Understanding Workers’ Compensation in 2 Minutes
There was a company that was spending between $1.2—$1.4 million dollars each year on workers compensation costs, over a number of years. By encouraging injury reporting early and for all injuries (while less severe and less costly), by implementing a return-to-work program, and by starting an earnest safety training program, that business reduced its’ workers compensation costs to $850,000 in one year.
Now, small to medium-sized business may not be working with numbers that large, but the example above does demonstrate an area where significant savings can be achieved for any company navigating the maze workers compensation. Think of the year to year savings possible in your workers comp program.
Nationally, the patchwork system of workers’ comp law from state to state creates confusion—each state is a little different. The bottom-line for small businesses, particularly in high-risk industries like construction and manufacturing, is that workers compensation insurance is a significant variable expense.
The only real question for most small business owners is, ‘How much will I be paying?’
That’s not an easy question answer, so here’s some fast context...
Workers compensation is a type of insurance required, by law, for most employers. The general idea is that workers compensation insurance provides financial relief for employees who are injured on the job. For injured employees, workers comp insurance may cover medical care and rehabilitation, lost wages, compensation for resulting disability, benefits for surviving dependents of workers killed on the job, or retraining expenses. Workers comp is a ‘no-fault’ insurance system, meaning that employees who receive benefits cannot sue employers over an on-the-job illness or injury.
Employers are either Insured or Self-Insured for workers’ compensation, but let’s clarify two things quickly—there are variations and nuances within these two categories, as with monopolistic insurance states. However, those are the two major insurance category terms you need to know: insured or self-insured. Businesses looking to self-insure must get approval from a regulatory entity, usually the state. Insured companies are covered through a policy obtained from either a private provider or the state; several states run exclusive programs and require all qualifying businesses in those states to purchase insurance from those programs.
Being insured for workers compensation means your company pays a premium for insurance like you do for your auto insurance. If you are a 16-year-old boy driving a sports car, the auto insurance premium will be higher than if you are middle-aged and driving a sedan. Same is true for your workers compensation premium. It’s based on what sort of risk your company is associated with, and determined by a number of factors, including similar industry history, your specific history (dated to3 years), your safety training program, and written program documentation, among other things. Under most systems, employers and employees are grouped into industrial classification codes that reflect the type of work each employer is engaged in, like landscaping, plumbing, or painting, to help determine risk. This risk is called your “experience”.
That experience is given a numeric rating called, an Experience Modifier (EM). A complex formula for calculating premiums—involving payroll projections, classification codes, rates, and loss ratios—the EM is the most important factor in determining premiums for each employer. Your EM is assigned annually; ask your insurance company directly what your EM is or speak with whoever handles insurance lines and contracts for your operation.
If your experience modifier is 1.0, that figure means you are paying the average premium amount compared to companies with a similar level of risk. If your EM is .5 you are paying less than average, and that’s a good thing. However, if your EM is over 1.0, then you have some work ahead of you to start saving money.
Employers who are insured have most aspects of an injury or illness claim managed by a claims specialist with your insurance company, leaving the employer with little involvement in the process. Being self-insured for workers compensation means you do not pay a premium. You pay all the real costs for an injury or illness including lost-wages. Basically, any expense associated with restoring someone to “maximum medical improvement” (another insurance term). Many self-insured employers will have a workers compensation insurance company’s Self-Insured department manage aspects of a claim, including mandatory government filing. The employer pays the insurance company an administrative fee per claim for this work. Employers who are self-insured determine the level of involvement they want in managing a claim; in fact, companies with the infrastructure to handle it will manage all details without any administrative insurance help.
Here are three things you can do today:
- Find out if you are insured or self-insured.
- Then, ask for the name of your associated insurance carrier (the only time you wouldn’t have one, is if you are self-insured and manage all aspects of claims within your company).
Next, ask for the contact info of the insurance person assigned to work with your company. Usually, it’s a team with one lead.
Understanding Experience Modifiers
The most important factor in determining premiums for each employer is the ‘experience modifier’ (EM). Experience modifiers only apply to those employers fully insured for workers comp; self- insured businesses do not have experience modifiers.
