By Edward Canavan
During my close to 30 years in the casualty industry, I have had the privilege of handling California self-insured claims, participating in State audits and working closely with dozens of employers who decided to self-insure their workers' compensation losses. These employers ranged from school districts to municipalities and included some of the world's largest fortune companies.
Deciding how to finance risk is not an easy question. Many variables must be considered and closely analyzed. When a company has the needed credit rating and necessary capital, self-insurance can provide more control over how claims are handled. Self-insured employers work closely with their claim administrators regarding best practices and mitigation techniques. Self-insureds usually handpick their ancillary service partners, such as third-party administrators and defense attorneys. This is not always the case in guaranteed cost or high deductible insurance policies.
The Alternative Securities Program
California has the largest workers' compensation self-insurance program in the nation. As of January 1, 2018, a total of 7,141 California employers were actively self-insured. The ability for an employer to self-insure was made much easier in 2003 when California created Labor Code Section Â§3701.8 defining an innovative approach via the Alternative Securities Program. The ASP, a first of its kind, guarantees the collateral deposit requirements be based on the applicant meeting specific credit standards. Applicant's that do not meet the ASP requirements must directly post their collateral security deposit with OSIP.
The Importance of Accurate Reserving
So, why is accurate reserving so critical for employer's deciding to self-insure their Californiaworkers' compensation losses? First and foremost, California self-insured employers are required to provide the Office of Self Insurance Plans with an annual independent actuarial analysis that determines the ultimate exposure of the self-insurer's workers compensation liabilities. Per Labor Code Section Â§3710(c), unless the employer is a member of the ASP, the collateral deposit shall be an amount equal to the self-insurer's projected losses, net of specific excess insurance coverage and inclusive of incurred but not reported (IBNR) liabilities and unallocated loss adjustment expenses, calculated as of December 31st of each year. The Office of Self Insurance routinely audits self-insureds. The first phase of an audit consists of the auditor conducting a "desk review" of the actuarial report and summary of past audit findings. If the auditor is not satisfied reserving practices are sound the audit will progress to the second phase in which individual claim reserves are analyzed. If, as a result of the audit, reserves do not accurately project losses, the collateral amount owed will increase. No one likes adverse financial surprises. This can become a challenge for actuaries, financial officers and risk managers.
California Self-Insured Reserving Requirements
When I began my career in 1993, no regulations on how to reserve self-insured claims existed. It was a challenge to explain to employers why these funds needed to be set aside. Often times I would invite OSIP to have a conversation with the self-insured employer to discuss requirements and the consequences of non-compliance. Thankfully, in 2006, Article 6 "Estimating Work Injury Claims and Medical Reports" was adopted and placed in Title 8 of the California Code of Regulations. This article provided specific guidance on how claim administrators were required to reserve self-insured claims. Below is a brief description of the various sections of Regulation Â§15300. This outline in no way is met to replace the need for those adjusting claims to review and become familiar with the actual regulation. Instead, the below is met to provide a high-level understanding of some of the requirements placed on administrators reserving self-insured claims.
â¢ Set Realistic Future Liabilities: The administrator shall set a "realistic" reserve of future liabilities on each claim listed on the self-insured's annual report.
â¢ Set Reserves Based on Probable Cost Expected Over the Life of the Claim: A realistic reserve must be sufficient to cover the "probable total future costs" of compensation and medical benefits that can be reasonably expected to be due over the life of the claim. This can get tricky when it can be expected the employee will eventually be found entitled to lifetime medical care.
â¢ Reserves Based on Information Contained in the Claim File: The reserve must be based on information in the claim file at the end of the period of time covered by the annual report.
â¢ Timing of Reserve Adjustments: The administrator is required to adjust the reserve immediately upon the receipt of medical reports, orders or other relevant information that impacts the valuation of the claim. Each reserve must be reviewed no less than annually and prior to the filing of the Self Insurer's Annual Report.
â¢ Medical and Indemnity Reserves Itemized Separately: Each estimate of future liability shall separately reflect an indemnity and medical component.
The indemnity section shall include the estimated future cost of all temporary/permanent disability, death benefits including burial costs and the supplemental job displacement benefit. The medical section shall include the estimated future cost of all medical treatment.
In 2012, certain medical cost containment fees were carved out of the medical reserve and instead considered unallocated loss adjustment expenses.
