Businesses today are putting more emphasis on improving riskmanagement than ever before. This is due in large part to increasedregulation, emerging exposures such as cyber liability and supplychain interruption, as well as the associated escalation infinancial consequences. According to a 2014 Price WaterhouseCoopers (PwC) global survey of approximately 2,000 businessexecutives and risk managers worldwide, 75 percent are investingresources to create a more risk-aware company culture, with one infour identifying fragmented risk data as the largest capacitygap.

Over the next 18 months, 82 percent of the respondents plan todevelop an in-depth process to continually identify and monitorrisk, a trend corroborated by the Risk Management Society’sExcellence in Risk Management XI survey. Though 90 percentof C-suite respondents said risk management impacts businessstrategy, only 25 percent feel their companies use risk managementto its fullest ability. Key areas in which the use of data andanalytics can be improved, include risk identification,quantification and mitigation.

Implications for workers' compensation

Workers’ compensation is the one property and casualty coveragewhere a business can exert the most control to reduce claims andcost, yet many middle-market businesses fail to identify importantkey performance indicators (KPIs) to help them understand,effectively analyze, track and measure process improvements thatreduce claims, maximize ROI and increase profitability:

• Where is the organization in relation to the report’s findingsand claim analysis abilities?
• Is the business using current methodologies to evaluate,analyze, track and measure the performance of your workers’compensation program?
• Is the business aware of the cost of a workplace injury beyondwhat is shown on a loss run?
• What does the business have available for comparing resultswith other California businesses in the industry, or across thecountry?
• Is the business using this information to grade the broker’sperformance in managing those costs as effectively aspossible.

What gets measured gets improved—the more effective the measure,the more dynamic the opportunity to obtain the desired results. Anideal system of best practices includes seven specific keyperformance indicators incorporating a unique combination ofanalytics and metrics that a management team must not only know butalso implement and monitor to achieve the full potential of itsworkers’ compensation program.

Forward-thinking businesses are capturing and using relevantdata in new ways to develop innovative metrics and operate moreeffectively. With more precise information in hand, managers canbetter evaluate, track and measure outcomes to make quicker, moreinformed decisions. The results extend beyond simply solving aworkers’ compensation problem. From a more global perspective, theability to prevent and mitigate workplace injuries has far-reachingbenefits to support an organization’s strategy to maintain orimprove its competitive position. The rewards include the abilityto reduce costs, enhance employee health and wellness, foster asafer work environment, improve productivity, create a better riskprofile and add more profit to its bottom line.

The Seven Key Performance Indicators

1) Lowest Possible Modification: The ExperienceModification Rate (EMR) is an important baseline and benchmarkingfactor for internal use, and as a comparison to competitors. Abusiness’ Lowest Possible Modification (LPM) is the value theexperience modification would be if the business had nowork-related injuries during the applicable experience ratingperiod. Think of it as the perfect score. This will be differentfor every business. So, knowing the LPM is essential.

The gap between the EMR and LPM is a controllable cost and hasmany implications. Aside from what the numbers themselvesrepresent, it measures the degree of inefficiency in anorganization’s ability to manage the expense side of theirbusiness. Within this context it points to:

• The level of understanding management has regardingoperations.
• The amount of energy a company is willing to devote to peakperformance.
• The knowledge of the service providers, i.e. insurance broker,and the effectiveness of the support received.

Once the gap is exposed and the implications are understood, theLPM becomes the focal point from which a consistent and sustainableplan can be conceived and executed to close that gap. If the brokerhas not provided the business with the LPM, it’s likely no one isexamining the important gap between the businesses EMR and LPM toimprove its risk efficiency.

2) Claim Incidence Rate and Cost Rate:Effectively managing a workers’ compensation program begins withidentifying the sequential events within the business process thatlead to employee injuries. Understanding the underlying proximatecause(s) is essential to interpreting and interrupting thatsequence. A businesses Claim Incidence Rate/Cost Rate are extremelyimportant numbers in the risk- management equation and specificallyfor this analysis. The Claim Incidence Rate/Cost Rates are ameasure of the cost of production or operation that carry over intosubsequent years and represent the slippage between intention andthe combination of design and effort (process). The first measuresthe frequency (number) of claims, and the second accounts for claimdollars, expressed as a cost per some significant internal measureof production or expense.

