It's Not Rocket Science, But Close

After the NCCI Annual Issues Symposium (AIS) I received an email from Peter Rousmaniere, a noted columnist who covers the workers' compensation industry for Risk & Insurance Magazine.

Peter was at AIS and I was fortunate enough to share a couple moments with him, though not enough. I've always considered Peter's observations on workers' compensation to be sharp and insightful - considerate of the many interrelations necessary to make the system work.

In an email to me after AIS, Peter said: "I am repeatedly struck when I come to this conference how all consuming, for professionals in it, is the work behind the sustainability of insurance enterprises, which is such a hugely complex undertaking, which branches out into brokerages, the delivery of insurance throughout the complex economy, the demand that not a single claimant be left holding the bag (almost), and the recruitment of the next generation of leaders for the task."

Peter makes a very poignant observation.

Most of the time we deal in the claims environment. For instance, most "reform" legislation and regulation deals with benefit delivery, i.e. claims.

In claims we focus on the friction between the payer (be it insurance company, self-insured/administered employer or self-insured/third party administered employer) and the recipient (injured worker or vendor).

The claims process is complex and requires coordination of many moving parts to successfully accomplish the conflicting goal of resolving expenses and rendering medical services and indemnity to the claimant.

When done right we can say that the claims process has delivered value to all constituents, particularly if the process executes timely and efficiently.

Most of us lack much understanding of the complexity of gathering, maintaining, and protecting the resources that are necessary in order to meet the delivery promise of claims.

At AIS, as Peter observed, one comes to a much better understanding of what the "front end" (policy procurement) of workers' compensation requires in order for the "back end" (claims fulfillment) to meet obligations.

To say that the hugely complex process on the front end is tenuous and frail is accurate - there are so many moving parts to the front end of the insurable obligation that it is a wonder that the workers' compensation industry is able to stay right side up.

When working the front end, consideration needs to be taken of the general economy - and not the present general economy, but forecasts of economic trends overall, and within industries, and even within sub-industries.

Complete understanding of the market risk being undertaken is absolutely necessary - sort of a micro-risk analysis - because the ability to manage anything requires detailed knowledge of the subject.

Corollary to understanding the micro-risk is understanding the investment risk. Underwriting profits (premium minus claims) is virtually unheard of in workers' compensation. The lure of workers' compensation insurance business is cash flow to place into investments that theoretically will beat inflation and return a profit.

Typically insurance cash (gross premium less reserves and less operating expenses and losses) is placed into relatively safe, albeit benign, investments - bonds.

As we know, there are all sorts of different bonds with different maturities and different rates of return. Insurance financiers have their hands full now as older bonds that were purchased years ago with good yields (when inflation was relatively high compared to today's environment) are maturing and need to be replaced - but historically low interest rates don't give bond purchasers many options for returns.

So the long term portfolio of carriers is not going to generate the same returns as in years past, which puts pressure on rates and premiums in order to keep cash flow sufficient to meet the legal obligation of paying claims.

What a conflict of resources versus market acceptance to manage.

Then there is the risk management part of the front end - reinsurance.

Reinsurance is simply insurance for insurance - protecting the really big downside to prevent complete catastrophe. The reinsurance game is insurance on a much larger scale, involving much bigger money, much bigger investments and much bigger claims.

Reinsurance is that funny sort of dichotomy where insurance companies find themselves as insureds, paying premiums and making claims. The complex financial instruments that are used to manage this relationship can sometimes back fire (see Unicover) and then there is complete disaster because of cash flow impingement on insurance companies - and particularly in insurance, cash is king.

Then there's the whole cadre on the sales end of insurance - brokers and agents.

The complexity of the broker relationship in the industry is completely under valued and misunderstood; talk about potential conflicts of interest!

The broker's obligation is to place the employer with the most satisfactory insurance product available for the employer's particular risk. Most of the time this is dictated by cost, aka premium. Some of the time, though, this is dictated by service quality and risk management techniques and systems. Some of the time there simply isn't a market for an employer's risk. And some of the time brokers need to come up with creative, sophisticated contractual relationships in order to get the best value for an employer.

But the broker is paid in commissions - so there is this tension in the relationship that is dictated by the conflict in getting the best value for the employer versus the amount of money that a commission is going to generate off a particular policy.

Going to AIS is going to a different workers' compensation world - one where the language is different, and the concepts are complex and difficult. It is an objective world.

I look at the front end as the more objective side of the workers' compensation industry. The front end is highly consumed with lots of numbers because it is the numbers that ultimately drive the financial ability of the system to work. When it all is considered we're really just talking numbers on financial statements. There's not a whole lot of fuzziness when just numbers are involved.

I see the back end of the industry, claims, as largely subjective. We have numbers to track costs and efficiencies, but ultimately we're dealing with the feelings of the end-subjects of the claims processes - the injured worker and to some extent the employer. Because of the emotions that are part of claims there's quite a bit of fuzziness involved - it is much more subjective.

That workers' compensation even works is amazing and testament to social intelligence. I spend a lot of time in this blog criticizing "the system." But every once in a while it's good to pull back and take a look at everything that needs to come together in some coordinated fashion for the system to work.

Workers' compensation is amazingly complex and sophisticated which is why it is so hard for those not in the industry to understand it. It's not rocket science, but darn close.

And most of the time the system does work.