How To Benchmark Loss Control

HOW TO BENCHMARK LOSS CONTROL

Use this proven method to measure the effectiveness of your clients’ risk management programs.

Loss control programs play a key role in helping your clients manage their risks. Although these programs offer significant benefits, calculating their impact can be difficult. One effective method involves an analysis of losses versus payroll. To calculate this result, called the pure loss rate, develop reported losses for each of several years to an ultimate level, and then trend these losses to a common date using benefit level, payroll, and medical costs. Comparing these adjusted losses with similarly trended payrolls yields a credible pure loss rate for each year.

Here’s an example that shows how to choose a benchmark and track improvements in loss experience. First, calculate pure loss rates for five to seven years before the implementation of the loss-control program. Second, select a reasonable pure loss rate based on the historical data.

Although the average might not be a good choice as a selected rate, in this case it makes sense because of the small range of rates. In real-life situations, the choice of pure loss rate requires careful judgment — otherwise the task would be assigned to a computer. This example uses the benchmark of $3.75 to show the potential dollar impact of the loss-control program. It can’t show the actual impact because there will be variability from year to year, and there can always be random good and poor years.

Continuing with this example, assume that the program was implemented in 2003 and the results have been positive.

The loss experience for 2003 certainly looks like an improvement. The rate of $3.27 is outside the range of $3.57 to $3.94, in the previous five years. However, one year might be due to random good experience. The 2004 rate supports the idea that the loss program is working. The good experience for 2005 indicates that a trend has indeed emerged.

This is certainly good news — but how do you measure how good? If you assume that all improvement is due to the loss program, then go back to the benchmark pure loss rate of $3.75. The improvements over the last three years are $0.48, $0.81, and $0.98, respectively. For every $10 million of payroll, this is a savings of $227,000 ($48,000 + $81,000 + $98,000) during the three years.

You can use this type of analysis to calculate additional compensation for the group in charge of the program based on a percentage of the savings. However, be aware that: (1) It takes several years to complete a credible analysis; (2) the improved loss experience might not be due to the loss program; and (3) a system of checks and balances is needed to ensure that claims haven’t been manipulated.