Loss runs are useful reports to draw information but lack thecapacity to provide necessary details for exposing patterns andtrends and setting baselines and benchmarks from which theappropriate processes can be designed. Because both claims andpremiums have too many variables causing them to change over time,the antiquated loss ratio (Claims $ / Premium) is a poor data setto establish a reliable and consistent measure for diagnosing andsolving potential problems. Therefore, it is important to use theright denominator in the Incidence Rate/Cost Rate formula – onethat is subject to minimal variation. This precise measure deliversconsistently reliable numbers correlating past performance withcurrent events and allows for higher confidence in predictingfuture outcomes. Often a current internal KPI is best. Examples ofa precise measure range from, units of electricity to tons of dough(used by a bread manufacturer), or patient bed days (healthcare)and even raw material expenses.

In spite of the huge amount of premium, exposure, and claim dataproduced by the workers’ compensation industry, many businessescomplain about the lack of actionable information available to makeinformed, real-time decisions. It is more beneficial, therefore, tocross-reference, analyze and correlate multiple sources ofinformation—both internal and external—in order to make educateddecisions.

3) Industry Comparison: A competitor’sexperience modification provides a business with valuable butlimited information. There is a way, however, to compare the ClaimIncidence Rate with the industry average, specific to state andalso nationally. It’s a great benchmarking tool to determine howthe businesses operation is performing. By underperforming, abusiness relinquishes advantages to the competition. Similar to theLPM, this comparison provides a specific metric to gauge resultsand a target to aim for to close the gap.

4) Indirect Cost of Claims: Dr. Edward Deming,who gained world renown for introducing and instructing Japanesemanufacturing CEOs about Total Quality Management, lists at numberfive of his Seven Deadly Diseases of Management, “Running YourBusiness on Visible Numbers.” He cautions that using only obviousand visible numbers with little or no consideration of figures thatare unknown, can lead to uninformed, costly actions. This certainlyhas workers’ compensation implications, particularly whendetermining the total cost of a claim. Little attention is given tothe indirect cost of a work comp claim, also referred to assecondary costs. Depending on the industry and claim size, thatamount can range from one to two times the medical, lost time,disability and associated expenses shown on your loss run. Thislinks to a study of direct and indirect workplace injury costs, whichaffect a wide range of areas in the business, such as:

• Damaged equipment and materials.
• Lost productivity due to time spent responding to andinvestigating the cause and outcome.
• Overtime associated with covering for an employee, who is nowunable to fulfill his or her responsibilities in the productionprocess.
• Time spent on claims management and litigation.
• Possible time spent searching for, interviewing and training anew replacement employee (and the statistically establishedlikelihood that a new employee is more likely to be injured at workthan an experienced worker).
• Three years of elevated insurance costs, as the injury isincluded in the experience rating formula.

There is no specific line item for the various hidden costsassociated with a claim, but they do show up as lost profit. Like aslow leaking pipe tucked away in the recesses of a building thatgoes unnoticed, indirect costs of claims represent leakage in afinancial statement.

Consider the effect of $250,000 in claims, and the associatedindirect costs at 1X (an additional $250,000). Now, take abusiness’ Net Profit Margin (say 10%) and divide it by $250,000 toget the additional sales required to fund this uninsured cost.$250,000 /.10 = $2,500,000. How many units of product would thecompany need to sell in order to cover this unrecorded cost? Is iteasier to increase the company’s sales by $2,500,000 or perhapsundertake a program to minimize workers’ compensation claims?

5) Loss Prevention & Control Program Audit &Rating: Business owners face the common struggle toidentify and control the drivers of workers’ compensation expense.In the absence of quality analytics and metrics, intuition oftenbecomes the default mechanism to determine a course of action.However, without the necessary experience, skills and resources,intuition often results in solving the wrong problem. Even with theright KPIs and capabilities, a plan still needs to be properlyexecuted. To ensure success, it is imperative to assess anorganization’s internal loss prevention and control program inconjunction with other stakeholders, i.e. insurer and medicalprovider. Examples of areas to review include:

• Management’s commitment and awareness.
• Return-to-work/transitional duty.
• Communication.
• Performance goals.
• Medical cost containment.
• Training initiatives.

Quantitative measures, such as claim incident and cost dataabound. However, proper consideration is rarely given to measuringand scoring the quality of a risk management program.

