Workers' compensation costs have escalated at an alarming rate during the past ten years, thereby reducing the availability of workers' compensation coverage. This crisis has been caused by the increasing cost of medical care, excessive legal disputes, liberal court awards in what is supposed to be a no-fault system, broadening definitions of job-related injuries, and rampant fraud and abuse.
    For instance, employers' premiums for workers' compensation have increased from $22.3 billion in 1980 to an estimated $56 billion in 1990. During the same period, the average medical cost per claim rose from $1,748 to $6,611. Further, the medical cost per injury paid by workers' compensation insurers has increased an average of 14 percent per year, compared with seven percent for the medical component of the Consumer Price Index. Medical expenses account for approximately 40 percent of all workers' compensation outlays, up from 33 percent a decade ago. Additionally, the wage-replacement cost, paid by insurers to cover an injured employee's salary during the time missed from work, has increased 11 percent per year, compared with five percent for average weekly wages. In 1980, the average wage replacement cost per claim was $4,390 compared with $12,833 in 1990.
    Since the mid-1980s, the two major cost drivers have been litigation and new types of compensable injuries. For many states, injured workers routinely retain lawyers to handle their cases even though the system was designed to be no-fault.
    Six states -- California, Hawaii, Michigan, New Jersey, Kentucky, and West Virginia -- now recognize stress as grounds for a workers' compensation claim. Many other states recognize cumulative trauma injuries, such as carpal tunnel syndrome which involves painful nerve damage in the wrist.
    Stress and cumulative trauma injuries pose enormous problems in determining both job relatedness and the extent of injury. This uncertainty invites fraud and abuse as well as protracted litigation
    The asset-based debtor (ABD), if not generally, then certainly during the depressed economic times of the past few years, dwells in an environment characterized by skinny profit margins and tight cash flow. Therefore, remedial action is imperative and should be strongly encouraged by the asset-based lender (ABL), if the enterprise is to survive this crisis and repay the asset-based loan. This article identifies four areas of the risk management function to which this corrective action is warranted: risk financing, loss prevention, cost containment/claims management, and broker/agent's service.

Risk financing
    Even with prudent loss-prevention procedures employed, there will always be workers' compensation claims. Thus, it is paramount that the optimal risk-financing program be implemented to finance these risk costs (premiums, retained losses, and administrative fees). However, the determination of the optimal program is a disconcerting exercise, because the list of alternative risk-financing options is almost endless and the optimal program for one company may not be the optimal program for others.
    The following is a representative sample of the available risk-financing programs. This list can increase dramatically as these basic options are embellished.

     Before jumping in feet first, the number of alternatives should be reduced to a few plausible options for further evaluation. To do that, it is necessary to consider the entity's financial profile and operational requirements.
    The major financial and operational characteristics that should be considered in choosing and designing the program are:

     Once the feasible alternatives have been identified, the evaluation and decision should be based on the net present value (NPV) cost The option with the least net present value cost should be selected for implementation. Specifically, the after-tax cash flows associated with each program design are discounted using the entity's after-tax cost-of-borrowing rate to determine the NPV cost.
    Because of the limited sources of equity and debt financing, the ABD has been plagued with two sources of distress -- inadequate cash flow and meager profit margins.
    Thus, the optimal program is one that affords deferral of risk-cost payments, mitigates fixed costs, (residual market loads/premium taxes), and limits overall costs at an acceptable level.
    Despite this environment in which these businesses operate, there appears to be a preponderance of risk-financing plans such as the guaranteed-cost program, which maximizes the cost-containment objective (the policy year premium is fixed and not impacted by current loss experience) at the expense of the cash-flow objective. Further, a number of concerns, because of their size, find themselves in a loss-sensitive program such as the incurred-loss retro, which exacerbates the cash-flow shortage and does not contain risk-costs as effectively as the guaranteed-cost program.
    The program that optimally satisfies these objectives (defers risk-cost payments, mitigates fixed costs, and limits total costs to an appropriate amount) is the self-insurance wraparound. This program, designed for companies with a concentration of employees/loss exposures in several states, is an integration of workers' compensation qualified self-insurance, workers' compensation deductible plans, and paid-loss retro programs. Specifically, the company becomes a qualified self-insurer for workers' compensation in the selected state(s). The workers' compensation exposures in states not chosen for self-insurance are financed/insured in a paid-loss retro and/or deductible plan if a deductible plan is approved in the subject state(s). The deductible plan eliminates premium taxes, including residual market loads (RML) on losses within the deductible layer.
    The insurer provides all services (loss control and claims administration) associated with a paid-loss retro or deductible program including services in the self-insured state(s). Additionally, the insurer will provide specific and aggregate excess insurance for the self-insured portion of the program. Through this program, payments are deferred until the claimant is compensated (this often takes ten years or longer); fixed costs, premium taxes, and RMLs are mitigated; and the tailoring of the specific and aggregate excess attachment points caps costs at a level that is compatible with the ABD's risk tolerance.  
    Although the self-insurance wraparound optimally addresses these generic needs of the ABD, a specific company's operational and financial characteristics may preclude its implementation. As stressed previously, these parameters must be thoroughly evaluated before rushing to conclusions.
Loss-prevention
    Loss-prevention may be defined as any conscious action intended to reduce the frequency of loss. Loss reduction, sometimes referred to as cost containment/claims management, is any action taken to reduce the severity of losses. Together these two disciplines constitute loss control.
    When one considers that incidental costs (e.g., lost time of the injured employee(s) and other employees, damage to machinery, tools and other property, and interference with production) have been found to be four times as great as the compensation benefits themselves, loss-prevention is the most effective workers' compensation cost-containment program. Yet, a number of small businesses allocate far too few resources and effort to loss prevention.  Additionally, many companies misdirect resources into programs that either are not effective or react to losses after losses have occurred.  The reason for this dilemma is that few entities have an accounting system to measure the costs and benefits of the loss-prevention function.  Therefore, the mindset, "If you can't measure it you can't manage it," develops. This is another area that ABL ignores much to its detriment.
    A cultural change is needed in most small business organizations to make significant headway in loss-prevention. First, all companies must recognize that accidents and losses are caused and most are cost-effectively preventable. Thus, the loss-prevention function must be managed as well as other aspects of the business, such as sales, production/ operations, accounting, and legal. Some suggested actions include:

    To be effective, the loss-prevention program must be anticipatory, not reactionary. Senior management must ensure that a concerted effort is undertaken to identify and analyze all the risks a business faces. Priorities must be established to address those risks that threaten the company's survival.

