(December 2020)
State legislatures develop and implement the rules, rates, classifications, and procedures to rate workers compensation insurance. The National Council on Compensation Insurance, Inc. (NCCI) administers them in many states. Its rules address the details and procedures to follow in a series of sequential steps to rate the Workers Compensation and Employers Liability Insurance Policy. The sequence is necessary because of NCCI's automated reporting requirements designed to collect accurate and timely statistical information. This analysis reviews NCCI's rating approach.
The first step is selecting the proper classification codes. Each classification has a four-digit code. Each code has a corresponding loss cost or rate that is used to start the rating process. Some risks have only one classification and loss cost or rate. Others have two or more, depending on the type of business, operations performed, and classifications that apply.
Related Article: Workers Compensation and Employers Liability Insurance Policy Classification and Underwriting Considerations
NCCI (or another rating organization that has jurisdiction) determines advisory loss costs based on the required statistical information that participating insurance companies provide.
Advisory loss costs do not include charges for expenses such as claims handling, loss control, administration, and similar expenses. These vary by insurance company, so each insurance company develops its own expense factor that it multiplies time the advisory loss cost to determine the final rate for the code. These rates are then filed by the insurance company.
Some classifications have provisions to add loadings to the rate that reflect its common and usual exposure to potential diseases. This is the disease loading. The insurance company may request that the disease loading be removed if a specific risk does not have a disease exposure. However, a disease loading may be added if a risk has an unusual disease exposure that the classification does not contemplate.
Most workers compensation classifications use remuneration or payroll as the exposure or rating basis to calculate premium. A few are rated based on a flat premium charge per-employee or per-capita, such as domestic workers. The primary reason to use remuneration assumes that employees in more hazardous jobs are paid more and, the more hours worked, the higher the pay. It is important to realize that remuneration includes more than just payroll. NCCI defines remuneration as "money or substitutes for money." This definition results in a list of other items NCCI manual rules treat as remuneration. It includes the following but is not limited to just these:
The complete list is in the NCCI Basic Manual for Workers Compensation and Employers Liability Insurance. This abbreviated list gives just an idea of the many types and extent of remuneration and the fact that it may be more than just a paycheck.
Some
types of remuneration are not included and are not used to calculate premium.
Those include tips, employee awards, severance pay, military duty pay, food,
lodging, uniform allowances, and similar expenses for company-sponsored travel.
Overtime pay is the most complicated issue involved in accurately determining remuneration because the increased per hour paid for that overtime cannot be used. The base per hour remuneration can be used but not that increased per hour rate. Incentive pay or shift differential pay that encourages employees to work unpopular shifts or days is not treated as overtime pay. When the employer maintains good payroll records that clearly indicate the amount of overtime, the remuneration used to calculate the premium does not include the additional or extra rate of pay for the overtime.
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Example: Rat Race, Inc. pays $10 per hour for the first 40 hours in a workweek. Scenario 1: Rat Race pays $2.00 per hour extra for any hour worked over 40. Mary works 60 hours one week and is paid $600 + $40 = $640. However, her remuneration to calculate the workers compensation premium is only $600. The $40 overtime bonus is not included. Scenario 2: Rat Race cannot get any employee to work swing shift so begins paying $12 per hour for any employee that is will willing to work it. Mary works 40 hours on the swing shift and is paid $600 + $80 = $680. The entire remuneration is used to calculate the workers compensation premium even though $80 is a pay differentiation. |
Payrolls to calculate premiums may be limited to specific amounts for certain classes of employees based on formulas and limitations. The most common one is executive officers because they sometimes receive bonuses or other forms of incentive pay that do not relate to their workers compensation exposure. The payroll limitation caps the insurance premium charge by limiting the amount of payroll applied to executive officers and some other classes of employees listed in the classification section. The state usually establishes an average weekly amount of pay to apply to executive officers that is then multiplied by the number of weeks of pay the executive receives. Remuneration above the figure this formula develops is not included to calculate the premium.
The rating formula to calculate workers compensation premium is direct and fairly simple. The classification's total remuneration is determined and divided by $100. That result is multiplied by the rate for the classification code. The result is the class premium charge. All class premium charges are added together to arrive at the classification portion of the total workers compensation premium charge.
The expense constant is an additional charge. It is how the insurance company recoups expenses that represent its costs of doing business, such as issuing the policy, reporting statistics, loss control activities, and premium audit. It is added to the total workers compensation premium charge only once, regardless of premium size or the number of classifications. It is not subject to any credits, discounts, modifications, or other premium adjustments. It varies by state. If a policy covers more than one state, only the highest state expense constant is charged. The expense constant is always added before determining the minimum premium, not after.
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Examples:
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Workers compensation policies that insure larger risks have a premium discount factor applied to them. The theory is that larger policies cost less to handle than smaller ones when viewed as a function or percentage of the premium charged. A premium discount is therefore developed whenever a policy’s standard premium exceeds a pre-determined threshold amount.
Related Article: Premium Discount Endorsement
Experience rating applies to each risk that generates premium above a certain threshold amount for three consecutive years. The rules are very detailed and can be found in the National Council on Compensation Insurance Experience Rating Manual. The experience rating modification factor is available every year after the premium threshold is met and the insurance company accurately reports classifications, payroll, premiums, and loss information.
