The Anatomy of Workers Compensation
Each business controls their own workers compensation cost. Too often business owners view work comp expenses as unmanageable, their sole influence being to periodically shop their insurance policy with a different insurance company. Nothing could be further from the truth. Workers compensation costs can be tamed and, with care, be controlled. To understand how, let’s first explore the factors that affect them.
Payroll
Payroll is the first and most obvious driver of workers compensation expense. If a construction company has $200,000 in payroll one year and the next year $400,000, they now have twice as many employees, are working twice as many hours, and have twice the chance of an injury occurring. Thus, insurance costs will double (all other things being constant) because workers compensation premiums are directly based upon payroll.
Control Techniques
Proper payroll records help ensure a business does not overpay for workers compensation coverage. One primary area prone to error which inflates costs is the management of subcontractors and 1099 employees. If subs and 1099 employees do not carry their own workers compensation coverage, their pay will be added to the business’s workers compensation policy. In most states, this is required by law. Control payroll charged to the workers compensation policy by:
- Requiring all subcontractors to carry workers compensation insurance and by obtaining certificates of insurance from them. These certificates of insurance are proof to the work comp auditor that subcontract and 1099 employee payroll should not be added to the business’s policy.
- If uninsured, ensure subcontractors break out invoices by labor and materials. If not, all will be lumped onto the business’s work comp policy.
Classification
The work employees perform is the next largest influence upon workers compensation costs. For example, office workers are a lower risk classification than roofers, and therefore influence work comp costs less.
Control Techniques
Ensure payroll is categorized accurately in accounting records according to workers compensation classification. If an employee spends half their time performing low risk duties and the other half in higher risk classifications, this should be reflected in payroll records. If not, all pay for that employee will be lumped into the higher-risk category. In particular, ensure pay for office workers, drivers, and outside salespersons are separately classified. Ask your insurance agent what workers compensation payroll classifications apply to your business.
Rate
A rate is applied to payroll charged to each classification. The rate determines how much premium will be charged. Using our prior example, the rate may be 0.20% for office workers and 20% for roofers. Thus, $200,000 payroll for office workers would cost only $1,000, but $40,000 for roofers. The basic formula looks like this:
payroll x rate = premium
On a per-classification basis is would be:
Office Workers
$200,000 x 0.20% = $1,000
Roofers
$200,000 x 20% = $40,000
Control Techniques
Lower rates can be won from insurance companies by:
- Hiring or assigning a safety manager.
- Implementing a proper safety program.
- Requesting a safety inspection from the insurance company and complying with findings.
Shopping insurance coverage may land a lower rate by a different insurance carrier. However, to obtain best rates, several steps should be taken before ever submitting workers compensation insurance applications. Don’t risk broadcasting a poor business resume to the workers compensation insurance market by talking to your insurance agent about what financial levers should be pulled before shopping your insurance coverage.
Claims History
In addition to the primary premium calculations based upon payroll, classification, and rate, other factors are considered when calculating workers compensation premiums. In the absence of compelling evidence otherwise, insurance companies use past claims to project future expenses. Claims, therefore, directly impact workers compensation cost. But not all claims affect it the same. The two primary factors are 1) number of claims (frequency), and 2) size of claims (severity).
Several small claims can have a greater impact than a single larger one. This is because a pattern of small, frequent claims is a flag signaling more will likely follow. That said, a large claim can still have big impact on work comp costs. This is all considered in the business’s experience modification (more on that next).
Control Techniques
Controlling claims is accomplished by preventing them in the first place and by proper handling after the fact. All control techniques discussed under Rate also apply here, but several others should be added:
- Protect business interests by actively tracking and managing claim progress with the employee and the insurance company. Ensure the employee gets necessary medical treatment and impress the importance of keeping appointments. Follow up with the insurance company to ensure timely responses and avoid delays. The longer a claim stays open, the more likely it will continue to grow.
- Implement a Return to Work RTW programs reduce the time employees are out of work and reduce claim expenses.
- Reduce claim impact by 70% by keeping claims medical expense only.
Experience Modification
The experience modification is a final calculation adjustment which either saves the business money or increases expense. Each year the states collect claim information, payroll, and work classifications and compare them to other businesses with similar operations. They then issue an experience modification for every business within their borders. The formula is as simple as:
premium X experience modification = final premium
For example, a business with an experience modification of .85 gets a 15% reduction in work comp premium, whereas a 1.25 would mean a 25% increase.
Assigned Risk Adjustment Program (ARAP)
An ARAP factor only affects workers compensation coverage obtained through the state’s assigned risk program and can greatly affect insurance premiums. An ARAP factor may be applied to businesses considered by the state to be of particularly high risk and increases premiums. An ARAP factor of 1.30 means a business will pay an additional 30% surcharge. The best way to avoid an ARAP factor is to partner with your insurance agent to get out of the state’s assigned risk program.
Control Techniques
Talk to your insurance agent. There are many factors that affect an experience modification and having a good one is critical to remaining attractive to insurance companies. Claims do not affect the experience modification immediately but go through a one year waiting period to stabilize before they are brought into the calculation. Businesses should review their experience modification each year and ask their insurance agent regarding possible issues.
Understanding the factors that affect workers compensation expense and leveraging appropriate control techniques will moderate cost and restore control. Many other techniques exist, so we encourage you to work with your insurance agent to identify opportunities, issues, and pull appropriate financial levers so your work comp application is presented to the insurance market its best light.
Questions regarding workers’ compensation insurance? Contact your Bankers Insurance agent. Not a client of ours? Let us earn your business! Each client is assigned a personal agent in our office, given their email address, and provided a phone number that rings right on their desk.
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