A version of this article appeared in Risk & Insurance Magazine

In 1977 Stanley Zax with some colleagues bought Zenith National Insurance Company for $10 million. Wall Street’s market value of the Woodland Hills, CA based company in late 2004 was about one billion dollars. Premium revenue is approaching a billion dollars, making the firm one of the largest for-profit monoline workers comp insurers in history.* It issues only guaranteed plan policies. Most of its business is in two of the highest cost states in the nation, California and Florida. Zenith’s combined loss ratio (claims and related expenses divided by premium income) for its California business has trended about 20 points below the average for workers comp insurers. I met with him to find out he does it.

If there is a word to capture his success it is “transparency” in financial controls.

Each month, Zax receives each month a one-page report which he uses as a variance analysis to catch departures from targets for operating results. The report shows the expected incurred losses of fresh claims, the total of reserve increases, and reserve deceases that were recorded in the prior month. Separated out are reserve increases from reopened claims.

Zax holds that if the initial reserves are appropriately set, then he can apply a management standard that future reserve reductions should exceed, or at least match, reserve increases. If monthly reported reserve reductions come in increases, this is an adverse variance that must be accounted for. Initial reserving might have been too low. Laggard claims handling may have allowed costs to float up. Claims settlements may be too generous. Medical inflation, over which the company has limited influence, may be a factor. Zax uses the variance report to force a search for corrective action.

Monthly discipline has the effect of continually auditing and reporting on the integrity of the initial reserves placed on claims. This transparency helps Zenith to guard against two mortal sins of a workers comp carrier -- tolerance for low ball premium quotes in order to “get the business”, and denigration of claims as a back office clean-up operation.

Zax’s message is this: if claim reserves reflect the best estimates, policies are priced appropriately and claims are handled proficiently, satisfactory end results are almost assured. This formula works particularly if competitor’s internal laxity forces them to price higher. This has not always been the case in California, where recently a giant state-run insurer, low-balled the competitive market, ultimately contributing to the worst workers comp crisis of any major state since the early 1990s. While Zenith cannot immunize itself from the destructive forces of the marketplace, Zax holds out that Zenith can do relatively better in all market conditions. For instance, he says can make money in California regardless of what if any reforms take hold.

His way is a departure from the siren song, which transfixes many of whom Zax refers to as “the lunch club,” that a workers comp insurer is essentially a vehicle for sponging up premium dollars for investment. In this model the head of claims not much more than a human file cabinet which way stations claims files from their creation until their final internment. In contrast, Zax views each claim as a fountain of profit or loss.

I asked a claims executive, a veteran of several large insurers, to comment. In his view, so many factors drive claims costs that any simple formula comparing initial reserves to end claims cost is not very reliable. His performance is evaluated through several measures such as compliance with procedures, claims duration, and loss costs. A seasoned TPA executive in California told me that Zenith’s focus on claims reserve accuracy was right on – the lynchpin to profits, according to this executive.

Within the ranks of workers comp executives Zax is an acquired taste – a blunt talking contrarian, who has filled his board with luminaries far beyond the confines of insurance. Let’s see how he does as California’s workers comp market starts a new cycle of rate competition. Let’s see if he can grow this company to $2 billion in premiums by the end of the decade.

The article was written in late 2004. As of March, 2006, revenues were $1.3 billion and market capitalization was $1.85 billion.