Here’s the thing: if your small business is ‘super small’, with one or two people on the payroll, and the work isn’t risky, you probably don’t have an experience modifier associated with your workers comp policy. And that’s a very good thing, because you will be able to better forecast your expenses with a near static figure for workers’ comp insurance.
Yet, if you’re a small business owner with, say, 25 employees and you’re paying between $5-10K in premiums each year, it is likely that your policy has an experience modifier attached to it. Whether or not your policy has an experience modifier is different from policy to policy, and business to business—there is no widely accepted, objective threshold triggering experience modifier application.
The best news for new small business owners is that experience modifiers typically are not factored in your premiums until after three years of operation—that’s because there is not a sufficient history of claims to form a basis for a reasonable experience modification ratio.
The bad news is that once an experience modification rate is applied to your premium, your insurer may be able to apply that figure for up to three years. So, if you’ve had a history of worker injuries when the experience modifier is applied, you may find yourself stuck with a higher than average EM for the next several years.
How it Works
An experience modifier is a calculated figure that accounts for the history of occupational injuries with your business, and so a measure of future risk.
The experience modifier is a complex formula for calculating premiums, involving payroll projections, classification codes, rates, loss ratios, and claims history vs. the industry average. If your business has a higher claim average that the industry base rate, you’ll pay a higher premium. If not, you might even receive a credit or qualify for a premium discount.
Example: “Base Rate X EM X Payroll (per $100) +/- Adjustments = Premium
‘Adjustments’ are a combination of factors related to risk, so let’s explore those for a moment. The experience modifier accounts for the severity of claimed injuries experienced by your workforce, frequency of injuries, and the difference between the average expected injury loss for the industry and your claims history.
What it Costs Your Business
This is where issues with poor workplace safety, accidents, and resulting workers comp claims combine to lower your margins, potentially making your small business less profitable than it could be; this is true for all business covered by a comp insurance policy.
Example: Across all industries, the average experience modifier is 1.0, but because of accidents, your business is assigned by your insurer an experience modification rate of 1.3, okay? That would suggest that your workers’ comp insurance premiums may be as high as 30% above the premiums of your direct competitors. The additional expense of your workers comp insurance premium may be absorbed, which would lower your profit, or passed directly onto your customers as increases in the price for goods or services. Either way, the cost is real, it is there, and it makes your business less competitive than its peers, jeopardizing the long-term viability of your operation.
Yet, the opposite is also true; with effort and attention to incident prevention, businesses may drop premiums below 1.0, securing a competitive edge in comparison to industry peers.
What to Watch Out For...
Claims That Won’t Leave the Books
It is critical that you have an advocate working to close claims as expediently as possible, because having open claims when it comes time for your provider to recalculate your experience modifier may result in a substantial premium increase associated with a high modifier. Work to get claims closed before as quickly as you can to control your experience modifier. It is fair to ask insurers how long you can expect a claim to stay; insurers can provide you with estimates based on experience with injury types. That helps you know what to expect and what to look for, and trigger action when specific claim resolution has not met the given expectation.
High Claim Reserve Levels
Your insurance premium is designed to cover losses associated with payment of workers comp claims. In the event of an injury claim, your insurer may set what’s known as a ‘reserve’. That’s the highest total dollar amount your insurer anticipates any particular claim to cost them. In other words, it is a forecast, and it is important because claims are seldom reconciled for the full reserve amount. If reserves are not adjusted to reflect progress on claims, they can have a negative impact on your experience modifier by establishing a higher-than-actual-cost for the claims. It’s the right of employers to request a review of reserves with insurers, perhaps quarterly. This is a recommended best practice for protecting your EM.
Facts in Dispute
When working with any workers comp provider, it is critical to put your business in a position of leverage in the event that substantial differences in data create a problem. This requires detailed recordkeeping, diligent relationship building with both injured workers and claims managers, regular communication, and sound, internal program auditing. Two things to consider here: (1) fraud is real and it happens, and (2) people make mistakes. That’s why when facts are in dispute or the numbers seem off, you can stand up for yourself with accurate contrasting facts and figures, and make a case for resolution in your favor. Employers may consider inviting insurance carriers to educate them on fraud identification, and how insurers plan to protect employers from this risk.