How Workers' Compensation Works

How Are Premiums Calculated? 

 

Understanding how workers' compensation insurance premiums are determined is very important.  Many calculations and comparisons are needed in order to customize each employer's insurance premium.  These calculations and comparisons ensure employers, in low hazard industries, pay smaller premiums than do high-hazard industry employers. Employers with fewer claims and good safety records pay less in premiums than do employers with many claims and undesirable safety records. 

 

The National Council on Compensation Insurance (NCCI) keeps statistics necessary to differentiate high and low hazard industries and high and low hazard employers within the same industry.  The NCCI combines statistics of hundreds of insurance carriers in several states, including Missouri.  Each insurance carrier, writing workers' compensation policies in Missouri, keeps a claims record for each of its clients.  At the end of the policy year for each client, the carrier sends the claims records to the NCCI.  This pool of statistics is then used to help calculate experience modifiers, rates, and classifications. 

 

High hazard and low hazard industries are distinguished by the classification code they are assigned and the manual rate they pay for workers' compensation insurance.  The classification code and corresponding manual rate are the first factors used to calculate an employer's insurance premium.  If an employer is assigned to a high hazard code such as roofing, trucking or logging, the employer will pay a higher manual rate that employers assigned to a restaurant, clerical or light manufacturing code.  Manual rates vary widely from one (1) classification to another and are expressed as a dollar figure per $100 of payroll.  It is easier to look at rates, however, as a percentage of payroll rather than per $100 of payroll.  For example, $13.71 per $100 of payroll is simply 13.71% of payroll.  

 

Each occupational classification code may either represent entirely different industries or a segment within different industries.  For example, Code 2501 Clothing Manufacturing represents an entire industry, but Code 8810 Clerical Office Employees represents a segment of employees within many different industries.  There are three (3) classifications considered standard exception codes--Code 8810 Clerical Office Employees, Code 8742 Outside Salespersons, Collectors, or Messengers, and Code 7380 Drivers, Chauffeurs and their Helpers.  Standard exception codes can be separated from the employers' main classification code because employees engaged in these jobs are normally not involved in other operations. 

 

After a specific classification and rate is assigned to an employer's operations, their manual premium is determined by multiplying the employer's payroll by the appropriate rate.  Throughout this discussion a hypothetical employer, 'ABC Trucking”, will be used to show how the entire rating system works. ABC Trucking has a $453,000 payroll and is classified as Code 7229, Trucking-Long Haul.  Their manual premium would be 453,000 X 13.71% or $62,106.  All employers' worker compensation premiums are based primarily on their manual premium, adjustments are made to the manual premium that will be discussed later. 

The company insurance agent or insurance carrier determines the company's classification code from the definitions available to them from NCCI for the scope of work performed. These definitions are contained in the 'Scopes of Basic Manual Classifications' manual which insurance agents use to classify their employer clients.  Since many classifications are very similar, codes are sometimes difficult to determine.  In these instances, an insurance agent or carrier may ask the NCCI to physically inspect a specific employer's operations and make the final classification decision. 

 

Employers should obtain a description of their classification from their insurance agent and familiarize themselves with the code assigned to their business.  An employer who feels there are significant differences in the description of an assigned classification code and their actual operations should notify their insurance agent or insurance company.  The agent can probably explain the discrepancies, but if not, the employer should contact the NCCI for answers.  If a company changes operations substantially, e.g., purchasing new equipment, the agent or the NCCI should be asked to re-evaluate the company's operations for possible reclassification.

 

What Determines Manual Rates? 

 

Each year the NCCI files suggested rates with the various States. The States combine these suggested rates with their own statistics to determine the approved rates.  The approved rates are effective for all employers in the assigned risk pool. Rates can also be used as a basis for insurance carriers to establish their voluntary or competitive market rates, but the carriers are under no obligation to do so. Employers, not in the Assigned Risk Pool, pay competitive market rates set by their individual insurance carriers.  Deregulation of workers' compensation premium rates began January 1994, and allows insurance carriers to set their own rates in the voluntary market. 

 

Manual rates in the competitive market vary among insurance carriers. The company's insurance agent should provide them with a minimum of three (3) separate written quotes, each year, to ensure they are getting the best rates.

