To pay the cost of workers compensation claims, the insurer or the self-insured employer sets aside the amount of money the company anticipates as necessary to cover the cost of the claim. The process of placing money in a reserve – reserving – sounds simple, but it’s not. While most financial obligations of a company have a set price, workers comp claims do not come with a predetermined cost. The amount of money needed to pay the claim is an estimate based on the experience of the adjuster with previous similar injury claims. Even though the reserve is an estimate, it is a legal obligation and appears on the insurer’s balance sheet.
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Under-Reserving & Over-Reserving Creates Issues
If the workers’ comp adjuster for the insurer underestimates the amount of money necessary to pay the claim, the claim is under-reserved. If the adjuster overestimates the amount of money needed for the claim, the claim is over-reserved. Both under-reserving and over reserving creates issues for the insurer.
When a claim file is over-reserved, the extra money placed in the insurance reserve to pay the claim is not available to the insurer for any other purpose. The growth of the business is reduced because the insurer has less money available for its financial operations – investing, supplies, salaries, etc. While the impact of one claim being over reserved may not be felt, the impact of many claims being over reserved significantly curtails the growth of the insurance company and can even strangle the potential of the insurance company by reducing the funds it has available for its business.
Over-Reserving Causes Side-Effects
Over-reserving also causes a serious side effect for the workers’ comp insurer because of the way the premiums are calculated. The two components of workers comp claims affecting insurance premiums are frequency and severity. Workers’ comp claims are often referred to as “long-tail” claims because they often remain open for years. Therefore, when the underwriter at the insurance company computes the insurance premium, both the closed claims – where the reserves reflect what was actually paid – and the open claims, are used to calculate the future premium.
When the claim files are over-reserved, the severity of the claims is overstated in the calculation of the insurance premiums. This has a detrimental impact on the cost of workers comp insurance. The extra money in the over reserved open claims results in the premium calculation being higher than it should be. The employer is penalized for over reserves by having to pay higher insurance premiums than should be charged. If the employer can obtain the same workers’ compensation insurance at another company, at a lower price, the insurer loses the employer’s business. If the over reserving is severe enough, it can cause the financial collapse of the workers’ comp insurer because the insurer is unable to sell any new business as the insurance premiums it charges employers are too high.
Adjuster May Over-Reserve Out of Caution
The workers comp adjuster may over reserve the claim out of an abundance of caution, or more often, because it is easier to put a high reserve on the file than it is to spend the necessary time evaluating the medical information, the extent of the impairment/disability, and the applicable workers comp statutes to determine the correct reserve amount. As claims management understands the impact of over-reserving, when they see a pattern of over-reserving, the usual conclusion is the adjuster is either inexperienced or incompetent. The insurer or self-insured employer needs to work with the adjuster who is over reserving to improve the adjuster’s reserving skills. When over reserving is corrected, the excess money being held in reserves is released and goes straight to the bottom line of the insurer’s financial report.
The financial security and well-being of the insurer or the self-insured employer is dependent upon the adequacy of the workers’ comp claim reserved. If the reserved is overstated, it will diminish the monetary funds the company has available for its other financial obligations and opportunities. It will also cause the necessary premiums to be overstated, resulting in a loss of business for the insurer.
If you are a self-insured employer and believe your workers’ comp claim reserves are set too high, please contact us and we will be glad to set you up with an independent claims auditor to verify the accuracy of your claim file reserves.
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