, as they did in 2010 and 2009, when total medical losses were $4.3 billion and $4.2 billion, respectively.

Carriers paid $3 billion in indemnity benefits, with $1.5 billion in temporary disability and $1.2 billion in permanent partial disability benefits, in 2011.

Loss adjustment expenses are comprised of all of the various components that carriers use to deny or reduce claims, be it indemnity (by limiting either the rate or duration) or medical (utilization review, bill review, attorneys, and other consultants).

This is where things get interesting.

In 2005, just after the institution of SB 899's utilization review mandates (carriers were required to have systems in place, but they didn't necessarily have to use them), $197 million was spent on medical cost containment services.

In 2011 the cost of such services was $384 million - 94% more than was spent in 2005, or $187 million.

According to the analysis addressed to DIR Director Christine Baker, prepared by Bickmore actuary Mark Priven, the proposed reform bill would result in a net savings to employers of between $95 million and $375 million. The median would be $235 million - not that far off from what carriers spent on medical cost containment services last year.

And the increased spending on medical cost containment services from 2005 to present doesn't appear to be too terribly effective, given that the cost of providing medical services continues to grow by $100 million per year even though claims frequency is at an all time low (except for an anomaly in 2010 when there was a spike in claims experience).

In 1997, after "open-rating" (i.e. pure price competition by carriers without Department of Insurance oversight) was made possible by SB 30 there was justifiable concern that some carriers would not be able to exercise the discipline necessary to price risk properly, and that concern was played out over the next few years with the demise of a couple dozen of carriers that drank the Unicover KoolAid.

It seems that 2005 brought in its own medical cost containment services KoolAid.

And maybe this is what the new Independent Medical Review system will curtail - runaway utilization review and runaway medical bill review.

When DIR started on its present reformation agenda, I argued that there could be no "real" reform without also seeking change in the risk allocation part of workers' compensation. I was met with an unsupported argument that doing so would increase costs and increase rates.

So the focus on the present reform is solely about the benefit delivery system.

The fundamental flaw with the present risk allocation system is that there is no incentive for carriers to more tightly manage loss adjustment expenses and it may very well be that increased complexity of the system over the years inhibits carrier's ability to do so.  Evidence of this is the simple fact that despite a near doubling in the amount of money that was spent on medical cost containment services it has had no discernible effect over the long term. Medical costs continued to grow.

Before SB 30 carrier competition centered on tight claims management because the only way to demonstrate a savings to an employer, and thus win the employer's business, was to ensure the lowest possible experience modification factor possible. And this was accomplished by tight claims management to get the claim closed as quickly as possible thus minimizing indemnity AND medical.

And guess what, carriers didn't rely upon utilization review or bill review back then. Claims adjusters had much more discretion and made professional decisions based on experience and knowledge accumulated through years of training and dealing with claims. Good claims management got rewarded with more business volume.

Let me summarize this rambling post: the machinations that go into keeping the benefits under workers' compensation affordable to employers are complex. The present day system angst is a product of changes that go back two decades. System performance is compromised by increased complexity (to which the proposed reform bill adds in my opinion), and the delegation of individual responsibility to regulatory subsystems that are applied without appropriate discretion.