It's Time to Revisit Payroll Calculations Used in Work Comp

A simple change would resolve a major conflict concerning bonuses.

For as long as anyone can remember, the basic method for calculating workers’ compensation premiums is RATE x PAYROLL x EXPERIENCE MOD. Rates vary based on job classification codes (which is much more complicated than it sounds), and the experience mod is based on prior losses. This is how premiums have been calculated for years. This method inevitably leads to a payroll audit at the end of the policy term to determine whether any audit premium is owed. This issue can lead to conflict between the carrier and the policyholder. One reason there is so much conflict is because of how “payroll” is defined by the rating agencies (NCCI, WCIRB, etc.). Actual wages paid to your employees are easy to define. But “payroll” goes beyond wages. There is some variation by state but, for the most part, “payroll” used to calculate workers’ compensation premiums includes things like vacation pay, holiday pay, bonuses (including stock), sick pay, auto allowances and commissions. The list is very extensive. An area of much contention right now relates to the inclusion of bonuses. Bonuses in the form of cash or stock are both treated as payroll. But I have frequently heard complaints from employers who were upset because they received a large premium audit bill because of these bonuses. Employers argue that these bonuses usually do not increase carriers’ claim exposures. Each state has a maximum indemnity benefit rate, with the highest being around $1,000 a week. That means that, if an employee earned wages of more than $80,000 a year, there is no impact on his benefit rate if he has a workers’ compensation claim. So a bonus would have no material impact on the claims exposure for a carrier. The problem arises because the payroll rules are outdated based on the reality of the U.S. workforce today. It used to be that only the top executives in companies received substantial bonuses. The payroll rules in every state include caps for the directors and officers of companies for this very reason: the recognition that their higher wages did not increase the carrier’s exposures. However, we are no longer a country where the majority of our workforce is in the manufacturing industry. A significant percentage of the workforce is now in highly skilled “white collar” jobs. More and more companies are using bonuses to assist in retaining their skilled workforce. Companies are making these benefits available to a wide segment of their workforce, far beyond the directors and officers who were considered in the rules for calculating workers’ compensation premium based on payroll. The solution to this is relatively simple – extend to all employees the director/officer payroll caps used in calculating premiums. Nevada has done this for several years. Implementing this change would not be overly complex, as these payroll caps and the methods for calculating them are already in place. This issue is currently being discussed by the NCCI Underwriting Committee. If NCCI were to recommend such a change, I would expect it would be quickly adopted by both NCCI states and the independent bureau states. Would these changes result in lower premiums for employees? Perhaps for some employers, it could. But other employers could see higher premiums as carriers adjust their rates to ensure adequate premiums are being collected. The workers’ compensation industry’s combined ratios have been more than 100% for a number of years. Because of this, carriers have to be cognizant of the impact any changes in premiums would have on their surplus. As workers’ compensation continues to evolve, we must constantly review the rules and regulations governing the industry to ensure they are still appropriate. Perhaps it is time to review one of the most basic issues, the method of calculating premiums.

Mark Walls

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Mark Walls

Mark Walls is the vice president, client engagement, at Safety National.

He is also the founder of the Work Comp Analysis Group on LinkedIn, which is the largest discussion community dedicated to workers' compensation issues.


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