Workers’ Comp Costs Part 1: Why So Much?

Ulf Wolf with Steven Ferry

May 2008

Workers’ Compensation. Few other words have the power to upset stomachs or clam hands: Not only do they cause the occasional sleepless night, but some say workers’ comp worries alone increase the sales of antacids in parts of the country.

The thing is, though, workers’ comp costs can be controlled, and when it comes to taking this particular bull by the horns, there is no better way than to play it safe.

But before we get there: What, precisely, is workers’ comp?

Workers’ compensation (colloquially known as workers’ comp in the United States) provides insurance to cover medical care and compensation for employees who are injured in the course of employment—or contracts an occupational disease—in exchange for mandatory relinquishment of the employee’s right to sue his or her employer for negligence.

That is the tradeoff—a limited, but guaranteed, coverage with no legal recourse outside the workers’ compensation system. This is usually referred to as the "compensation bargain.”

Depending on jurisdiction, workers’ comp can take the following forms: weekly payments in place of wages (not unlike disability insurance); a lump-sum compensation for economic loss (past and future); reimbursement or payment of medical bills (serving here as health insurance), and benefits payable to the dependents of workers killed during employment (acting as life insurance).

Note, however, that neither damages for pain and suffering, nor punitive damages for employer negligence, are available under worker compensation statutes.

Supporters of workers’ comp say that it improves working conditions and provides an economic safety net for employees. On the other hand, workers’ comp laws are often criticized by their opponents for removing, or severely restricting, the worker’s common-law rights (such as suing the employer for negligence) in order to reduce the financial liability of governments and insurance companies.

A Very Brief History
Prior to workers’ comp, the only recourse available to employees injured or taken ill on the job, was to challenge their employer in court.

In the United Kingdom, the legal view of employment as a master-servant relationship required employees to prove employer malice or negligence—a steep hill to climb for any employee since the courts usually ruled in favor of employers, paying, as they did, little or no attention to losses experienced by workers, including medical costs, lost wages and loss of future earning capacity.

A similar legal climate held true in the United States, where the injured employee had to prove that he or she was in no way responsible for the accident, that no fellow worker was in any way responsible, and that the accident was not a normal, understood and accepted risk of the industry. And to top that off, the injured worker also had to prove the nature and extent of the injury.

The upshot of all this was that only a small percentage of work-related injuries were ever tried, and even fewer were compensated. You worked at your own peril.

Enter workers’ comp.

Workers’ comp laws (or their equivalents) were first enacted in Germany in 1884, in the United Kingdom by 1897, and in the United States by 1908—yes, a centennial of sorts. Today, every state in the union has some form of workers’ comp legislation on the books.

Current Climate
Today, in most states, workers’ comp represents a major employer cost of doing business. And not only that: with both business and labor lobbying to shift the compromise balance struck by workers’ comp, it is still a moving target. Business groups—no surprise here—seek to limit the cost of workers’ compensation coverage, while labor groups seek to increase benefits paid to workers. The jury is still out on this one.

Insurance Market. Workers’ comp is a major line of business for the commercial insurance market, even if often a problematic one. Even though the premiums are large, insurers still find it a challenge to turn a profit in many states. It’s not unheard of for the benefits paid to exceed premiums received.

To alleviate the situation, many states have given insurance companies greater pricing flexibility in recent years, with the hope that by encouraging price competition among insurers, employers will ultimately benefit by resulting lower overall premiums.

While this has been the case, the introduction of competitive pricing for workers’ comp insurance has also led to significant swings in cost of premiums as the insurance markets shift between "hard” and "soft.”

As a result, employers enjoy lower premiums in "soft” insurance markets, only to see their premiums increase, sometimes exponentially, when the insurance market "hardens.”

Controversy. Injured workers often complain that insurance companies do not treat them fairly or in compliance with the law, while employers likewise protest that the costs of insurance is driven up by exaggerated or fraudulent claims.

Also, labor groups claim that existing caps on disability valuation may or may not reflect the total cost of providing for a disabled worker.

As an example: A state legislature may pin the monetary cost of total spinal incapacity at far below the amount actually required to keep such an injured worker in reasonable comfort for the remainder of his life.

A related issue—and one that is not always addressed—is that the same physical incapacitation impact the earning capacity of individuals differently depending on profession. For instance, the loss of a finger would have a moderate impact on a banker’s ability to do his or her job, while the same injury would totally ruin a pianist.

These and other issues that are still being debated and legislated in the various state capitols across the land. Stay tuned.

Premiums The premium paid for workers’ comp is determined primarily by two things: job classification and experience modification factor (sometimes called "experience modification rate,” or EMR, or just plain, ole "mod”).

