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Where Workers' Compensation Goes Wrong

Padded bills, murky disclosures, and controls gaps are among the possible perils when self-insured employers outsource the management of their workers' comp programs; ''I'm saving myself to death," says one manager.
David M. Katz, CFO.com | US
June 9, 2005

On the surface, you might think a company that self-insures its workers' compensation risks would be providing its executives with an excellent means of managing that liability and controlling the resulting cash flow.

After all, an employer that self-funds this insurance also holds on to money it might have paid out in premiums, and the company could pay less to cover its exposures if it manages them well. Insurance experts have long held that if a company puts its own dollars at risk, it has a powerful incentive to prevent injuries from happening in the first place, which also cuts down on medical costs and lost work hours.

In return for those benefits, however, self-insured employers take on a whole lot of risk. One major hazard: the possibility of being too optimistic about how much money to set aside to cover the treatment of back problems, slips and falls, and other workplace injuries. Understating such liabilities can lead to weighty financial-reporting problems. In 2004, for example, at least two companies, Goodyear Tire & Rubber and Interstate Bakeries Corp., had to restate their results because of problems related to workers' comp reserves. Indeed, Interstate's revision resulted in a charge to pre-tax income of about $40 million.

Less prominent, but certainly serious enough on its own, is the risk faced by many self-insured companies when they outsource the administration of their workers' comp plans. The Sarbanes-Oxley requirement that corporate chieftains must sign off on financial statements suggests that the CFOs of heavily self-insured employers should have a firm grip on what their companies pay out in workers' comp claims. Typically, finance chiefs rely on risk managers to handle those outlays. But risk managers, by some accounts, often hand over the management of claims and medical costs to third-party administrators (TPAs) without a clear idea of their relationships with medical and claims-services providers.

In some cases, such wholesale delegation can result in "the complete outsourcing of the risk manager's fiduciary responsibility to the organization and its shareholders by allowing these service providers to control what should be viewed as a line of credit," according to one senior sales executive for a managed care organization specializing in workers' compensation. Potentially, a self-insured corporation's lax management of its workers' comp outlays could represent "a huge hole in internal controls," said the executive, who asked not to be identified.

To be sure, it's no easy task for a risk manager to track payments to and from the managed care companies, bill-review outfits, nursing clinics, and the host of other vendors that TPAs contract with on behalf of self-insured employers. But critics of the system say that not keeping track can result in substantially higher costs for self-insured employers. For example, certain questionable payouts from medical networks to administrators can lead to excessive bills for managed care services, according to Joseph Paduda, the principal of Health Strategy Associates, a Madison, Connecticut-based workers' compensation and managed care consulting firm.

Although no TPA or services vendor has been accused of wrongdoing, state regulators have homed in on this complex web of relationships. In February, New York Attorney General Eliot Spitzer subpoenaed workers' comp services provider Concentra Integrated Services Inc. "regarding CISI's relationships with third party administrators and health care providers in connection with [Spitzer's] review of contractual relationships in the workers' compensation industry." Richard Parr, Concentra's general counsel, didn't offer further comment on the case, but he did say that the "kind of transparency and disclosure" that the investigation might spawn would be "a good thing for the industry."

Last December, Spitzer also slapped subpoenas on two leading workers' comp TPAs, Gallagher Bassett Services Inc. and Crawford & Company. Representatives of the attorney general, Crawford, and Gallagher wouldn't comment, except for the Gallagher representative's statement that the company was cooperating fully with Spitzer's investigation.

In Florida, chief financial officer Tom Gallagher — who earlier this month announced his bid for that state's Republican nomination for governor — said that he's set up a task force to look into broker practices in the workers' comp industry, also with transparency as its goal. The Florida task force has already issued its own subpoenas.

Subtle Disclosure
The regulators haven't yet spelled out just what it is that they're investigating. But some industry players suggest that the way some TPAs are compensated in discounted health-care arrangements could promote conflicts of interest as well as an overabundance of doctor visits.

By accepting such payments from vendors, the administrators put themselves in a position like that of Marsh, Aon, and Willis, the three big insurance brokers who accepted contingency commissions from property/casualty insurers, according to Paduda. Claiming to be acting solely on behalf of their clients, the brokers ended up apparently serving two masters and later agreed to multimillion-dollar settlements of Spitzer probes. (Another big broker, Arthur J. Gallagher & Co., last month reached a $27 million settlement of a contingency-fee case with the Illinois attorney general and the state's director of insurance. Gallagher is the parent company of Gallagher Bassett, the TPA that was subpoenaed by Spitzer in a separate action.)


Given adequate disclosure of vendor payments to TPAs, insurance buyers would be able to make their own best judgments about administrators' loyalties. Sources say, however, that service bills and plan documents rarely disclose much about such compensation. In one contract between a large, self-insured company and a TPA that Paduda cites, for instance, the only disclosure of such an arrangement is a phrase in which the employer "acknowledges that the TPA has the right to reimbursement from the managed care firm for fees to cover its expenses in working for the managed care firm."

