More bang for the buck: performance metrics that work; with the soft market of the 1990s just a memory, finding ways to lower the cost of risk is worth its weight in gold

Risk & Insurance, May, 2003 by Mary Montgomery

The reality for risk managers is that their organizations' total cost of risk is probably much higher now than it was a few years ago. In a recent survey, Liberty Mutual found that the two greatest concerns of risk managers were rising premiums and managing the overall cost of risk.

Current market conditions leave risk managers wary. They must deal with soaring medical costs, increasing benefit levels, rising reinsurance costs, poor investment returns and tough availability issues related to terrorism and risk concentration. In this environment, performance metrics can play a greater role managing a risk program.

There's help out there for risk managers who want to ramp up performance measurements. Brokers and agents will identify and monitor specific metrics to improve the performance and structure of a risk management program. They can evaluate a client's risk management program and tell whether it uses the best measurements.

The key questions that need to be answered to develop an effective metrics program include:

* Do the metrics tell senior management how their insurance program is performing?

* Are these measurements being calculated properly?

*What structural changes to the risk program does the performance suggest?

Helping clients answer these questions requires a thorough understanding of performance metrics.

Identifying Metric Characteristics

Performance metrics should be identified with the intent of lowering the cost of risk for an organization. Administrative costs and loss costs comprise the cost of risk. Loss costs claim a larger piece of the pie, typically ranging from 70 percent to 80 percent of the total cost of risk. Administrative costs such as claims handling, taxes and assessments, and risk transfer costs comprise the remaining 20 to 30 percent. Performance metrics should focus on managing loss costs. A good performance metric should also be understandable, quantifiable, credible, cost effective and controllable.

Brokers and agents can help clients integrate performance metrics into a risk management program by following these five steps:

* Identify overall trends.

* Identify loss costs.

* Establish objectives.

* Benchmark results.

* Monitor results.

Calculating Macro Trends

The goal is to identify indicators that track the effectiveness of a risk management program so that the manager can compare his organization's performance against a benchmarked measure.

For example, with a heavy manufacturer looking to evaluate workers' compensation costs, the key measure might be the loss rate per $100 of payroll. Other measures could be the accident frequency per $1 million of payroll, and average cost per claim results. Calculating those trends is critical because incorrect or misleading conclusions occur if the data isn't analyzed in a rigorous way.

Loss and claim count data by year should be projected to ultimate values. If ultimate claim counts and ultimate losses are not available, then the maturities for the years that are being compared must be equivalent.

For example, if you have five years of losses by calendar year, and all of the years are valued as of 12 months then the data would have consistent maturities. The losses by year should be inflation- and benefit-level adjusted to current levels prior to calculating the trends.

Loss and claim count data should then be compared to relevant exposures such as payroll, revenue or vehicle count. If the exposure base is inflation sensitive, historical exposures must be inflation-adjusted to current levels.

Uncovering Costs

Once the macro trends have been analyzed, the next step is to determine the items that have an impact on those trends to explain the performance of a client's risk management program.

The broker, insurer and risk manager should analyze the loss sources and the types of injuries that cost the company money. This analysis must show the cost and frequency of each type of accident.

Looking at claim frequency by location can help identify where costs are highest. Other loss costs worthy of analysis are Preferred Provider Organization (PPO) penetration and medical savings analysis. PPO penetration shows what percent of a client's medical payments are going through a PPO. The objective is to increase PPO penetration, which reduces loss costs. Medical savings analysis demonstrates the savings an insurer has obtained on a client's behalf through managed care programs such as bill review or nurse intervention. Both should be calculated at the company level as well as for individual units, geographic divisions and facilities.

One of the most significant loss cost-drivers relates to the timeliness of claims reporting, or "lag time." A shorter lag time allows the claim manager to communicate earlier with the claimant, direct care more efficiently and begin the return-to-work plan sooner.

If lag time is a problem, steps can be taken to reduce it, such as changing claim reporting procedures and providing online reporting tools. All of these metrics, help determine what factors have an impact on a client's loss costs and where the greatest opportunities for improvement exist.