Job Classification. The National Council on Compensation Insurance is the primary organization responsible for developing the classification codes used by workers’ comp underwriters in 35 states, including Virginia, Maryland and the District of Columbia. Some states, however, including California and New Jersey, use other classification systems and codes such as the North American Industry Classification System.

The purpose of either system is to analyze and group employee duties under descriptive categories, which in turn are ranked as to risk for injury. In other words, some jobs are more "dangerous” than others.

The lumberjack stands a much better chance of getting hurt than the farmer, who, in turn, lives dangerously when compared to the trucker, who, in his turn, lives a daredevil existence when compared to the clerical office worker.

NCCI provides more than 600 classification codes that aim to assign each employee to the one that best describes his or her duties.

To determine the precise classification for any one employee, the employer should ask his insurance agent for the complete description of any applicable classification(s). Too many employers, and agents for that matter, simply match the employee’s job title with a classification heading, and leave it at that. By not digging deeper—by not making sure that the chosen classification indeed reflects this employee’s duties—the employee may be misclassified, which can lead to thousands of dollars of added costs each year.

And as if that weren’t enough, many employees, from a workers’ comp perspective, perform duties from more than one job classification. In this case—and this is important—the rule is that the employee’s entire payroll is, unless differently agreed with the insurance company, categorized in the classification that carries the higher manual rate.

So what to do with John? He is an estimator who occasionally, as the workload demands, gives the installers a hand. For the most part he sits at his computer, or by his phone, working up bids, doing research, answering questions; but about once a month he puts on a tool belt and heads out to a job site. For 80 percent of the time he’s an NCCI Code 8810—a clerical office employee, but 20 percent of the time he’s a 5437—a drywall installer.

Do you follow the rules to the letter and pay John’s workers’ comp premium as a drywall installer (at about 10 times the rate of an office worker), or do you "forget” that he occasionally installs drywall and count him as a clerical office employee?

Statistically speaking, many employees—even though they do perform other duties—are classified as 8810 Clerical Office, period. The agent doesn’t ask, nor does the employer bring it up—for obvious reasons. So far, so good. But three years down the road an industrious auditor catches this, and John is unceremoniously bumped up into the drywall installer category, along with an impressive bill for back premiums. Ouch.

One way around this is to have John keep very good track of the hours he performs his 5437 (drywall) duties. This will allow the employer to separate his employee’s 5437 payroll from his 8810 payroll, and pay the workers’ comp premium accordingly.

A third way of addressing this issue (the first being "don’t tell and hope for the best,” the second being "deal with it, if it comes up, at audit time”) is to sort this out with the agent—and the auditor—before you sign a new policy. Go over the duties in question and establish—and document—an agreed-upon premium calculation for that employee.

Say Joan in bookkeeping is classified as an 8810, but every Friday she drives to a client to pick some tax records used for her duties. The underwriter can decide that this is an incidental exposure and instruct the auditor not to re-classify Joan into another, higher rated, category that includes traveling as an exposure.

The point is, you should confront and sort out any "unusual” situations or job classifications in the beginning, and make sure they’re documented. This way you’ll avoid unpleasant surprises due to ambiguous job classifications later.

Experience Modification Factor. Once each employee has been assigned the correct job classification, you now have what you need to calculate the total base premium. But it doesn’t end here. To arrive at what you actually will pay, you must multiply the base premium by the experience modification factor.

Joe O’Connor with INTEC, AWCI’s safety consultant, explains it this way: "The insurance company establishes an experience modification factor by looking at the average losses for a wall and ceiling contractor, and then looking at the losses that you have had over the last year. Now, you are either average, better than average, or worse than average. It’s a ratio.

"If your losses match the average, it’s a 1-to-1 ratio, and your insurance company would then multiply the manual rate, or base premium, by 1.0 to arrive at your actual premium for the next year. If your claims or losses are higher than the average, the experience modification factor may be 1.1 or 1.3, and you’ll now pay 1.3 times the base.

"If your losses are lower than average, the ratio may be 0.55, or 0.4. In fact, I have seen contractors with experience modification factors as low as 0.23 or 0.22.”

The calculation is done annually, but it is based on the previous three years, O’Connor says. The important thing is for contractors to interject themselves through their insurance agent to ensure the correct data are being reported and used.

The key then, to lower workers’ comp premiums, is to first make very sure that employees are not incorrectly classified to categories with higher than necessary rates, and then to do all that you can to gain as low an experience modification factor as possible.

And how do you do that? Three words. (Hint: It has to do with safety.)

Los Angeles-based Ulf Wolf and Clearwater, Fla.–based Steven Ferry write for the construction industry as Words & Images.

For More Information
The Hartford provides workers’ compensation insurance coverage as part of AWCI Insurance Services, Ltd. More information can be found by going to www.awci-insurance-services.com.