How to cut high cost of workers' compensation.

The cost of workers' compensation coverage has been rising dramatically since the mid, 1989s-frequently posting double-digit annual increases. For many employers, the annual premium now represents the single largest insurance outlay.

Unfortunately, many employers accept each year's bigher premiums as the price of doing business, believing they can do nothing about it. In fact, there are steps they can take to get those spiraling costs under control.

SAFETY FIRST

The obvious first step is to reduce the number of workers' compensation claims. A safer workplace-with fewer and less-severe employee injuries as well as lower subsequent medical costs and indemnity payments for lost wages-reduces the premiums.

Management accountants should strongly advise top management that corporate safety programs be reviewed carefully with an eye to improvements. They also should encourage management to get behind these efforts, for without such involvement, safety programs often are reduced to lip service.

This article focuses on how workers'compensation operates. With this information, management accountants can save a company money without jeopardizing coverage.

AREAS TO EXAMINE

Three factors go into setting workers'compensation premiums: size of payroll, employee job classifications and the company's claims experience.

* Payroll. With some exceptions, this figure represents wages and salary paid to employees. Excluded are the bonus portion of overtime pay, employer-paid group insurance premiums and certain perquisites. Also, a number of states have limitations on the maximum payroll to be included for certain positions, primarily senior executive officers.

* Employee classification. There are approximately 700 workers' compensation employee classifications. They include job location (the state in which the work is being done) and the primary job function (clerical, furniture assemblers, etc.). Each classification has a distinct rate. For example, the annual rate for a machine-shop employee in Nebraska is $3.74 per $100 of payroll, while a construction superintendent in Mississippi is rated at $4.28.

These values are calculated by rating bureaus, which are independent organizations that gather workers' compensation data from insurance companies. Employers can't adjust these data, but companies should be sure the information relayed to the rating bureaus is accurate; the procedures for checking accuracy are detailed later in this article.

The following example illustrates how a rating can affect premiums. Workers' compensation codes 8008 and 8017 cover retail store employees: code 8008 is for retail stores in which more than 50% of the sales are represented by clothing and dry goods, while 8017 is for retail stores with more diverse merchandise. That seemingly trivial difference, if overlooked, can be costly to an employer. For example, in Illinois, the rate for code 8008 is $1.43 per $100 of payroll, while the rate for code 8017 is $2.16a difference of $.73. With a $5 million payroll, the premium difference totals $36,500 a year.

To be sure, because of the large number of employee classifications, it is difficult to determine that workers are listed correctly. If errors are found that affect a company's premium, however, retroactive changes can be negotiated and insurance premiums returned. Many employers turn to workers' compensation consultants to guide them in this area.

* Claims experience. Experience modification is the insurance industry term for the rate adjustment conditioned by a company's past-claims-payment experience. Naturally, each employer has its own experience modification. Rating bureaus generally calculate each employer's experience modification once a year. A modification of 1.00 means a company's claims are average compared with employers with similar employee codes. A modification in excess of 1.00 means the claims experience is higher than the average, and the workers' compensation premium is increased accordingly. If the modification is less than 1.00, the experience is less than average and the premium is decreased. A modification of 1. 50, for example, increases a $300, 000 premium to $450,000.

An employer should cheek its experience modification calculation for errors at least annually. Errors are not uncommon, and it is up to the employer to verify accuracy.

VERIFYING MODIFICATIONS

To check a company's modification, a management accountant should obtain an experience-modification calculation worksheet. The worksheet is available from the rating bureau or from the company's broker or insurance company. An insurance company can provide the address for the rating bureau.

Management accountants should verify two areas on the worksheet:

1. Payroll data. Once a year, insurance companies send their examiners, whom they call auditors," to examine their clients' payroll data to check employee classifications and other information. The client's management accountant should keep copies of those audits to verify information reported by the rating bureaus.

Important point: Insurance companies generally send their entry-level employees to examine clients' payrolls. However, these people, entry-level or not, wield significant influence in establishing a client's premium. Prudent managers treat them with as much respect as they would Internal Revenue Service auditors.

2. Claims payments. To verify payments listed on this worksheet, the management accountant should compare the insurance company's data with the data reported by the rating bureaus.

Included in the insurance company data is an accounting of what is paid already on each claim and the amount the insurer is holding in reserve for future payments. The size of the reserve is based on the claims adjuster's judgment.

Insurance company claims statistics should be reviewed about eight months before the policy anniversary date. Not only are claims errors sometimes made, but it's not uncommon for the data to include a person not even employed by the company.

Some insurance companies deviate from the published rates. They may apply what they call a "schedule credit," an adjustment to the rating bureaus'ratings. In most cases the adjustment is downward-providing a premium discount.

PAYING FOR INSURANCE

Another means of keeping workers' compensation costs down is to select the most efficient funding plan for the coverage. In general, choice depends on the size of the loss claims.

There are four funding categories:

* Guaranteed cost plans. These are for the smallest companies, those with premiums of less than $100,000 a year. With a guaranteed cost plan the premium is entirely a product of payroll x rate x experience modification.

* Loss-sensitive plans. These are for organizations with premiums over $100,000. Premiums are adjusted after the policy period to reflect losses. If the loss experience is low, the insurer will return some of the premium; if it's higher, the company may have to pay an additional premium.

There are variations to the loss-sensitive plans. One, the dividend plan, generally rewards a client for good loss experience, but it does not penalize for bad loss experience.

Another, the retrospectively rated program, takes many forms. Generally, such programs charge certain fixed costs plus the client's losses up to a predetermined maximum amount. These are extremely complex plans and companies should not take them on without a thorough understanding of how they operate.

* Deductible plans. These are primarily for companies whose premiums exceed $500,000. Although deductibles aren't new in the insurance industry, their applicability to workers' compensation is relatively recent. The deductibles are usually in the range of $100,000 or higher and are particularly advantageous in states that have high premium taxes or assessments. Not all states have approved such plans.

* Self-insurance plans. Generally, when a company's premium in any one state exceeds $500,000, self-insurance should be considered. Since employers have to qualify on a state-by-state basis, many companies that probably would benefit from self-insurance may not qualify in a number of states where they operate.

Any responsible self-insurance program also includes the purchase of some umbrella insurance-that is, coverage to protect against catastrophic losses. Generally, an employer self-insures the first $250,000 of loss in any one year. Reinsurance is purchased for losses that exceed that amount.

Clearly, the more management accountants know about workers' compensation insurance, the more competent they will be controlling costs. And considering the soaring prices of such coverage, that's an important consideration in maintaining the financial health of a business.