Workers' Compensation: 101

A recent article in the Los Angeles Times was alarming to many California employers as it stated “California businesses recently learned that their workers' compensation (WC) insurance premiums could swell this summer.” (To read the articles from Los Angeles Times, please click here.) The article explained that a state board charged with tracking WC expenses recommended a rate increase of 24% based on rising costs such as: higher medical expenses, the threat of increased payments to permanently disabled workers, and sharp increases to medical cost containment and medical legal costs. Many employers know they must pay for WC insurance but may not know how the premium is calculated and/or what they can do to keep their premiums as low as possible, which will be the focus of this article.

What exactly is workers compensation? Workers compensation is a state-mandated, "no-fault" insurance system that pays benefits to workers injured on the job to cover medical care, supplement lost wages, and to settle any permanent disability claims. In return, employers are generally entitled to immunity from civil lawsuits that employees might have as a result of their on-the-job injuries.

How are WC premiums calculated? Each occupation is generally assigned a risk classification, determined by two historical factors: the frequency of on-the-job injuries within a particular occupation and the average severity of injuries suffered. Severity is measured by the medical costs (to return a worker back to the workplace) and any payments made directly to the injured employee (in connection with benefits provided through the workers’ compensation system).

To arrive at a base rate for workers' compensation insurance in California, each risk classification is translated into a dollar amount, which is then multiplied by 1% per $100 of the total payroll for that employee. For example, an office clerk’s compensation rate could be calculated at roughly $1.25 per every $100 that employee’s payroll may total.  If the office clerk is paid $500 per week, the WC insurance premium for that employee costs an employer roughly $6.25 per week.

The base premium for your policy is then multiplied by your experience modification (ex mod) to get your actual premium.  For example: If the total base premium for your entire policy is $5,000 per year and your ex mod is 1.2%, the total premium would be $5,000 multiplied by 1.2%, or $6,000. 

How is the Experience Modification (ex mod) calculated? The WC ex mod is calculated based on three years of experience (annual payroll and losses), not including the most recent year. The ex mod for 2009 would be based upon loss experience, plus payroll records reflected from 2005 through 2007. The ex mod calculation is based on what has been paid and any money the insurance carrier has set aside or reserved to resolve open claims. Reserves reflect only an estimation of what a carrier believes will be paid and do not necessarily reflect the actual amount that will be paid once the claim is closed.

How can an employer reduce/limit WC premiums?  There are many ways to help reduce the cost of WC premiums. Employers can reap the rewards of ensuring job classifications and payroll records are accurate; invest in aggressive safety programs that reward good and safe workplace practices; create opportunities for modified work programs to help return workers to productive; and closely monitor open claims and reserves. 

Above all, do not allow your cost saving interests get ahead of good claims practices. Time and time again, the news will feature an employer who thought that by simply understating the number of employees they had and/or under reporting payroll, they could enjoy a discount in payroll.  However, this practice is considered as insurance fraud and carries severe penalties for those who perpetrate this act. Below are some excerpts from the Los Angeles Times which highlight how this seemingly good idea can go very wrong.

• The owner of a security firm and two vice presidents accused of defrauding the state of $9 million in an elaborate workers' compensation scheme pleaded not guilty.
• The men allegedly created a shell company, International Armored Solutions Inc., to hide the true number of employees at the security firm to avoid paying higher WC insurance premiums.
• Authorities said state officials were told that the new company employed about 20 workers and it was not part of the main security firm. The company failed to pay $9.5 million in WC premiums for its 1,500 employees and the men were taken into custody Wednesday on suspicion of fraud, prosecutors said.