 

Two (2) factors affecting the insurance premium are the manual rate and company payroll. The third factor affecting the premium is the employer's experience modifier.  The experience modifier is one of the most important components of a company's worker compensation premium.  It is used as a multiplying factor of an individual company's manual premium and is often the most effective tool for controlling premium cost.  

 

An average experience modifier is expressed as 1.00 and simply means that a company has average losses and will pay 100% of their manual premium discussed earlier.  A higher than average experience modifier would be any number greater than 1.00.  A company with a 1.43 experience modifier will pay 143% of its manual premium.  This 43% surcharge reflects the higher than average claims which the company has experienced. 

 

The experience modifier is not always 1.00 or greater, but can also be lower than 1.00.  If a company has an experience modifier of .73, they will pay only 73% of their manual premium.  This effectively gives the company a 27% discount, and reflects the company's lower than average losses, claims and injuries.  

 

Calculating the Experience Modifier 

 

This section discusses the basic method used to calculate the experience modifier.  One common misconception concerning the experience modifier is that a high hazard industry will have a high experience modifier and a low hazard industry will have a low experience modifier.  This is NOT the case.   The experience modifier compares only companies within the same industry classification code. 

 

ABC Trucking, for example, is compared ONLY to other trucking companies in Code 7229.  It is important to remember that RATES vary based upon the hazard level of the industry, whereas the EXPERIENCE MODIFIER varies only by a company's performance within their specific industry.  Achieving a less than 1.00 experience modifier is as much an accomplishment for a restaurant or clerical office as for a construction or logging company. 

 

The easiest way to understand how the experience modifier is determined is to examine the loss ratio or the expected loss rate of an individual company.  The loss ratio is the dollar value of a company's manual premium.  The expected loss rate is simply the loss ratio expected for a particular industry multiplied by the manual rate for that industry.  The expected loss rate is multiplied by a company's payroll to determine expected losses. 

 

If ABC Trucking had 9 claims during their policy year totaling $32,295 and a manual premium of $62,106, their loss ratio would be 52% (32,295 divided by 62,106 = .52 or 52%).  The NCCI determines the actual expected loss rates for all classification codes and publishes them each year.  Many of the expected loss rates are around 52% of the manual rate.  For this reason, assume expected losses of 52% are average for the trucking industry.  With this assumption ABC Trucking will have a 1.00 (average experience modifier) because they have a 52% (average) loss ratio. 

 

 

The calculation of the experience modifier is more complicated than this example, but this should help employers understand the basic calculations used to determine the experience modifier.  Most importantly, employers should realize that experience modifiers are not arbitrary numbers assigned by the insurance carriers, but instead are calculations based on employers' actual claims history.  The NCCI publishes a booklet titled 'The ABC's of Revised Experience Rating', explaining the experience modifier calculation in detail.  Your insurance agent can obtain a copy of the NCCI booklet for their clients.  'The ABC's of Revised Experience Rating' and other NCCI publications can also be ordered directly from the NCCI.  The resource page at the end of this section lists telephone numbers for NCCI and other relevant organizations. 

 

Each year, the experience modifier is re-calculated using the combined claims history from a three (3) year rolling period.  By using a three- (3) year rolling period the experience modifier will remain more consistent and eliminate most wide variations from year to year.  Each year the rolling period drops off the oldest policy year and adds the most recent policy year.  If a company has unusually high claims during one (1) policy year their experience modifier will be affected for three (3) years. However, the effect of the high-claims year will be stabilized by the experience of the other two (2) years on the period.  This stabilizing effect works the same when a company has an unusually low claims year. To effectively lower the company experience modifier, the company must consistently control claims over the entire three (3) year period of the experience modifier.  

 

The three (3) year rolling period includes a one- (1) year lag period immediately preceding the actual three- (3) year claims period.  The one-year lag period is included because of the difficulty placing an immediate cost on claims resulting from serious injuries.  A claim resulting from a serious injury may take several months or even years before it is settled.  If ABC Trucking has an employee injured on June 30, 1997, and their policy ends the same day, it would be impossible for their insurance carrier to determine a cost for the claim and apply it to that claim year.  Since the experience modifier is required for the new policy beginning the next day, a lag period is necessary.  The one-year lag period allows the insurance carrier time to settle and close most claims, and more accurately estimate the cost of claims that continue for more than one year.