Cost containment/claims management
    While loss prevention is geared to reducing the frequency of loss, it does not eliminate all possibility of loss, and it does so without necessarily having an effect on the severity of loss. Consequently, loss-reduction/cost-containment measures must augment loss-prevention practices.
    In the employee benefit arena, a number of loss-reduction/cost-containment procedures have been successfully adopted to cope with the runaway cost of healthcare. However, in the workers compensation environment, employers have done little if anything to contain the cost of medical treatment for their injured employees.  Explained below are several suggested cost-containment procedures.

· Fee schedule compliance A number of states have legislated fee schedules for treatment of workers' compensation injuries and illnesses. The employer and/or the claim adjuster should monitor medical care charges for compliance with the fee schedules;

· Designated provider Several states permit the employer or insurer to direct the injured employee to a preselected healthcare provider. When: permitted, this option should be exercised, as it is conducive to discounted rates if usage is frequent enough to justify the discount.

· Managed care/utilization review This follows a case through the treatment process. It involves analyzing the case to see what type of treatment is necessary, for instance, second surgical opinions and hospital pre. admission authorization. It also involves a concurrent review if the injured worker is hospitalized. This review is normally performed by a registered nurse (RN) and typically begins with pre certification of a hospital stay for an initial specified length of time. The RN then works with the physician to monitor the length of stay and determine if other alternatives to hospitalization are available, such as home care and rehabilitation therapy.

· Audit medical bills Hospitals have a history of improper invoicing practices. Consequently, to assure accuracy, invoices should be audited for accuracy as to diagnosis and procedures employed in the treatment of injuries and illnesses.

    Extended absences and litigation exacerbate the spiraling medical portion of workers^' compensation. The following procedures can reduce the convalescence period as well as medical costs and preclude unnecessary litigation:
· Empathy and frequent communication The workers' compensation system is a no-fault arrangement. An injured worker is entitled to prescribed benefits regardless of the employer's negligence. However, if the injured employee perceives that the employer is unconcerned, a sense of abandonment develops, which usually precipitates litigation. The end result is longer absenteeism and increased settlement costs. An attitude of caring coupled with frequent communication will preclude the insecurity, anger, contempt, litigation, and prolonged absenteeism;

· Modified work program The injured employee returns to work in a modified capacity until fully recovered; and

· Psychological counseling Occasionally, counseling motivates individuals to return to a life close to normal or return to work in the same or substitute capacity.

    The optimal course of action after a severe injury is immediate medical care, followed by the best available treatment. Quality care gets the injured person back to work faster and can help hasten a full recovery. This can have the greatest effect on reducing overall workers' compensation costs, not just the medical expense, but also the amount of compensation paid (indemnity payments).

    If it is to be successful, the claim function must be properly managed whether it is performed by the insurer or a third-party administrator. The claim activities must be clearly defined in a service agreement at the program's inception and periodic. ally monitored for compliance with the service agreement. Specifically, the reserves on several claim files, both large and small, must be reviewed for propriety. The monitoring process should be performed by an employee of the business in conjunction with the agent/broker. The frequency of the review process depends on the frequency of losses. However, at a minimum, it should be performed twice per year.
    As the old saying goes, "You can delegate, but you can't abdicate responsibility." Thus, it does no good to design an effective cost-containment program if it is not properly managed.

Broker/agent role
  
To effectively combat the workers' compensation crisis, a proactive posture is essential. Consequently, the broker/ agent must do more for the enterprise than just place insurance coverage. Specifically, the agent/broker should work in tandem with the company to identify/project the workers' compensation exposures/losses and design a risk-financing program (including the retention limit and amount of excess coverage) that satisfies the entity's objectives. It is incumbent on the insurance professional to seek out and engage the underwriter(s) and service provider(s) that are best qualified to execute the designated program. Additionally, the broker/agent should augment the service providers' efforts in the loss control and claims administration areas. Finally, the agent/broker should monitor the program's effectiveness, providing the necessary remedial action and ongoing communication with the ABD/client. Services typically provided by a full-service broker/agent include:

    Considering that the commission rate for workers' compensation ranges (rates decline as premiums increase) between three percent and eight percent of premium, it is apparent that the full-service agent/broker is providing these professional services at a loss. To ensure the continuation of these professional services, the company should consider a fee-based remuneration arrangement that adequately compensates the broker/agent.
    A number of states are in the process of reforming their workers' compensation system. However, this is a highly contested political process that reflects the conflicting interests of the medical and legal professions in addition to the inherent conflict between labor and management. Therefore, the crisis is likely to worsen before it gets better. Nevertheless, the ABD and its ABL do not have to be a victim of the workers' compensation crisis. If entrepreneurs, with strong prodding by the ABL, take an aggressive approach to risk financing, loss prevention, cost containment, claims management, and broker/agent services, the ABD, and its corollary, the ABL, will survive the storm with tolerable financial damage.

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