Like Goldilocks testing chairs, a review might find reserves for a workers' compensation claim too high, too low or just right. This article will discuss the function of reserves and why you want them to be "just right."
A loss reserve is money the insurer sets aside to pay future claims expenses. In the case of a workers' compensation policy, a claim could potentially last a lifetime, making estimating reserves a difficult task. A workers' compensation claim reserve could have three components:
• Indemnity reserves, or estimated lost-time payments
• Medical reserves, or estimated costs of medical treatments
• Expense reserves, or costs of adjusting and administering the claim. These might include the costs of hiring investigators, independent medical examiners and vocational rehabilitation specialists in connection with the claim.
Claims adjusters use past experience and statistical information to make these estimates. Factors that can complicate the process include:
• Medical cost inflation/advances in medicine and pharmaceuticals. In the last 20 years, medical costs have increased from 49 percent of total workers' compensation loss costs to 58 percent.
• Legislation that increases benefit levels or adds to types of claims covered by workers' compensation (such as laws that presume that a healthcare worker who contracts AIDS became infected through work).
• Increases in longevity.
If the claims adjuster underestimates the amount of money needed to pay a claim, under reserving occurs. A pattern of under reserving can make an insurer's policies look more affordable, but can jeopardize its ability to pay claims over the long term.
Insurers can also over reserve for workers' compensation claims by putting aside too much to pay future claim costs. Insurers may invest their reserves; however, state laws generally require them to invest reserves extremely conservatively. This makes funds unavailable for other uses — for example, making higher-profit investments and writing new policies.
Over reserving also affects employers. If you have an experience modified policy, over reserving could affect your experience modification and ultimately your premiums. It will also distort your loss profile and make your firm a less attractive risk if you want to "shop" your coverage.
When calculating your experience modification, the insurer will look at your loss experience, of which loss reserves are a component. The formula includes losses of less than $5,000 in full and discounts losses in excess of $5,000. In this way, larger losses have a smaller relative impact on your ex-mod than small ones do.
Each state also sets a "maximum single loss" amount, which caps the amount of any single workers' compensation claim that can be considered when calculating experience modifications. This prevents a single claim from having too disproportionate an effect on your experience modification. Still, larger losses do affect your ex-mod, so if you can get a reserve amount dropped significantly, your experience modification could improve.
The nature of any claim can change over time. You will want to conduct periodic claim reviews to ensure that reserves for any particular claim are not too high, not too low, but just right. For help or further information, please contact the PCOC Insurance Program department of Jenkins Insurance Services at (877) 860-7378 or, email us at ProPest@Leavitt.com.