 

It is important to remember the lag period when analyzing an experience modifier and when setting goals to reduce it.  If ABC Trucking has a year with an unusually high claim it will not be reflected in the next experience modifier.  It will, however, be reflected in the experience modifier two (2) policy years away.  If, for example, ABC Trucking has a claim on July 1, 1997, the first day of their 1997-98 policy, it will not affect their experience modifier for the policy due on July 1, 1998.  The premium for the policy year beginning July 1, 1999, is the first time the employer actually is charged for the 1997 claims. 

 

Management needs to understand the lag year in order to evaluate the effectiveness of their safety programs.  Suppose ABC Trucking implemented a successful safety program beginning July 1, 1997, and had no claims for the next two (2) years. It would still be July 1, 1999, before ABC Trucking realized any monetary savings from a lower experience modifier.  The full benefits of the safety program wouldn't be realized in the experienced modifier until the policy due on July 1, 2001.  Understanding the one year lag period and subsequent three (3) year rolling claims period can help management set realistic goals for new or existing safety programs.  

To forecast whether an experience modifier will be higher or lower, analyze the oldest or first year on the current record and compare that year to the lag year. The experience modifier will likely decrease if the year dropping off the record had more claims and losses than the lag year.  If, however, a year with fewer claims and losses than the lag year is dropping off the record, the experience modifier is likely to increase.  

 

It is only possible to lower the experience modifier by implementing a successful safety program and reducing claims over a period of at least two (2) years.  However, it takes four (4) complete policy years for the experience modifier to decrease from reduced claims and better safety.  There is little a company can do to have an immediate impact on the experience modifier.  Patience and consistently controlling claims through safety and proper claims management will have a positive impact, but it does not happen immediately. 

 

New companies are often confused about when they will be assigned their first experience modifier.  Companies with first time policies pay their manual premium without the adjustment of the experience modifier.  This is the same as having an experience modifier of 1.00 because there is no surcharge for a higher than average claims record and no discount for a lower than average claims record.  The first experience modifier will be assigned depending on the size of the first year's policy premium. 

 

Out of Pocket Claims

 

The employer may pay out of pocket claims under $500 in medical costs involving no lost time.  The incident must still be reported.  This is not considered a deductible, but operates in much the same manner.  Medical bills the employer pays cannot be used when calculating the employer's experience modifier discussed earlier.  The employer should contact their insurance agent to determine the amount of claims, up to $500, to be paid.  It does not benefit all companies to pay claims under $500.  In many instances, the $500 paid for a claim will be more than the dollar benefit saved on the premium.  The insurance agent should provide a close dollar estimate of claims, to be paid, based on individual policies.  The employer should evaluate the actual benefit, if any, of paying low dollar claims compared to insurance premiums.

 

Choosing a Designated Physician

 

Missouri law allows employers to select the physician or health care provider to treat their injured employees. In many case the employer allows the insurance carrier to make the choice. The authority to direct medical attention is an important workers' compensation control measure available to employers, and ensures injured employees receive treatment for work-related injuries and illnesses from qualified physicians.  Most employers choose a general practitioner or an occupational health physician as their primary care physician.  Either of these physicians is capable of treating most injuries and referring serious injuries to proper medical specialists.  Employers may choose specific medical specialists such as an orthopedic surgeon.  A primary care physician should be notified in advance if referrals to individual specialists are desired. 

 

Several questions need to be addressed when selecting a primary care physician.  Some services the company may want to consider are: 

 

1. Immediate treatment for emergencies and 24-hour appointments for other injuries or illnesses.
2. How employees injured after office hours are treated - 24-hour clinics or the local emergency room?
3. If an emergency room is used, can fees be negotiated?  Is the employee referred to the designated physician for follow up?
4. Will the physician visit the work site?  If so, how often?  Is the visit included in the contract?  Is there an additional charge?
5. How quickly is paperwork returned to the company?
6. Does the physician or clinic have a qualified case manager on staff?
7. Will the physician help develop a modified or light-duty program and recommend its use?

 

Discussing these issues with a designated medical care provider will provide savings on emergency room visits for non-life-threatening injuries.  Employees, who have made prior arrangements with a designated medical provider, should expect prompt medical attention with an office visit instead of the more costly emergency room visit.  Many injuries such as cuts and sprains require prompt medical attention.  However, using the emergency room for all types of injuries can become expensive.  A doctor should advise which type of injury requires emergency room services and which may be treated with an office visit. 