The anniversary date is the annual date when the experience rating modification factor is applied. It is determined by using a mathematical formula. The formula is applied to the statistics reported for the individual risk. Doing so determines how that risk's experience compares to the actuarially determined expected results for all risks in the same class or classes. If the risk's loss experience is better than the average for the class, the experience rating modification factor is a credit. If it is worse, the factor is a debit. One factor is developed for each risk for each state, regardless of the number of classes involved. The experience rating modification factor applies for one year, based on calculations and adjustments at the annual anniversary rating date.
The experience rating modification factor is applied for the policy period at the policy's inception date, based on at least three years of previous loss experience. It applies for the full annual policy term, based on the anniversary rating date that does not change during that policy period. It applies to the current policy period based on past loss experience. Improvements made in loss control initiatives and reflected in favorable loss experience are not rewarded during the policy period when they actually occur.
Related Article: Experience Rating in Workers Compensation
Insurance
An important factor that affects the experience rating modification is either a change in the named insured's name or a material change in ownership that exceeds 50%. If either takes place, the insurance company, the state, and the rating organization that has jurisdiction must be notified and the change must be filed using the appropriate forms and procedures. Some changes in ownership result in changing the experience rating modification factor and the anniversary rating date.
Related Article: Anniversary Rating Date Endorsement
Every policy is subject to a minimum premium. It is the lowest charge the insurance company makes for the insurance coverage provided, is not subject to any credits or discounts, and is charged only once per policy.
Each classification in the manual’s state rates section has a corresponding minimum premium. For policies that have two or more classifications, the minimum premium is the highest minimum for any one classification.
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Example: A policy is issued with two classifications. Classification A has a $250 minimum premium. Classification B has a $500 minimum premium. The $500 minimum premium applies even if the remuneration for Classification A is higher than the remuneration for Classification B. |
Notes: If the employers liability limit is higher than the basic limit, the minimum premium is adjusted upwards based on the increased limits factor for the higher limit.
The minimum premium is adjusted when the premium audit is performed if classifications were added or deleted, based on the risk's actual exposures.
The premium charged at the policy’s inception date or on its renewal is not the final premium. It is only a deposit premium based on the named insured’s best estimates of the payroll for the next policy period. Because payrolls are only estimated, the deposit premium is also only estimated.
After the policy expires or is cancelled, the insurance company audits the named insured's payroll records, determines the actual payrolls, and calculates the final premium. If the earned premium is less than the deposit premium, it refunds the excess to the named insured. If the earned premium exceeds the deposit, the named insured pays the insurance company the difference.
Part Five–Premium, G. Audit in the Workers Compensation and Employers Liability Insurance Policy details the audit process. The named insured must give the insurance company physical access to its premises to examine and audit its records as they relate to the insurance provided as often as the company requires. The records may be in hard copy or electronic format. The company has the right to conduct audits during regular business hours during the policy period and for up to three years after expiration or cancellation. Final payrolls and premiums are not reported to the rating organization that has jurisdiction until after the company performs the audit. Formal premium audits may be waived in certain cases, such as with risks that have small premiums. In these cases, the named insured usually voluntarily submits payroll information to the insurance company on its prescribed forms.
Retrospective rating differs from experience rating.
1) Experience rating is a mandatory part of the workers compensation program and must be applied to all businesses that meet the premium eligibility threshold criteria. Retrospective is voluntary.
2) Experience rating is backward looking and may not provide credit for a company making significant changes in loss control until three years after the fact. Retrospective provides adjusts premium based on the losses that occur in the current year, subject to parameters established, so that the named insured can more quickly be rewarded for positive impacts.
Each insurance company develops and implements retrospective rating plans and the named insured participates voluntarily. The plans explain how premium credits and debits are developed and applied. Retrospective rating plans are attractive because they can reward the employer with return premium if the named insured initiates an active loss control program that controls and reduces losses and that program actually reduces the losses. However, there is a risk because an additional premium is charged if the loss experience actually deteriorates. Most plans establish maximum and minimum premium criteria so that both parties know their potential obligations.
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Example: Patience, Inc. is not pleased with its safety record, so it works with its insurance carrier to develop a rigorous safety program. The 1/1/2020 implementation is expensive, but the loss trend immediately changes. Its new policy term begins on January 1, 2021. Scenario 1: Patience, Inc. experience mod for 2020 contains only the experience for policy years 2016, 2017, and 2018. It will not receive any credit for the 2019 improvements until the 2023 policy year, and even then, it will only receive the benefits of the 2019 improved losses but still have the poor 2017 and 2018 years. Scenario
2: Patience, Inc. is on a retrospective plan in 2019. Patience will pay
premium as established in the rating formula. However, based on the plan
selected, after the policy expires and losses evaluated, a premium is
adjusted based on the actual losses paid in 2019. The time period may extend
out three or more years, but Patience will eventually receive premium returns
based on the actual experience in 2019. Of course, Patience may be required
to pay additional premium if losses exceed those anticipated. |