Facing the new reality Featured

8:00pm EDT June 29, 2006
Like the proverbial frog in a pot of water heating on a stove, CorVel Corp. didn’t seem to notice that its environment was changing in a way that was endangering its very existence.

From the time it was founded in 1988, CorVel Corp. had experienced an unbroken string of profitable years and growth, which might explain, at least in part, why it didn’t heed the warning signs that it might be in hot water.

After all those winning years, it proved hard for Gordon Clemons, chairman, CEO and one of the founders, to face the possibility that the company was headed for a losing streak. Worse, Clemons had a tough time at the outset deciding that the conditions that conspired to slow CorVel in its tracks weren’t likely to reverse themselves.

CorVel’s revenue slipped from $305 million in 2004 to $291 million in 2005. It wasn’t a precipitous drop, but net income also fell, from $16 million to $10 million, and there were signs of trouble before that, as well.

“For me, I think the biggest challenge as a company has been the last three years when, for perhaps more than one reason, our business got more difficult,” says Clemons. “We went through 15 years of good times, and I think you have a tendency, perhaps, to take it for granted.”

Clemons says that he’s not certain why the critical trends in his business have gone the way that they have, but he knows how they’ve affected CorVel, a company that manages workers’ compensation claims and provides other managed cares services.

Falling claims
Put simply, CorVel earns its revenue, for the most part, by managing workers’ compensation claims for large employers, insurance companies and third-party administrators. So when claims levels are high, CorVel got a lot of work. When claims levels fall off, so does the workload.

Normally, during tight labor markets, when a lot of people are working, the volume of claims tends to rise, and when unemployment is high, the number of claims decreases. So when the economy began to bounce back after the last recession, Clemons had every reason to believe that the number of claims would rise again, allowing CorVel to sustain its 15 percent annual growth rate.

But history wasn’t about to repeat itself. For a variety of reasons, including porous U.S. borders that allow undocumented labor into the country, off-shoring by some industries and reform of the workers’ compensation laws in several states, including California and Colorado — where CorVel has a significant presence — claims volumes didn’t bounce back in the post-recession period.

“Historically, we had been having for about eight or 10 years a 2 percent decline in workers’ comp claims, starting in about ’92,” Clemons says. “I think productivity gains and other things, like a shift to service, were creating that sort of underlying negative trend, which I think was probably going to go on, we thought, perpetually.”

But an unusual and disturbing trend began to take shape. Instead of a slow, steady decline in the number of claims, the line began to drop off sharply.

“Starting three or four years ago, claims started going down 10 percent or 15 percent a year, a very big change,” Clemons says. “Claims are half of what they were four or five years ago.”

Add to a fast-shrinking marketplace the effect on CorVel of compliance with the Health Insurance Portability and Accountability Act and the Sarbanes-Oxley Act, and it’s easy to see why the company’s net income took a beating. Clemons estimates that legal and accounting costs have increased 14-fold as a result of those two legislative acts.

But even in the face of the negative trends, Clemons found it difficult to face the need to change.

“I’ve learned that I exaggerate the amount of change I’m being asked to make, and I have a very hard time changing,” say Clemons. “In business, I think I’m changing a lot, but an outsider might say, ‘I don’t see the difference.’ So the hardest part to accept was we had to let go of some things.

“We believed in constant growth; we had set our incentive plans for constant and perpetual growth. Everything about our business process was focused on more is better, and letting go of that was tough.”

He was slow to react to the need for change because the recession seemed like a brief bump in the road for CorVel, Clemons says. History had shown, too, that there’s a lag of about 18 months between the start of an economic recovery and an increase in workers’ comp claims filed, a fair reason to wait out any slump in the near term.

And CorVel was in good financial shape, with substantial cash on its balance sheet and no debt.

Facing the new realities
Ultimately, however, the trend lines were undeniable. Clemons says at first, the company simply tried to work harder, a strategy that proved flawed because the problem wasn’t grounded in a lack of effort but in the fundamental changes that were occurring in the industry.