â¢ 132(a), Serious and Willful Misconduct and Penalties: Reserves must include reasonably expected costs related to Labor Code Section Â§132(a), Labor Code Section Â§4553 regarding Serious and Willful Misconduct and penalties per Labor Code Section Â§5814 resulting from an unreasonable delay in paying benefits owed.
â¢ Permanent Disability and Conflicting Medical Reports: In estimating a permanent disability reserve where conflicting permanent disability ratings exist, the reserve shall be based on the higher rating, unless there is sufficient evidence in the claim file to support the lower rating.
â¢ Estimating Medical Costs, Employee is not MMI: In setting a medical reserve in a case in which the employee is not yet MMI, the reserve must reflect the anticipated medical costs for the life of the claim. This can be challenging when it is anticipated early on the employee will be entitled to medical care for their lifetime.
â¢ Estimating Medical Costs, Employee is MMI: When the employee is MMI, medical costs must be estimated based on the average medical costs over the past three years since the employee was declared MMI, or a lesser period if three years has not yet passed. This average annual medical cost is multiplied by the employee's life expectancy per the life expectancy chart listed in the "Forms" section on the Office of Self Insurance Plans website. This estimate must also include the costs of medical care, for example surgeries, that can reasonably be expected over the life of the claim.
â¢ Reduction in Estimated Costs:
o Documentation that Future Treatment will Not Occur: Medical reserves based on average past costs can be reduced for treatment not reasonably expected to occur backed by medical documentation contained in the file. Reductions based on anticipated decreases in treatment frequency, the examiner's prior experience, educated guesses and/or conjecture are not permitted.
o Decreases in Official Medical Fee Schedule: Reserves based on past costs canbe reduced if a reduction is made in the official medical fee schedule for the relevant anticipated future medical treatment.
o Uncontested Utilization Review: Reserves based on past costs can be reduced based on utilization review, unless the utilization review decision was successfully contested.
o Order Allowing Credit for Third Party Recovery: The only time reserves can be reduced based on subrogation is when the file contains an approved order from the Workers' Compensation Appeals Board allowing for credit based on the third-party recovery.
o Permanent Disability and Apportionment: Reserves for permanent disability can only be reduced based on apportionment when the file contains the needed evidence that justifies this decrease.
â¢ Present Value: Reserves shall not be reduced to reflect present value of future benefits.
â¢ Excess Recovery: Estimates of future liability shall not be decreased based on projected reimbursements from aggregate excess insurance reimbursements.
Rationale, Timing and Consistency is Critical
While working with some of the world's largest companies, I quickly discerned in conversations with actuaries that the timing of the reserve and consistency in approach is critical in allowing that company to clearly understand their future exposure. How can you satisfy the financial needs of a company while complying with the self-insurance regulations? It is important to educate the employer in what California law requires and that reserving practices will be closely scrutinized by the State. Not complying can result in adverse unexpected financial outcomes and the need to increase the required collateral. Consider building a reserving philosophy and approach, secure consensus with the client, educate your team on expectations and measure compliance. Work to build transparency with your team on reserve progression and what loss years represented the largest movement. It is encouraging when newer loss years drive reserve increases and not claims that have matured. This is a sign that probable reserves needed for the life of the claim are being recognized and set early providing consistency and reducing large reserve increases on mature claims. The examiner rationalizing the reserve is just as important to timing and consistency. California workers' compensation cases can be complicated and difficult to unpack. Knowing the examiner's thought process and having them point to the evidence relied upon can help improve the outcomes of a State audit.
Deciding how to finance risk can be a complicated exercise with the decision maker needing to contemplate several variables. When companies decide to self-insure their workers' compensation losses, the administrative and financial requirements must be considered. The reserving requirements for insured versus self-insured are like night and day. Administrators are held to numerous requirements by the California Office of Self Insurance Plans to ensure the collateral set-aside is adequate to pay losses. The state routinely audits self-insurers, adequacy of reserves and soundness of practices. The examiner's documented reserve rationale, timing of setting the estimate and consistency in practices is critical in ensuring adequacy and predictability when estimating future costs.
Hudson Claims Consulting is here to help. Contact me at email@example.com if your team needs training regarding this subject. Further, HCC can conduct audits to help you understand compliance, performance during a State Audit and achieving consistency in approach.
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