Workers’ Compensation and How it Differs from Traditional Insurance

by Preston Cavignac, CPCU, CIC

The Basics

Workers’ compensation is unlike traditional insurance. It is “no-fault” insurance, which means the same party (the employer) covers the loss no matter who caused the loss. The purpose of work comp is to deal with work-related injuries in the most effective way possible.  Although the employer pays for the claim regardless of fault, they have the benefit of tort exemption from injured workers. Tort exemption means injured workers can’t sue their employer for the employer’s negligence (there are rare exceptions). This saves a significant amount of money for both parties.

Although work comp is associated with other property and casualty coverages (property, general liability, auto, etc.), it functions differently. Think of work comp as a financing mechanism to pay for an employer’s claims.

How it Works

Work comp provides four types of benefits for an injured worker:

  1. Disability loss of income (also known as indemnity) benefits
  2. Medical benefits
  3. Survivorship (death) benefits
  4. Vocational (rehabilitation) benefits
  • Example: An employee is working on a construction site and a piece of wood falls on his back causing an injury. Work comp will pay for the hospital visit (medical benefit), it will provide indemnification for missed work (disability benefit, normally 66% of the employee’s average weekly wage), and it will pay to re-train the employee if there is a permanent disability that prohibits the employee from returning to their previous job (vocational benefit). There would be no survivorship benefit in this case since no one passed away.

How it’s Priced

Premium is determined by rates and payroll, and rates are determined by class codes. Class codes are codes assigned by the WCIRB (Workers’ Compensation Insurance Rating Bureau) in California (National Council on Compensation Insurance for other states) that help differentiate between the various job duties or “scope of work performed” by different employees.

  • Example: The class code for Clerical Employees is 8810 and is 5403 for Carpentry. The rate associated with 8810 will be lower than the rate for 5403 because office employees are assumed to have fewer injuries than carpenters throughout the year. To calculate your base premium, you take your payroll, divide it by 100, and multiply that by the rate of the class code.

If the rate for 8810 is $1.00 and the rate for 5403 is $25.00 and your clerical payroll is $200,000 and your carpentry payroll is $500,000, your base premium (not including any taxes, fees, credits or debits) will be $127,000.

($200,000 ÷ 100) x $1.00 = $2,000 for 8810 (Clerical)

($500,000 ÷ 100) x $25.00 = $125,000 (Carpentry)

$2,000 + $125,000 = $127,000 (total base premium)

Three Types of Credits/Debits

Once your base premium has been calculated, credits and debits will be applied. There are three main types of credits and debits:

  • Your Experience Modification Factor (Ex Mod)
    • Your Ex Mod is extremely important. This number signifies how favorable your loss history is in comparison to other companies like yours. If you have better-than-average loss history, your Ex Mod will be below 100 and you will have a credit mod, and will receive a discount off the base premium. If you have a worse-than-average loss history, your Ex Mod will be above 100 and you will have a debit mod and a surcharge will be added to your base premium.

Using the clerical/carpentry example above, if you had an Ex Mod of 75%, you would pay $95,250 ($127,000 x .75). If you had an Ex Mod of 125%, you would pay $158,750 ($127,000 x 1.25)

The purpose of the Ex Mod is to encourage and reward a safe working environment. They fewer claims you have, and the better those claims are managed, the more you will save.

  • Premium Discount (a filed credit)
    • This is solely determined by the size of the account; therefore, it is out of your control. The larger the account, the larger the credit.

 

  • Scheduled/Experience Credits and Debits
    • This credit/debit is up to the discrepancy of your underwriter. Underwriters generally have a 25% variance to play with so it’s important that both you and your broker make the underwriter feel comfortable and confident with your account.

 How to Control Cost

  • Fraud

Fraud is a huge issue in work comp. Employees fake injuries to collect work comp benefits, and/or try to prolong their benefits by exaggerating their injuries. Studies show that the longer an employee misses work, the greater the chance that they will never return to work. The San Diego district attorney’s office states that insurance fraud is the number one white collar crime in California and number two in the country, behind tax fraud. It is estimated that insurance fraud in California costs the state $15 billion annually.

  • Remedy: It’s hard to fight work comp fraud, but it all starts with the employees. It is imperative that you have a thorough hiring process; after all, the best time to prevent a potential claim is during the hiring process. It is also important to have a Return-to-Work Program. Often employees can do clerical work before they return to their original position (called Modified Duty). The quicker they return to work, the more you will save on costs.

First Aid

  • Many employers do not understand what is and isn’t allowed under work comp. They will send employees to a doctor when they’re injured which causes claims to stack up, and their work comp premium starts to rise.
  • Remedy: You need to have a First Aid Program. Injuries have to qualify to be treated as first aid, but when they do, losses do not go on record. So if an employee has a minor scratch, bruise, sprain, etc., make sure they have a note asking the doctor to treat it as first aid, if possible. This could drastically reduce the frequency of claims which, in turn, will lower your Ex Mod and work comp premium. (Note: the Ex Mod formula penalizes frequency yet discounts severity meaning that five $7,000 claims would increase your Ex Mod significantly more than one $35,000 claim).
  • Claims Management
    • Once a claim is filed, the insurance company will set up reserves. These reserves are the insurance company’s best guess as to how much the claim will cost. When the Ex Mod is calculated, the WCIRB uses the reserve amount, not the amount that has already been paid out on the claim.
  • Remedy: It is extremely important that you have someone managing your claims. If the insurance company has a $15,000 reserve on a claim that will realistically pay out $2,500, your Ex Mod will increase dramatically (If $15,000 is used in the formula instead of $2,500). It is important that your broker stays on top of your open claims (by reviewing reserves and case statuses), particularly prior to the time when the carrier submits claims and payroll info to the WCIRB for calculation of your Ex Mod.

Summary

For every $1 dollar in claims, you will pay anywhere from $1 to $3 dollars in premium (primarily due to the Ex Mod), thus work comp is more of a financing tool than an insurance policy. However, there are several opportunities to lower costs and most importantly is your employees. Do you have a formal hiring process? Have you discussed it with other HR professionals or consultants? Do you have a First Aid Program for minor injuries? Do you have Return-to-Work programs for injured workers? Do you have a work comp professional who manages open claims and runs Ex Mod projections? Your broker can help you create these policies and procedures which will make a significant difference in your work comp costs.