“I’d say that eventually, we realized that we needed to do some short-term things to address the need to balance expenses with revenue,” Clemons says. “I think it took us a little bit to recognize that having a goal of 15 percent a year growth was no longer the way we should run the business.

“We needed to not give up on that in the long term, but in the short term, we better batten down the hatches and start bailing water.”

Clemons decided to adopt measures to stem the tide in the short run as well as prepare the company to focus on its core business of managing workers’ compensation claims. The plan called for cost-cutting, heavy investments in technology to both increase its business and optimize operational efficiencies, and development of new products to offer clients. Instead of trying to break into new markets, it would introduce new products to existing clients.

As an example, CorVel launched a disability management product that could be readily marketed to its existing customers.

“In our case, our strategy is to meet an ever-increasing number of the needs of claims managers or claims decision-makers in workers’ compensation,” says Clemons. “So we do go into new services where we struggle to learn what we need to do, but we stay pretty tightly focused on our customer and their needs, and that’s worked pretty well for us.”

The company didn’t cut back on its investments in the business, instead plowing back a larger share of its revenue into software development and systems. Field operations converted from a legacy medical review system to a Web-enabled version. The company implemented document management, converting from paper claims handling, and converted most of its processing to incorporate scanned images and optical character recognition.

“We have just hung in there persistently to try to continue investing in our business,” says Clemons. “For instance, our corporate overhead was 8 percent of revenue. We were always proud of how low it was. But in that 8 percent, about 60 percent of that was in software development and systems.

“During this downturn, our corporate overhead has jumped up to 13 percent of revenue because we have refused to cut our systems expenditures and we had to pay for the added Sarbanes-Oxley costs. So we just did that even though it fought very hard against the need to try to hang in there on earnings per share.

“That hurt us in earnings in the trough, but we just persisted on that so that we let the earnings fall more than they might have if we had cut back.”

That aspect of the plan at times made the board skittish, and Clemons often found himself persuading its members that the plan was sound. He says one hurdle that the directors had to confront was the high bar for fiduciary responsibility that Sarbanes-Oxley imposes on boards, so facing reductions in earnings was a tough pill to swallow.

“I think Sarbanes-Oxley has scared the heck out of a lot of people, and it scares boards of directors because they have to show that they’re addressing their fiduciary responsibilities,” says Clemons.

CorVel also cut staff, mostly by attrition, but some of the cuts came from paring back in its branch offices. At its peak, CorVel employed 3,500; today, its head count stands at approximately 2,600.

But those cuts could have been much deeper had Clemons decided to eliminate branches and centralize operations. Instead, CorVel invested in technology to make its 120 branches more efficient. It converted from paper processing to document management and implemented a substantial amount of artificial intelligence to manage and automate the work flow in the business.

Face-to-face contact has proven to be a competitive advantage and branch offices are a key component.

“We still believe in a field sales force and field branch offices, so we still have the largest number of branch offices of anybody in our industry, and the others have gone to centralized operations,” Clemons says.

“The value of having a branch office in Syracuse is that we sell to people in Syracuse.”

Clemons decided that CorVel had to stop chasing low-margin business to catch market share. Instead, some customers had to go.

The company gave up trying to hold price down to hang on to volume. Half of its business is a commodity called case management, and Clemons says he just accepted that the company had reached a point where it had to raise prices to get adequate margins, even if it meant losing some customers.

“We started to, for the first time in our history, accept that there were some customers we couldn’t afford to service,” Clemons says.

While Clemons has to be cautious about making predictions about CorVel’s future performance — Sarbanes-Oxley is still in play, after all — he has reason to be optimistic. While revenue for fiscal 2006 was down to $267 million from $291 million the previous year, net income dropped only $368,000 compared with the $6 million it had fallen the year before, and gross profit increased 1.6 percent.

The third and fourth quarters produced earnings per share that were improvements over comparable periods in 2005.

Says Clemons, “I think we’re headed toward a time where we are going to feel at the other end that we’re glad we stuck it out.”

How to reach: CorVel Corp., www.corvel.com