The Adjuster's Notebook: Getting Reserves Right (Part 3)

Editors Note: This is the last of a three part installment. Part 1 is available here. Part 2 is available here.

Part Three of Three: Five methods for setting reserves

In our previous installment, we looked at building a reserving philosophy. We also reviewed the stair-stepping of reserves and something called loss development. In this final part, we will look at five different methodologies for setting case reserves. We will also look at some of the information required to accurately set medical reserves.

• Individual case method

A method of setting reserves predicated on the claim’s circumstances and the claim representative’s experience in handling similar claims. The individual case method is the focus of this article.

• Roundtable method

This is a method of establishing reserves by using the consensus of two or more claims personnel who have independently evaluated the financial exposure presented in the claim file. It is particularly helpful in identifying the stair-stepping of reserves. It may also bring some reality to a case when overconfidence exists as to the real versus perceived value. On severe cases with long duration probability, the roundtable method is beneficial in developing medical cost inflation factors.

• Average value method

A case reserving method that establishes a predetermined dollar amount of reserves for each claim as it is reported. This method is useful when the file is initially received and a reserve is posted merely to acknowledge that a financial exposure exists. In such an instance, the reserve is a very short-time place holder in anticipation of an accurate reserve based on the claim investigation,

•  Formula method

A method of setting reserves based on a mathematical formula. For example, a predetermined ratio may be based on the assumption that a certain ratio exists between claim costs and wage loss costs (indemnity), i.e., the indemnity reserve will be set at a certain percentage of the medical reserve.  

• Expert system method

This is a method of setting reserves by employing a software application or artificial intelligence (AI) which estimates loss costs and loss adjustment expenses. Currently the use of AI is skyrocketing across the business sector. When you see television ads touting the instantaneous processing of mortgage applications, it’s through the use of AI. Some insurers are currently using the AI application in the development of workers’ compensation experience modification factors. This calculation traditionally took into account four or five loss and underwriting factors. With AI, hundreds of data points (bits of claims and underwriting information) are processed in a matter of milliseconds with the use of mathematical formulas known as algorithms.

Similarly, one of the better software tools for aiding in the establishment of reserves is the medical program based on statistical analysis. This is more commonly known as Evidence Based Medicine. Such programs provide critical information such as duration of disability, when that duration is beyond average, various treatment forms, and the costs of care and various modalities. This type of statistical information is excellent for getting that loss development factor close to the desired percentage. Further, it brings credibility to your reserving process

Information Required

Of the two primary benefits that most state-specified compensation systems mandate- disability and medical-disability is most often the easiest to calculate. Obtaining payroll and other employer based information is generally the easiest part of predicting the wage loss cost of the disability. At the same time, understanding the employer’s propensity to institute workplace safety techniques and place injured employees back to favored work is paramount in estimating future disability benefits.  

Rule for Reserving: In investigating dependency factors which affect the disability rate, care should be taken to obtain proof of marriage and dependency status. Acquiring copies of marriage and birth certificates is a valid means of proving dependency. Obtaining proof via tax records is another means of verification. This is not without the recognition that such information is sensitive and proprietary. On the other hand, your fiduciary duty to the insured to perform a diligent good faith investigation, necessitates such inquiry.  Your claims guidelines or management/legal counsel should be able to provide direction in the acquisition of such confidential documents.

The more difficult reserve to estimate is the medical cost and the effect the care will have on the duration of the disability. You are already cognizant of the factors which come to mind when you focus on setting your initial medical reserve: age, gender, occupation, education, dependents, nature of injury, work ethic and motivation. However, estimating accurate reserves necessitates that you inquire into the claimant’s medical history to the extent that preexisting conditions may affect the duration and severity of the occupational injury.

To the listed factors identified in the previous paragraph, I would add a number of comorbidity factors. Comorbidity factors, or what’s known as confounding factors, tend to obfuscate the outcome of the claim by complicating the occupational diagnosis. Such factors are: smoking, diabetes, hypertension, obesity (body mass index), opioids, substance abuse, surgery and depression or other psycho-emotional disorders.

Conclusion

In order to establish and maintain accurate reserves, the adjuster must develop a wealth of medico-legal knowledge. This takes time. It also requires diligently reading and studying medical reports and legal correspondence. In the meantime, reliance on supervisors, nurse case managers and legal counsel is an excellent strategy for building the acumen to accurately establish loss reserves.

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About the Author

Brian Francis is a Licensed Insurance Counselor. He also teaches continuing insurance education on behalf of the Michigan Association of Insurance Agents. He can be reached at brian.riskresearch@gmail.com.

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