November 8, 2018 |
In the state of California, employers of all kinds, big and small, are under a legal obligation to take care of their workers when they are injured in the course of doing their jobs. This legal mandate, generally known as workers’ compensation protection or coverage, comes in the form of an insurance policy every employer has to have in place and pay for if operating within California. The cost of this coverage for the employer is determined by a specific formula and cost factors that the employer is expected to accept but has no control over. This is an ongoing matter of concern for employers because the cost of the coverage is an unavoidable operating cost to do business in the state.
The primary formula used for determining the cost of workers’ compensation coverage is very straightforward and easy to understand. It essentially works as follows:
Payroll (per $100) x classification rate x experience modifier = premium
What cause premiums to vary so widely from company to company are payroll size, when payroll should be measured, what classification rate and modifiers should be applied, and choosing one point in time to reflect the appropriate cost for a full year.
The payroll component seems easy to develop at first. Simply multiply the payroll value against set factors and you get a result of cost. Unfortunately, actual payroll levels of the full year tend to fluctuate. Furthermore, a company’s use of employees changes over time so one payroll level may not reflect the real size of labor over the year. As a result, rate-setting uses what is known as an estimated payroll figure instead of a real one from one month of the year.
First, determine what the overall payroll is and how much it is likely to change by in a year. Where a company’s growth is stable, this is fairly predictable. A company spent $5 million last year in labor, nothing much is expected to change, so $5 million is the estimate for the next year. However, where a company is growing fast, wide variance can occur in estimates based on how much that business is expected to grow over the next 12 months.
An incorrect payroll size can have hefty consequences because the cost for workers’ comp coverage is a percentage of the total payroll. So, a high estimate can drive a higher, incorrect coverage cost. The business then has the choice to “do nothing,” dispute the payroll figure, or seek coverage from a different provider. However, changing providers can be time consuming and challenging, so many try to challenge the matter and get to an agreement with their current provider.
The lowest one can go in terms of initial payroll for rate setting is actual payroll paid. Each year the coverage can be reset, but generally the actual payroll being paid at the moment of determination is the floor. Then the payroll total, per $100, is multiplied against classification rates of the employees.
The classification of an employee essentially is a valuation of an employee type. A secretary is one classification and a construction worker is another. Clearly one has more risk associated with the nature of the work than the other, so a valuation of risk is determined for each category. An employer is then evaluated for which classifications apply to its workers.
Each classification will have a value predetermined. Assuming, as an example, the rate is $3.50 for a given employee classification. That factor will be multiplied against every $100 of payroll an employer has. Assume $1 million in payroll for the example; the premium valuation is (1,000,000/100) x $3.50 which equals $35,000. That becomes the coverage premium for the year.
The follow up question is where does the classification then come from? In California, it is the Workers’ Compensation Industrial Relations Board or WCIRB that created initial premium rates for the state and California Department of Insurance, the main regulator of insurance coverage in the state. Insurance provider rates use the initial advisory rates from the WCIRB to then create their own rates actually charged to an employer. What makes a difference between an actual charge and an advisory rate is the overhead, administration and profit margin providers add on for their own business recovery.
Again, classification rate values are for different categories of employees. They are job specific and industry specific. Because the classification applied can make a big difference in an overall premium charge, employers should pay close attention to which classification is being used for their company, especially if the nature of the employee makeup is changing in the same year.
Risk is the fundamental driver for valuation of a given category. That element is determined by statistics kept on injuries reported about different employee types. The WCIRB manages this research when it puts together its advisory rates, which then saves insurance providers in California the time and effort of having to do the same research.
The other factor that impacts a premium is the experience modification. The experience modifier adjusts workers’ compensation insurance premiums for a particular employer based on a comparison of past losses of that employer to what is calculated to be “average” losses of other employers in that state in the same business. Keeping injuries and claims at a minimum will improve a company’s Experience Modifier over time.
Note that rates are not influenced by the WCIRB alone. Nationally, the National Council on Compensation develop similar advisory classification rates to be used by states across the U.S. Where the NCIC goes with classification risk valuations, the WCIRB follows closely as well.
Experience is what makes a coverage policy unique to a given company. That’s where a company can have one of the more long-term impacts on its policy cost. By reducing the amount of injuries and claims every year and managing the claims to keep the total costs down, the business can actually lower the premium formula result over time.
The bottom line on the other side of the spectrum is that as injuries occur and add up, a company’s premium will go up as well. Businesses that don’t avoid injuries or have working conditions that continue to trigger people getting hurt will see their premiums move upward.
Once the premium is determined, the invoice is then charged to the business being covered by a provider. Depending on the provider, the premium may be charged all at once up front or spread over time. For example, companies that use the State Compensation Insurance Fund (SCIF), California’s largest provider, will pay an up front lump sum charge for a policy. However, other licensed private providers may handle premiums differently.
There are a number of ways to make workers’ compensation manageable for your company. Where they are possible, a business should be pushing to make sure these tweaks and changes apply to their premium.
Clearly, any opportunity that avoids a lump sum payment is a good strategy for a business because it allows the company to match up future revenues with the cost of coverages versus taking the charge out of existing assets. Where it is possible, businesses should definitely choose payments over the year.
Many companies will be invoiced on estimated calculations but they should really be pushing for actual payment values instead. Again, estimates can vary significantly due to changes in employee makeup, payroll size, and actual experience.
A far worse scenario, however, is where a company lets its coverage lapse. This can be significantly damaging if the business had a good experience modifier in place. The entire experience element is forfeited as a new policy starts from scratch and is likely to be more expensive.
While most employers are aware that workers’ compensation coverage is required in California, they may not realize there is a stiff financial penalty if a business does not institute coverage. Further, providers report businesses that try to cheat their way into lower cost coverage by hiding payroll or fudging employee information. Once caught, the penalties can be painful, to the tune of thousands of dollars.
Additionally, aside from regulation, employees themselves can sue an employer who refuses to provide coverage or have it in place, even if an injury does not occur. The penalty can run into the hundreds of thousands of dollars when a judgment is levied by a court. It’s not worth the trouble trying to cheat the system. Instead, a business’ focus should be on trying to make sure it’s premium calculation is as accurate as possible and to reduce injuries to maintain a long-term good experience modifier.