Tag Archives: experience modification factor

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

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The problem arises because the payroll rules are outdated based on the reality of the U.S. workforce today.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.

Why Workers’ Comp Claims Stay So High

In meetings with employers who have a history of high workers’ compensation claims costs and related expenses, we hear a common story: “The insurance adviser does not to take an active role on the problem. The adviser provides little or no supervision of the claims process. Nor are the true costs of each claim incident evident to the employer.”

These employers tell us that they rely solely on the insurance company claims adjuster’s process and the recommended insurance carrier medical clinic treatment protocol. There seems to be no one enhancing communications with the injured employee.

This communication void can lead to misunderstandings and a lack of trust and cause injured employees to seek legal representation. The result can be higher claims costs and delays in closing claims.

In most of these situations, the insurance adviser goes through an annual exercise to obtain rate quotations in an attempt to “control employer costs.”  But the quoting process fails to help the employer understand the costs of each claim. Nor does the process inform employers how to lower costs.

Some time ago, Dave Smith, a safety consultant in Lafayette, Calif., shared a comprehensive list of items and costs that affect employers when a work-related injury or illness occurs. I've attached a copy of Dave’s creation that I share with employers.   

In our experience, this guide helps employers rethink the claims management process and their experience with their insurance adviser. The guide helps employers come to the conclusion that they must make some changes to achieve better financial outcomes.

Cost transparency helps an employer to understand where the costs are coming from. Employers will also be better able to see if they truly have a valuable insurance adviser or if the adviser's process is just too costly.

Many employers seem to forget that it is their money at work in workers' comp claims and that they must be involved in all aspects of their workers’ comp insurance and risk management program.

Remember that the expenses listed in this chart are all in addition to the increase in future workers' comp premiums that come because of the change in the employer’s experience modification factor.

The Changing Insurance Marketplace And How It Can Affect How Employers Manage Costs

Workers' compensation insurance, like other employee benefits programs, continue to be a major expense to most employers. Decision makers are always looking for ways to better manage their cost, but sometimes the containment can be out of their influence.

For many years, employers enjoyed lower workers' comp rates as a result of reforms signed by our previous Governor and the competitive nature of the California insurance marketplace. Late last year, the workers' comp market began to change and insurance companies began to raise rates and become more selective about which employers they would keep or consider as new customers. Rising medical costs to treat injuries, increases in the insurance company costs of doing business, as well as lower returns of investment by insurance companies also led to this market shift.

Employers who had a series of injury claims, or even a large claim, also experienced greater increases in their workers' comp premium, because of the way their Workers' Comp Experience Modification Factor calculation was changed.

As a result of these premium increases, there has been a move by employers to seriously consider a Professional Employer Organization (PEO) to take the place of their workers' comp and employee benefits programs. A Professional Employer Organization is an arrangement where an employer essentially transfers their employees to another organization who then “leases” them back to their organization. This may relieve employers of direct involvement in the management of employees, but they still retain responsibilities as a “co-employer.”

Professional Employer Organizations have historically been an alternative to employers who have had a history of claims, because the Professional Employer Organization companies seem to offer lower costs. In my experience, most Professional Employer Organizations organizations offered little or no reduction in the number and severity of work injuries and resulted in a continued increase in the employer's Experience Modification Factor.

To obtain up to date marketing information about how the major Professional Employer Organization organization view this changing insurance marketplace and how they are planning to respond to these changes, my firm's specialist contacted the seven Professional Employer Organization organizations that are utilized. The following information was obtained and it is being passed on to you, because this segment of employment and insurance providers is important for employers to know so they can make a more informed decision when considering the use of a Professional Employer Organization:

  • Those employers who are unprofitable to a Professional Employer Organization are receiving rate increases in their insurance premiums and/or administrative fees to make them profitable to the Professional Employer Organization
  • For those unprofitable employers who are not accepting the rate increases, they are being non-renewed. This action is very rare, but is a sign that the Professional Employer Organization marketplace, like the workers' comp insurance companies, are taking actions to become more profitable.
  • Professional Employer Organizations only seem to consider new employers that have at least 10 full time employees
  • The annual employees' compensation must average at least $30,000
  • Professional Employer Organizations are dropping certain industries where the PEOs have encountered consistent non profitability

This information update causes us to conclude that employers who are historically financial losers to the insurance industry are also losers to the Professional Employer Organization organizations.

It can no longer be assumed that a Professional Employer Organization is always a viable alternative to employers who are not controlling their cost of work injuries.

Claims-prone employers who feel they can just “shop” every year to get the lowest rate will probably have a rude awakening.

What are some of changes that employers need to make to avoid a history of frequent and costly work-related injuries to keep employees from becoming “patients” of the workers' comp medical system?

  • Accept that workers' comp is a way to finance claims
  • Understand that you, as the employer, are ultimately paying for each work injury — have a claim and you the employer pays it back plus more
  • Take the selection of employees and safety in the workplace more seriously — match the characteristics of the job with the characteristics of the candidate being considered
  • Take an active role in the claims process
  • Train employees in safe work practices and hold them and their supervisors accountable
  • Maintain a respectful and positive relationship with employees
  • Create an open working relationship with a medical clinic that practices “evidenced based medical treatment”
  • If you do not have the resources to make changes, hire the appropriate insurance advisor to help them

The decisions employers make will determine how profitable their enterprise will be and ultimately will influence the financial value of their business. This is one of those times where appropriate decisions need to be made. The organization's financial success and the welfare of those who are employed by the enterprise are in the “hands” of the company's leaders. Let's hope the best decisions are made.