Understanding the Kelly Decision and Total Benefit Theory By Brian Marx, CPCU, CSRP, New Jersey Chapter of CPCU, Florham Park, New Jersey

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1 Understanding the Kelly Decision and Total Benefit Theory By Brian Marx, CPCU, CSRP, New Jersey Chapter of CPCU, Florham Park, New Jersey This article is a sequel to my prior article, New York Workers Compensation Subrogation in the Winter 2005 Subrogator magazine, which provided the subrogation landscape for both auto and non-automobile losses for which New York workers compensation benefits are paid. Some of the concepts and sections of the New York law discussed in that article are applied in this one. The purpose of that first article was to create an awareness of a carrier s subrogation rights, but made no attempt to discuss what the actual recovery would be or how it is calculated. The purpose of this article is to explain how to calculate a carrier s recovery, reimbursement and credit, under the New York subrogation law when it asserts a lien against either a third party auto or non-automobile liability claim brought by the claimant and the workers compensation case is not judicially closed. Specifically the landmark case, Kelly vs The State Insurance Fund, 1 is discussed in four scenarios, which will enhance the understanding of its application, purpose, pitfalls and nuances. The application of Kelly is one of the most misunderstood aspects of the New York subrogation law. The decision modifies, or perhaps clarifies, Section 29(1) in the respect that Section 29(1) entitles the carrier to a lien on any recovery (for auto losses see prior article and discussion of Section 29(1a)) and requires that such expenditures (reasonable and necessary to effect recovery) shall be equitably apportioned by the court between the employee or his dependents and the lienor. 2 Kelly gave new meaning to the terms equitable apportionment and lien. Many would construe, and did before 1983, that both terms only apply to the current lien (i.e., benefits paid at the time of the third party settlement). However, Kelly introduced the Total Benefit Theory, a doctrine which states that a carrier must consider its total payout (i.e., both current and projected future benefits) when calculating its equitable (pro rata) apportionment of total expenditures (attorney fee and expenses of suit) paid by the claimants attorney to effect a third party settlement. The purpose of this decision is to require a carrier to pay an equitable share of litigation costs on all benefits paid and not get the benefit of only paying their share of expenditures on their current lien. Under Kelly, the lien is the total benefits expected to be paid to resolve the workers compensation case. In theory, neither the claimant nor the carrier should be concerned about the timing of the resolution between the third party and workers compensation cases; regardless of which case settles first, the carrier will be contributing the same amount. In practice, the case studies will discuss why the Total Benefit Theory redounds to the detriment of the carrier most of the time and why, therefore, a carrier should not be indifferent regarding the timing of the third party and workers compensation cases. The remainder of this article will present the formula itself, provide an analysis of the Total Benefit Theory, discuss its parameters and offer a spectrum of cases, each with a unique twist that applies the concepts discussed previously. The Kelly Formula Cash = current pay out - [(present value of total benefit)] x pro rata share of expenditures where Present value of the total benefit = current pay out + present value of the future exposure and Pro rata share of total expenditures = (attorney fee + expenses) / gross recovery

2 Restating the Formula Cash = current pay out - [(current pay out +present value of future exposure)] x pro rata share of total expenditures One important note: the calculation is only necessary when there is measurable, quantifiable future exposure. When the workers compensation case is closed or payment of future benefits is speculative, the current/final payout (which equals the total benefit) is reduced by a pro rata share of the total payout. Kelly Decision and Common Fund Theory Many jurisdictions maintain the common fund theory (sharing of legal expenditures by all parties benefiting from third party litigation) when a carrier asserts a statutory lien against a liability claim brought by a claimant. Thus, by definition, the carrier s contribution towards total legal expenditures is in direct proportion to the gross recovery, because the amount of the gross recovery has a direct relationship to the benefit the carrier derives from the liability settlement: reimbursement for benefits paid and/or credit against future benefits. The Kelly decision is based on the same premise, but goes a step further, requiring the carrier to contribute to legal expenditures based upon not only what it paid at the time of the liability settlement, but also its projected future benefit obligation. Unfortunately, the formula set forth in the decision yields inconsistent reimbursement and recovery results to the carrier. These results are a function of the amount of the gross recovery relative to the amount of the total benefit-two parameters that have no relationship to each other. Each is derived from two different types of remedies - negligence-based and no fault-based - with different valuation methodologies. The case studies below will show quantitatively why a carrier may end up obtaining little or no reimbursement in circumstances when the gross recovery is either some multiple of the projected total benefit or amount paid by the carrier at the time of the liability settlement. In the end, the carrier is left with a large credit against future benefits, however, much of the total available credit will go unused, since it will be larger than the future exposure. In other words, increases in the total available credit resulting from the dollar-for-dollar reduction to the current amount paid yields no benefit to a carrier. Parameters to the Kelly Formula Maximum reduction to current payout Many practitioners do not realize that there is a cap on the reduction to the current payout, which is the lower of the following two figures: the pro rata rate multiplied by the present value of the total benefit or the total legal expenditures. In short, a carrier can never be required to contribute more than the total legal expenditure to effectuate a third party settlement. Estimating future benefits Future indemnity benefits are far easier to estimate than future medical benefits, especially when the claim has been adjudicated or a settlement reached between a carrier and attorney. It behooves the claimant s attorney to inflate his or her estimate of future benefits, since this increases the total benefit and reduces the carriers reimbursement-with the possibility of no additional usable credit to the carrier. Collaboration with the workers compensation examiner (if different than the person handling the lien resolution) is crucial. If the workers compensation claim was not finalized, for example via a section 32 settlement, the claimant s attorney will probably argue or allege that his or her client will or may need future treatment. Scrutinize the medical reports for treatment recommendations and a prognosis, as well as the last date of treatment and the possibility of subsequent employment.