 

Many employers designate a medical clinic with several doctors.  Even though there are several physicians to choose from, the employer should try to utilize only one primary physician.  Building a close working relationship with one primary care physician is important. Working with one physician regularly simplifies employer and employee requirements for timely paperwork submission, etc. 

 

The physician should tour the work facility to better understand the employer's operations.  This may be difficult for a small employer, but the offer should still be made.  If the primary medical provider has a case manager on staff, these services should be utilized as much as possible.  Case managers are usually responsible for following up with injured employees and tracking their progress.  Case managers can be invaluable when a return to work program is implemented.  They also can assist and encourage injured employees with rehabilitation. 

 

If a particular physician or clinic has been used in the past and has provided satisfactory service, they should be considered when choosing the designated medical provider.  Another method of choosing a designated medical provider is to ask an insurance carrier for a list of the carrier's preferred providers and clinics in the area.  Medical providers on this list will sometimes offer discounts to clients of particular insurance carriers.  A third method of choosing a designated medical provider may be to contact other local business associates for referrals and references. 

 

Choose a physician early during the safety and health program implementation.  Notify employees, in writing, that a designated medical provider has been selected and treatment by any unauthorized physician will be at the employee's expense.  The insurance carrier should also be informed that a designated medical provider has been selected. 

 

Managed care organizations (MCO) are physician networks that provide effective cost containment of workplace injuries and illnesses.  MCO offer employers and insurance carriers discounted rates for medical charges.  Since carriers save money when their clients contract with a MCO, the carrier will usually offer the employer client a discount off the insurance premium.  Many MCO provide case managers, medical specialists, and additional services such as employee training and safety services. 

 

Modified Work Program

 

One of the main reasons for spending time choosing a designated medical provider is to effectively implement a modified work program.  Returning injured employees to modified work as soon as possible is very important.  It is just as important to allow injured employees to recover sufficiently from their injuries and return to their previous state of health before returning to work.  An effective modified work program will accomplish both objectives.   

 

Two core requirements needed to effectively implement a modified work program are written job descriptions and a designated medical provider.  Before the physician returns an injured employee to work, he or she must be confident the employer will keep the injured employee within any physical restrictions.  By supplying the physician with a written job description, the physician can better determine if the injured employee can perform the essential job functions.  It is important for the employer and medical provider to feel comfortable with each other.  Rather than returning an injured employee to a situation of uncertainty, the physician may not return the employee to work at all. 

 

Employers should never give up on complicated cases or write off claims management as unproductive.  Regardless of how long a case has continued, the employer should always strive to return the employee to work.  It may be necessary to involve the employer's designated medical provider if the employee has been seeing his or her own physician.  If this is the case, the employer should contact its primary care physician and the employee's current physician to have the treatment for the injured employee transferred. The employer's primary care physician should also ask the employee's current physician to transfer any medical records concerning the worker's compensation claim. 

 

Injured employees who return to work on modified light duty also benefit.  Employees do not receive workers' compensation lost wage benefits for the first three regularly scheduled workdays they are off unless they are off work for 14 days or more.    For example, an employee who misses five days of work will be compensated for two days of lost wages, but an employee who misses a full 14 days will be compensated for the entire 14 days.  This loss of income to the employee is often compounded by the delay in receiving these benefits from the insurance carrier.  Employees and employers are better off if injured employees, where possible, return to work and continue receiving wages on their regular schedule. 

 

Employers should explain this delay to employees who cannot return to work under a physician's orders.  It is advantageous for all parties to understand the claims process and the time constraints involved. 

 

Knowledge of workers' compensation and safety procedures is invaluable when setting goals to reduce and control workers' compensation costs.  Compensation claims and costs are controllable.  Employers who set goals to control claims and costs should realize these goals and many other related benefits.

Source: Washington State Department of Labor and Industries

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Disclaimer: This material is for training purposes only. Its purpose is to inform employers of best practices in occupational safety and health and general OSHA compliance requirements. This material is not, in any way, a substitute for any provision of the Occupational Safety and Health Act of 1970 or any standards issued by OSHA.

Source: Missouri Department of Labor & Industrial Relations

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