Connecticut Privatization: Good Idea Gone Bad

February 5th, 2008 by

Workers comp in the public sector is like an iceberg: what is visible from year to year does not really tell you how big the problem is. With the budget funding cycle running fiscal year to fiscal year, there is no incentive to close out open claims. It’s actually cheaper – in the short run – to keep paying on a monthly basis, as opposed to writing one big check to make the claim go away. There is no incentive for a sitting official to settle old claims.
The problem with this approach, of course, is that governments never confront the real cost of comp. The claims “ball” just keeps getting bigger and bigger – a problem, in effect, that is constantly pushed ahead to the next elected official.
Back in 2001 officials with the Department of Administrative Services in Connecticut recognized the problem and tried to do something about it. They made a deal with ACE Financial Solutions, which agreed to assume up to $150 million in potential liability from 660 workers’ comp claims. By privatizing the handling of the claims, the state reduced the number of workers’ compensation cases it was handling and saved $13.5 million in both 2002 and 2003. The state used a bond to raise the funds for off-loading the claims. (A bond spreads the cost over many years, as opposed to making a big hit on the “current” fiscal year.)
In return for assuming the $150 million liability, ACE was paid $80 million. Sounds like a good deal for Connecticut, doesn’t it? Alas, the state failed to follow its own procurement standards and they apparently way overpaid for the privilege of handing off the claims.
Nothing in Reserve
With private insurance, it’s pretty easy to determine the value of claims. You simply take, in this case, the 726 claims, add up the reserves and come up with a number. You cannot really do this in the public sector. With a “pay as you go” mentality, there are no meaningful reserves. You can project how much a claim will cost in a given year, but no one really knows how long the payments will go on and what the ultimate cost of the claim will be.
MRM Consulting,a private firm, was hired to determine the ultimate value of the claims: that’s where the $150 million figure came from. Unfortunately, MRM hired untrained college students to make the estimates, at the attractive rate of $105 an hour. That’s great for the students, but bad for the state. CT Attorney General Richard Blumenthal has determined that the estimated total value of the claims was grossly overstated. Over 60 of the claims included in the estimate had already closed. As a result, the state overpaid ACE and wasted taxpayers’ money.
ACE has paid the state $40,000 to settle a lawsuit by the AG’s office that alleged the company paid an illegal $50,000 commission to brokerage giant Marsh & McLennan to get the workers’ compensation contract. A similar lawsuit by the state against Marsh & McLennan over the deal is pending.
The AG’s bottom line assessment is pretty harsh: “Privatization spawned inefficiency, incompetence and increased costs. We must reform conditions – lack of funding and procedures – that led to this bungled deal.”
The Right Way
Privatization is really a good idea. When it is done right, it can save state and local municipalities a lot of money. But you need good fundamentals in three key areas: a professional assessment of the value of the claims; an open and competitive procurement process; and strong management oversight from day one. Yes, you can privatize the handling of claims effectively, but the need for good management does not end with the awarding of the contract. Indeed, good management looks for accountability and performance every step of the way. Privatization is not an invitation to wash your hands of a problem, but to partner with a competent vendor to achieve mutual goals.