3 In conjunction with a file review, case law addresses the issue of how to handle future medical treatment when the Kelly calculation is involved and the distinct possibility that attorneys may artificially distend their projection of future medical treatment solely for the purposes of negotiating the lien. Medical treatment that is considered speculative should be excluded from the lien calculation. In Briggs, the court determined that future benefits must be quantified by actuarial or other reliable means. 3 In Donaldson, the court ruled that future medical procedures and their costs are matters to be determined by the Workers Compensation Board if and when the plaintiff applies for that intervention. 4 It is clear that unless the claimant s attorney can clearly demonstrate other than by merely presenting a medical report from one of his examining experts used to litigate the liability case that future treatment can be quantified by a reliable means, future medical treatment should not be included in the total benefit. The carrier is entitled to due process and should challenge this issue before the Workers Compensation Board. All that extra investigation and time protects carriers from willy-nilly, specious medical cost projections. Fresh cash Fresh cash, payment of cash in addition to a waiver of the reimbursement (not lien), is definitely a dirty word in the lexicon of workers compensation subrogation. The notion of fresh cash arises when the result of a Kelly calculation is negative (see case #2). There is some judicial support in Wood, where the court alluded to a fresh cash situation by stating that the possibility that, the offset exceeds the lien is not abhorrent to this court. 5 Interest rate and pro rata rate The interest rate used to discount future benefits can have a profound impact on the results of the calculation; the discount rate has an inverse relationship to the present value figure and direct relationship to the reimbursement figure: a higher discount rate lowers the present value of future benefits and provides a more favor result for a carrier. In practice, six percent is customary and discount tables are readily available to make a present value calculation based upon the claimants attained age. The calculation of the pro rata rate is based upon the language in the fee agreement between the claimant and counsel. The fee may be a percentage of the gross settlement or net settlement (applied after expenses). As opposed to interest rate, the pro rata rate is inversely related to the amount of the reimbursement, if any: the higher the pro rata rate, the lower the reimbursement. Negotiation Strategy As the title of this article indicates, understanding the Kelly decision and other cases that provide guidance to its interpretation is paramount to effectively analyzing, quantifying and negotiating a New York workers compensation lien when the claim has a quantifiable, determinable future exposure. In addition to insight about the parameters and inconsistencies - what they are and when they arise - afforded by the formula, there is one main strategy and mantra before commencing negotiations, always ask for your adversaries proposed lien resolution first. Never provide your analysis and position first. As stated repeatedly, the formula and theory/doctrine of the Kelly decision promulgates a goal-to ensure that the carrier pays it equitable portion of total legal expenditures. To accomplish that goal, one must make estimates about the future based upon current information, numerical estimates and opinions. Therefore, adversaries, with information from the same loss, most likely will arrive at different results about what each feels is fair and equitable. In short, do not bid against yourself - let the other party reveal its hand first. Case Studies

