The "Ins and Outs" and "Ups and Downs" of Worker's Compensation Commutations: Motivations, Pricing and Disputes 

By Michael Goldstein, Mound Cotton Wollan & Greengrass 

Matthew Moore, Senior Solutions Specialist, Inpoint (an Aon business), moderated this panel of commutation veterans who promised to delve into the many facets of worker’s compensation commutations. The panel consisted of Holly Drake, AVP, Head of Asset Management North America – Group Reinsurance, Zurich North America; Gregg Frederick, Executive Vice-President – Reinsurance, Legion Insurance Company (in Liquidation); Ben Gonson, Partner, Nicoletti Gonson Spinner LLP; James Kleinberg, Senior Solutions Specialist, Inpoint; Michael H. Goldstein, Partner, Mound Cotton Wollan & Greengrass LLP; and Andrew Rapoport, Managing Director, Aon Benfield Analytics.

Mr. Moore introduced the panel of distinguished reinsurance practitioners and Holly Drake and Gregg Frederick kicked things off by providing an insightful overview of the commutation issues at play.  These presenters focused their discussion on the relevant parties’ motivations to commute and broke them down into the following categories:

  • Finality;
  • Cedant’s motivation and considerations to commute (e.g., solvency of assuming reinsurer, ability and willingness to pay, etc.);
  • Assumed reinsurer’s motivation and considerations to commute (e.g., solvency of cedant, GA claim handling, ability to control costs and assert offsets, etc.);
  • Contract language (commutation and sunset clauses) that forces commutation;
  • Distinguishing between treaty and facultative; and
  • Arbitration feasibility.

Aon’s Andrew Rapoport and James Kleinberg then presented their in-depth “Tabular Claimant Model,” which applies discounts based upon a mortality or morbidity table. This is to be differentiated from non-tabular discounts, which are determined from aggregate payment patterns rather than mortality tables. The presenters then walked the group through the relevant specific and global assumptions and factors and presented an illuminating “base case” valuation. 

The Aon presentation concluded with its “key takeaways,” which were presented as follows:

  • A few large claims will drive treaty settlement costs;
  • The impact of assumptions is dependent on how close payments are to the layer:
    • In or close to the layer -- Small impact;
    • Far below the layer -- Big Impact;
  • Annual medical rates and medical escalation get costs into the layer;
  • Mortality and discount affect costs in the layer; and
  • Contract wording affects calculations.

Ben Gonson made the next presentation and provided additional insights into the significance of commutation clause wording and stressed that not all commutation clauses are created equal. Mr. Gonson walked the audience through several examples of commutation clauses that he has come across over the years and broke down what can set them apart as follows:

  • Voluntary/compulsory spectrum;
  • Who has the option to invoke the clause?;
  • Commute individual losses versus entire WC exposure to the reinsurance agreement;
  • Definition of “Reserves” in the clause;
  • Multiple years of contracts – differing language;
  • Contract language applicable to dispute resolution; and
  • Relationship with “Sunset Clauses.”

Mr. Gonson then explained the role of “Sunset Clauses,” provided some typical examples of them, and explained their interplay with the commutation clause itself. His presentation concluded with the results from a March 2011 AIRROC actuarial survey regarding discounting for commutation in which 77% of the thirty respondents answered that they compute projected costs in the layer and then discount the layer (in the P&C context).

Michael Goldstein rounded out the morning’s presentations and provided a comprehensive cross-section of recent arbitration panel and U.S. District Court opinions to examine commutation and sunset clauses in the worker’s compensation context. The three court cases that began in arbitration illustrate some of the problems and pitfalls of arbitration.  For example, in Underwriters at Lloyd’s v. PARG, the U.S. District Court for the District of New Jersey examined the underlying panel award, which had spelled out what it considered to be examples of mandatory commutation provisions and required the parties to calculate the claims under the applicable treaties accordingly.  Because of perceived ambiguities in the Award, the parties landed in court. 

The District Court remanded the dispute to the arbitrators in order to answer the following questions:

  • Of the 24 treaties that are in dispute between the parties, which ones, specifically, fall within the parameters of the panel’s Final Order?
  • With respect to calculating the value of the commutations contemplated by the Final Order: On its face, the Final Order requires only that the parties perform certain calculations.
    • Did the panel intend to order only that the parties perform calculations, or did the panel intend to order that the parties come to an agreement on the value of the relevant commutations? (Or, alternatively, did the panel intend something else?)
    • If the panel intended that the parties agree, then what is the effect of the Final Order if the parties cannot agree?
    • Assuming that the parties do not agree, and mindful that the COURT’s only role is to confirm and enforce the award – not to engage in independent fact-finding – how did the panel foresee resolution of this dispute? In other words, by what formula must the parties calculate the damages contemplated by the Final Order?

The same District Court closely analyzed sunset/notice of loss clauses in the worker’s compensation context.  Mr. Goldstein concluded the panel by discussing several other recent holdings involving commutation disputes arising from sunset clauses and valuation, as well as tensions between standard arbitration clauses and valuation by neutral actuaries.