Workers Compensation Claim Reserving Practices and Reserve Management – How Insurance Companies Get in Trouble

You’ll find that workers compensation claim reserving practices and insurance company management of reserves make a big impact on future insurance company performance. Sometimes to the tune of being “no longer in business!” Let’s take a look at how claim reserving practices may affect your ability to secure workers compensation in the years to come.

Early this year, and last, we saw the effects of adverse reserving practices in action. The collapse of Tower Group International Ltd, a diverse insurer providing a rounded book of insurance products to the market place, may have been a surprise for some. However with a loss in excess of 80% of their stock value within a very short period of time leading to a hectic forced sale, they may well be the best example in a long time of how insurance companies get in trouble. You’ll also find that SeaBright Holdings Inc., another insurer, was sold in 2013 due to mounting problems related to reserving practices and required reserve changes. Another insurer, Meadowbrook,  likewise saw an approximate 35% drop in stock value due to multi reserve charges. If you read the specifics about these cases, and there’s been plenty of folks write about them, you’ll find one of the major culprits was adverse reserving practices. 

Reserves are money set aside by an insurance company to pay current and future claims. It works like this, an insurance company charges a premium for a policy. Part of that premium goes to pay losses and part goes to pay expenses, including insurance company operating expenses and profit. In the world of insurance workers compensation claims are commonly referred to as long tail claims. This is because the ultimate value of a workers compensation claim reaches far out into the future from the date the claim happened. A worker who’s injured on the job today may incur many additional medical expenses over the life of the recovery period which may take several years. Workers compensation claims are unlike typical property claims where the value of the lost property is a known fact at the beginning of the claim process. So an insurance company must plan for and secure their ability to pay their future obligation to the injured worker. This is accomplished through the practice of claim reserving and is the basic concept for claim reserves.

There’s another often unmentioned side of claim reserves, the effect reserving practices have on an insurance companies financial picture. Think of insurance company reserves as a pile of money sitting over there in the corner of the room with each dollar ear marked to a specific claim, waiting to be called on sometime in the future to stand up and pay a medical bill or lost wages for the injured worker to which they are assigned. Keep in mind these dollars are set aside for the specific purpose to pay future losses.

Wouldn’t it be tempting to take a dollar or two out of that pile? What harm could it cause? It usually turns out to be thinking like this that causes an insurance company to begin to look upon its reserves as a pile of money that they should be able to use, right? Doesn’t this happen with some frequency in politics? Where a politician uses money set aside to support a certain program for another more personal reason. How about to shore up a states fiscal status. Happens. Sorry, back to insurance. So it’s not unusual for insurance company reserves to be millions of dollars held back for future claim payments.

Recent news indicates that over a five-year period of time claim reserve releases by property and casualty insurance companies have made up nearly a third of their operating income. A significant number. Insurance carriers continue to rely on reserve releases to support and shore up their financial earnings. 

A delicate balance of rate increases, underwriting profits and reduction of losses will continue to play into the workers compensation financial melting pot. And for a line of insurance that has produced an underwriting profit in only one out of the past fifteen years workers compensation will continue to be an elusive line of business for property and casualty insurance carriers seeking to make an actual profit on what they do.

Reserving practices, the need to show financial growth and profitability, rate and loss cost adjustments and reduction in exposure base (payroll) due to economic fluctuation are all part of the tight rope walk an insurance company must make to stay out of trouble!

Hope this helps you out and thanks for reading!