Lacking specific information such reimbursements, the risk manager can't easily discern the incentives that drive the use of health care. Take the case of managed care networks such as preferred provider organizations (PPOs) that are paid based on the percentage of savings they can extract from doctors and other health-care professionals. If the TPA can pocket a piece of that percentage, it has an incentive to use a network that can deliver whopping discounts, Paduda notes.

So far, so good: TPAs who deliver big discounts via the networks they hire would seem to be doing exactly what their employer-clients ordered. However, there's a "perverse incentive" in that scenario, according to Paduda: the percentage-of-savings method nudges the network and TPA to show more savings by producing more bills. And that can add substantial overall costs — even though the charge on each bill is cheaper than it might have been. Paduda recalls the response of one workers' compensation insurer when the incentive was explained: "What you're saying to me is that I'm saving myself to death."

What's more, such overbilling can be hard for a risk manager to detect because bills are seen claim by claim rather than cumulatively. For example, in a high-deductible insurance plan — in which the employer essentially self-insures at least the first $500,000 of each workers' comp claim — the charges can mount up beneath a risk manager's radar screen, according to the managed care executive who requested anonymity. Such claims can remain open-ended for years, making their aggregate effect tough to detect. "If the risk manager isn't watching how those dollars are being spent," he observes, "you can get into material amounts."

Also problematic are the lucrative "bill-repricing" services provided by some bill-review vendors. Such vendors, who are also paid according to the savings they produce, provide computer systems that discount medical bills to rates that jibe with those of managed care companies or state-mandated fee schedules. Such purely administrative costs tend to be billed separately from medical expenses, according to a number of sources, making it hard for employers to track compensation arrangements.

In at least one state, the "percentage of savings" method, when it comes to compensating a TPA, is flat-out illegal. Florida's statutes contain a strict ban on paying an administrator "for any policies in which the administrator allows or settles claims contingent on claims experience," Gallagher, the state finance chief, wrote in response to a CFO.com query. "We view the 'percentage of savings method' an unallowable variation of a payment based on claims experience."

Another possibly perverse incentive cited earlier this year by Paduda in his blog, "Managed Care Matters," is what he calls "the long-established tradition of gifts from managed care vendors to claims adjustors, managers, and other staff, with either an overt or subtle link between the gifts and future business."

A Fair Deal
So how can finance executives keep workers' comp incentives tilting in their companies' favor? To begin, apply market pressure. Every two to four years, executives at Henry Schein Inc., a Melville, New York-based distributor of health-care products and services, put out a request for competitive TPA bids "to see if the administrator is giving us a fair deal," says chief financial officer Steven Paladino.

To unearth potential conflicts of interest, say experts, risk managers should demand that TPAs make a full disclosure of how they're compensated by providers. "If there's hesitation on disclosing that information — or even having a frank discussion — I think that would be a red flag," says Denice Goto, senior director of tax and risk management for Hawaiian Airlines.

Part of that disclosure should include specifying the "markers" that are the basis of percentage-of-savings plans, according to Mark Noonan, the leader of Marsh Inc.'s workers' comp practice. There would be no point in compensating TPAs or vendors for bringing down a doctor's rates to those of a state's fee schedule, since those are compulsory anyway. "Savings should be off the state-mandated rate," adds Noonan.

To keep administrators' feet to the fire, employers should install cost and performance metrics and monitor the TPAs' compliance with them continually, according to Paduda. Self-insured companies should demand that TPAs cap the total administrative expense per claim and break out charges for medical bill reviews and access fees to medical networks, he adds. Paduda also feels that risk managers should keep tabs on the use of nurse case-management services by TPAs; an employer can end up paying both the administrator and the nurse case manager for handling a claim, with the TPA picking up added fees in the bargain.


There are disagreements, however, about whether it's cheaper to have nurses handle cases on the phone or in the workplace itself. While Paduda thinks telephone case management can be more efficient, Carl Koch, the risk manager of United Natural Foods, wants to have the nurse on site. Working for the Danielson, Connecticut-based natural and organic food distributor, an outside nurse case manager coordinates treatment for injured workers at company facilities. "It's more costly, but the return on investment is significant as far as reducing lost time and medical benefits [expense]," says Koch.

The key to holding down those and other TPA-related charges is to have internal managers continually on the case, according to Koch. At United Natural, which is insured under a high-deductible plan, any claim that exceeds $5,000 is reviewed on a quarterly basis by the corporation's claims manager, its risk manager, and a human resources representative of the state in question. A representative of the company's insurance broker, RC Knox and Co., also takes a look.

Despite such vigilance, however, Koch feels the company must rely on a fair amount of faith in dealing with its TPA. While the company's contract with its administrator, ESIS Inc., demands full disclosure of fees or charges, Koch chooses not to delve too deeply into compensation issues. An employer has to have "a comfort level" in its relationship with its TPA, he says; "there has to be trust."




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