4 We will consider the application of the formula first under strong liability scenarios for both non-auto and auto cases and then two more when liability is tenuous. Assume the attorney fee is calculated net of expenses and there are no existing indemnity benefits for which the scheduled loss of use award (SLU) can be credited against. Case #1 Non-Auto (good liability, SLU award) Gross recovery: $400,000 Current lien: $53,000 Attorney fee: $130,000 (390,000/3) Expenses: $10,000 Future exposure: $45,000 scheduled loss award Pro rata rate: ( )/400 =.35 Cash = 53,000 - [(53, ,000)] x.35 Cash = 53,000-34,300 Cash = $18,700 Under this scenario the carrier receives $18,700 and a total available credit of $241,300 (400, ,000-18,700). The following occurred: 1) The carrier received 20% less cash and total recovery as a result of Kelly. Without Kelly, the carrier would have received $34,450 (53,000 X.65). The dollar-for-dollar increase in credit resulting from the $15,750 reduction in cash provides no benefit to a carrier because the future exposure, $45,000, is substantially less than the total available credit. 2) The carrier paid more than its 35% total expenditures. Under Kelly, the lien is actually the total benefit, since this is the figure the carrier must use in calculating its reimbursement. The carrier actually reduced its lien by 81% (18,700/98,000), not 35%, paying a disproportionate share of legal expenditures. 3) The $79,300 (98,000-18,700) reduction to the total benefit/lien is more than half the total legal expenditures of $140,000. Considering the carrier only received a 25% recovery (98,000/390,000) from the settlement as compared to the claimant s 41% (162,000/390,000), 6 the carrier contributed more than it received from the settlement. Case #2: Auto Loss (good liability, SLU award) Using the same figures as the non-auto loss, the carriers reimbursement on its lien for the bodily injury claim will be: Cash = 3,000 - [(3, ,000)] x.35 Cash = 3,000-16,800 Cash = -$13,800 Two factors differ in the auto loss as compared to non-auto loss. First, the total benefit is reduced by $50,000 pursuant to Section 29(1a) of the New York Workers Compensation Statute. That is, there is no lien on the first $50,000 of combined medical and lost time benefits on the bodily injury claim. However, all is not lost if one of the autos qualifies for Loss Transfer; in that case the carrier can pursue reimbursement for the first $50,000 through Arbitration Forums Inc. (AFI).

5 Second, the cash figure is negative, which creates the possibility that the carrier may not only end up waiving its reimbursement (not its lien), but also pay fresh cash in the amount of $13,800. Case #3: Non-Auto (poor liability, classified award) Gross recovery: $80,000 Current Lien: $53,000 Attorney fee: $24,500 (73,500/3) Expenses: $6,500 Classified rate: $200/week Age: 54 Present value of future exposure at 6%: 52 x x 200 = $117,000 Pro rata rate: (24, ,500)/80,000 =.3875 Total benefit: 53, ,000 = $170,000 Step #1: Compare lower of two figures. Pro rata of PV of future exposure: 170,000 x.3875 = $65,450 Total legal expenditures: $31,000 Step #2: Take the lower of the above figures and subtract it from the current lien. Cash = 53,000-31,000 Cash = $22,000 Note that the reimbursement of $22,000 is still $10, or 30% lower than the usual pro rata deduction of 38.75% of the current pay out or reimbursement of $32, Case #4:(non-auto very poor liability, classified award) This scenario uses the same figures as scenario #3 except as follows: Gross Recovery: $50,000 Attorney Fee: $14,500 (43,500/3) Expenses: $6,500 Pro rata rate: 21,000/50,000 = 42% Two possible answers: Under Kelly the reimbursement would be: 53,000-21,000 = $32,000 Without Kelly the reimbursement would be: 53,000 x.58 = $30,740 Since the total legal expenditures are even lower than scenario # 3, simply deduct the total legal expenditures from the reimbursement. However, this figure provides the carrier with a better result than simply applying the pro rata reduction as set forth in Section 29 (1). In short, for very tenuous liability cases when the gross recovery approximates the current payout, the carrier may actually fair better. The law is unclear as to whether a carrier is allowed to recover more than what was intended by Section 29 (1). Hopefully the above analysis will assist members in negotiating New York Workers Compensation liens with a potential future exposure. Knowledge is power, especially in jurisdictions like New York that utilize a formula which provides inconsistent, and at times inequitable results, leading to a disproportionate burden of legal expenditures for carriers. The intent of The Law Revision Commission in its 1975 Recommendation of N.Y. Law was a practical and flexible approach to lien resolutions and avoidance of rigid statutory

6 formulas. Unfortunately in practice, the Kelly decision is uncompromisingly and inappropriately used and computed by members of the New York Plaintiff Bar, making lien resolution an Augean task for workers compensation carriers. ENDNOTES 1. Kelly vs State Insurance Fund (1983). 2. Section 29(1) of the N.Y.W.C.s. 3. Briggs vs Kansas City Fire and Marine Insurance (1986). 4. Donaldson vs Ryder Truck Rental (2001); also see Mckee vs Sithe Independence Power (2001). 5. Wood vs Firestone Tire and Rubber (1984). 6. Net of expenses, the recovery was $390,000. The attorney received $130,000 or 33-1/3, the carrier received $98,000 or 25% and the claimant, after subtracting the $45,000 award he will forego as a result of the credit receives $162,000 or a little more than 41%. This article appeared in the Spring/Summer 2005 Issue of the NASP Subrogator. NASP