Claims Against the Claims Handlers Under Large Deductible Workers' Compensation Insurance Policies
| Publication year | 2017 |
| Citation | Vol. 2017 No. 2 |
| Author | David A. Shaneyfelt |
David A. Shaneyfelt
David A. Shaneyfelt represents businesses in disputes against insurance companies under a variety of policies, including employment practices, general liability, directors and officers, and worker's compensation. A former trial attorney with the U.S. Department of Justice in Washington, D.C., he practices with The Alvarez Firm in Calabasas, California - www.alvarezfirm.com.
Large deductible workers' compensation insurance policies arose in the late 1980s and early 1990s following a market crisis in which employers were unable to obtain required workers' compensation coverage from private insurers. The concept is simple. Employers can greatly reduce the amount of workers' compensation premiums they pay for employees if they agree to assume a large portion of the risk themselves—through a "high deductible" (commonly between $250,000 and $500,000)—after which insurance assumes exposure for amounts above that deductible.1
Under this notion, incentives exist for both employers and insurance companies to control costs incurred in managing workers' compensation claims. Because the employer is assuming risk on a dollar-for-dollar basis up to the limit of a high deductible, the employer has an incentive to ensure that workers' compensation claims are handled reasonably. Moreover, the employer has an incentive to keep the claim from exceeding the deductible, because the employer's subsequent risk ratings will normally increase when a claim exceeds the deductible, which will translate into higher premiums in subsequent policy periods. At the same time, once a claim exceeds the deductible, the insurance company has an incentive to handle the claim reasonably, because it is absorbing costs above the deductible.
But the critical feature of large deductible insurance policies is claims handling done for a fee charged to the employer. Because most employers lack personnel or expertise to adjust workers' compensation claims, they are eager to accept the offers of insurance companies to adjust those claims on their behalf. Under the typical arrangement, the insurance company (or its delegatee, a "third party administrator") undertakes the full scope of claims management—investigating the claim, challenging coverage if appropriate, managing medical treatment, reviewing medical bills, negotiating liens, seeking apportionment from third-parties, adjusting reserves, and settling claims.
The insurer advances expenses for such services under security (typically, a letter of credit) that the employer posts in case of default on amounts due. The insurer then bills the employer for services provided, and a tally is kept until the expenses reach the deductible. After the deductible is met, the insurer absorbs all remaining expenses itself (unless the policy arranges for the employer to share some percentage of ongoing expenses). Underwriters at the insurer determine the premiums to be paid, so this arrangement is suitably profitable for the insurer.
But trouble arises when the employer suspects the insurer is not adjusting the claims reasonably. What confidence does the employer have that the insurance company, with its interlocking bureaucracy of contractors and subcontractors and its own scale of profit for claims handling, is adjusting claims reasonably? As far as the employer is thinking, "It's easy to spend money when it isn't yours."
[Page 7]
Surprisingly little case law exists regarding employers' claims against insurance companies under large deductible insurance policies. The reasons for that are many: the difficulty in proving mismanagement of claims, the ebb and flow of market forces that allow employers and insurance companies to renegotiate policy premiums in subsequent years, an employer's tendency to view losses as "sunk costs," an insurance company's reluctance to pursue collection efforts against an employer beyond a draw of a letter of credit, the existence of mandatory arbitration provisions, and, most importantly, whether the amount at issue is worth the costs of litigation in trying to recover it.
But sometimes the losses at stake compel a judicial resolution. Losses come in at least two ways. First, workers' compensation claims can be expensive to both administer and settle. Multiple claims mean multiple claims management expenses, and if mismanagement has occurred on multiple claims, the employer ends up paying considerable out-of-pocket expenses that it should never have had to pay. For example, claims mismanagement on just twenty claims files that each have a $250,000 deductible can mean losses of up to $5 million. Second, the more claims management expenses an employer incurs, the more its premiums will increase in subsequent policy periods. Workers' compensation premiums are typically set in reference to experience modification rates (called "Ex Mod" rates) assigned to classes of employees. The higher the amount of claim expenses, the higher the Ex Mod rate in subsequent years. Claims mismanagement results in higher premiums because of higher Ex Mod rates. Even a small bump in an Ex Mod rate can result in a significant premium differential, given a sizeable workforce.
In addition, because big workers' compensation claims take years to resolve, amounts wrongly paid over time can result in large interest losses. Finally, the employer can sustain various tangible and consequential losses if the insurer wrongly draws on the letter of credit or other security. When losses like these occur, and the insurance company refuses to acknowledge them, an employer may find it has no choice but to seek recourse through litigation to recover its losses.
As even the scant case law in this area confirms, general principles of insurance law govern the relationship between the employer and the insurance company accused of claims mismanagement.2 The relationship is one of contract, and policy terms generally control. What makes claims against an insurance company under a large deductible policy unique is that such policies are a hybrid between first-party and third-party liability insurance.
The policy is a third-party policy to the extent it requires the insurer to defend and indemnify the employer against workers' compensation claims. Workers' compensation policies often contain a clause that provides, "We have the right and duty to defend at our expense any claim, proceeding or suit against you for benefits payable by this insurance." In cases involving a policy with such a clause, the duty to defend is...
To continue reading
Request your trial