Audit tools are available to assess workers’ compensationpractices and procedures, recommend improvements and receive thetargeted materials, expertise and training to implement cost-savingimprovements. A report generates a score to measure the initiativesmentioned above that are relative to best practices, and pinpointswhich areas are in the most need of improvement and will yield thegreatest savings in the quickest amount of time.

Once the rating is established, resources to improve the programare put into place, including:

• Claims benchmarking to determine the cost of current practicesand forecast the benefits of improvements.
• Access to training programs and collateral material to educatethe team about specific prevention measures.
• Processes to track and measure progress.

6) Health of Your Workforce: Today’s workforceis suffering from lifestyle-related illnesses such as obesity,diabetes and other chronic diseases. Employer awareness continuesto rise and studies present compelling evidence correlating ahealthier workforce to a reduction in the number and cost ofworkers’ compensation injuries.

Approximately 50 percent of Americans have at least one chronichealth condition. High-risk individuals are nearly three times morelikely to file a workers’ compensation claim. This populationaccounts for 85 percent of workers’ compensation costs, and havemedical expenses that are significantly higher per year thanlow-risk individual’s injuries. These conditions contribute to asignificant loss in productivity for any organization.

Population Health Management Programs (wellness plans) offer acomprehensive solution to minimizing workers' contributions to lossin productivity in a formalized and integrated manner.

This begins with an employee Health Risk Assessment. The resultsare aggregated to reveal where the workforce is at risk forlifestyle-related illnesses, with both current conditions and thosewith indicators for susceptibility. With this insight and baselinefactors, one can implement a tailored population health managementprogram to improve employee well-being, increase productivity andreduce workers’ compensation costs.

7) Broker Compensation: Similar to otheroperating areas in a business, broker’s compensation is aninvestment and should be known and open to measure. Compensation isan important component of the value proposition. Yet, brokers loathto let clients know how much commission they are being paid by theinsurance company and surprisingly, clients don’t ask. Ifclients are unaware of how much the broker is being paid forhis/her workers’ compensation services, how can they effectivelymeasure his/her performance? Isn’t it a critical part offormulating the ROI to assess the broker’s contribution to improveoutcomes and close the gap on the Lowest Possible Modification?

Often, a disproportionate balance favoring the broker exists insituations where the experience modification continues to rise overseveral years, developing a win–lose relationship with the client.As the renewal premiums increase, so does the broker compensation.Yet, the broker has not been able to bring a solution. Hence, thiscalls into question the value of the services rendered.

Using Meaningful Analytics

Despite the growing challenges associated with capability gapsand technology changes, companies are making progress atmaintaining and building their risk management competencies. PwC'ssurvey respondents reported being the least satisfied with theirabilities around risk forecasting and scenario analysis as well asbuilding up the risk function and resources. In a world of inherentrisk, where yesterday’s methods of addressing workers’ compensationcosts continually prove to be ineffective, it is more importantthan ever to explore and learn new risk managementperspectives.

There exists an increasing focus by a small group offorward-thinking professionals toward using more meaningfulanalytics and metrics to identify savings opportunities, formulateaction plans and measure the impact of change. What gets measuredgets improved - the more effective the measure, the more dynamicthe opportunity to obtain the desired results.

Knowing and employing these numbers gives organizations anadvantage. The aggregated savings and additional benefits obtainedfar exceed any potential year-over-year reduction in the renewalpremium. These measures not only provide transparency but alsoserve as a barometer to measure the organization’s own performance,as well as the broker’s overall ability and willingness to beaccountable for achieving the desired results.

About Stephen Paulin, CIC:Stephen Paulinis senior vice president with Sullivan CurtisMonroe Insurance Service in Orange County, CA, and an insurancerisk-management broker with more than 30 years’ experience. Paulinhas spent his career understanding the work comp challenges thatbusinesses face and is dedicated to developing the expertise,capabilities and resources to improve outcomes for sustained,long-term cost reduction, while improving productivity and profit.Paulin, a graduate of the Marshall School of Business at theUniversity of Southern California, is a member of USC’s MarshallPartners Board of Directors and a member emeritus of the USC AlumniAssociation Board of Governors. Paulin is also a member of thefounding board of directors of The Lott Trophy, which is awardedeach year by The IMPACT® Foundation and recognizes collegefootball’s Defensive Player of the Year who best exemplifiesIntegrity, Maturity, Performance, Academics, Community andTenacity. For more information, visit www.sullivancurtismonroe.com.To contact Paulin directly, email [email protected] or call949-852-4812.