What Is Worker's Compensation? Or... Like An Iceberg, 90% Is Below The Surface

Robert D. Wurtz

CPCU, principal of Aegis Corporation and General Administrator of the Wisconsin County Mutual Insurance Corpoatation

All worker's compensation policies are alike! All insurers use the same rates!

Right on! These two statements are 100% correct when it comes to worker's compensation coverage. It is what is left unsaid that hides the rest of the iceberg. And the whole cube is what you are paying for. Let's look at what goes into worker's compensation, it's coverage, services, and costs.

The two overwhelming consistencies surrounding worker's compensation coverage as it written in Wisconsin today are that every carrier uses the same coverage form as defined by regulations of the Office of the Commissioner of Insurance and every company uses rates and modifications promulgated by the Wisconsin Worker's Compensation Rating Bureau. These are facts and anyone who says something different is crazy or has a problem with veracity. Perhaps they are just "ensherints saylsmin" and have a problem with both!

Does this mean that all policies and carriers are all the same and it does not matter who you buy from? Not even close! We must look at what services an insurer provides with their policy and how the insurer affects it's pricing after the policy has expired. These can vary enormously.

The biggest single factor in your county's worker's compensation costs is claims. The Wisconsin Worker's Compensation Rating Bureau (WCRB) promulgates an "experience modification" for every worker's compensation policyholder in the state of Wisconsin who is large enough. This includes all counties who are not fully self insured. This experience modification is determined by comparing the policyholders claim frequency and limited severity, relative to the payrolls in each classification for the policyholder, to a standard frequency and severity for each classification. Subject to some modifiers based on size of base premium which act to limit the extremes of the experience modification for smaller insureds, the resulting ratio between actual for the policyholder and the standard, determine the modification. This modification is directly applied to the policyholder's premium. It may be a credit modification, such as .75, which means your premium is 75% of the standard premium. It may be 1.00 which means you are right on the average or standard. It may also be 2.25 which means your premium is over two times the standard. It can be between these extremes or even more extreme depending on your premium size and claims experience for the last three full years.

The point is, any insurer you go to must charge that premium. Your county's own past claims experience, relative to the standard, is the single greatest determinant of cost. Therefore your loss control efforts and the quality and effectiveness loss control services of the insurer you choose will directly affect the cost of your coverage. If you are committed to the necessary loss control effort to get your worker's compensation costs in line, then the quality of the loss control services of the insurer you buy from should be the most important single element in your buying decision.

While control of the cost of your claims is the most important element, it is not the only one. Almost all worker's compensation insurance is loss sensitive, the only exceptions being very small risks, and no, your county is not small enough! The coverage is written on a loss sensitive basis in two ways. One is prospectively, as the coverage is purchased, through the experience modification and premium discounts (another standard size related mechanism or volume discount). The other is retrospectively, that is, after the policy has expired.

I am using the term "retrospectively" in it's broadest generic meaning (that is rating done after the experience for the policy period is in) including, but not limited to, the normal meaning of insurance retrospective rating. To help illuminate, I will discuss a the terms and their ramifications more closely.

When an insurance agent or underwriter says "retro" or "retrospective rating plan", he means a plan that pays him or her for your losses and his or her expenses. Retrospective rating plans charge you an initial premium higher than you would normally pay. This is because you are giving up your premium discount which may be as much as 14%. After the policy has expired, the company looks back ("retrospectively", clever, eh?) at your actual experience, including the reserves they set up for your claims. (The reserves are amounts the company expects to pay in addition to what they have paid and,no, they do not pay interest on your county's money they hold.) They take this amount and multiply it by a factor of roughly an additional 12% to cover their claims handling overhead and some profit. They then take this product of 112% of your "incurred claims" (paid plus their reserve estimates) and add on an overhead factor for buildings, underwriters, vice presidents, golf outings, golf tour sponsorships, and some very cute advertising. Because this overhead charge includes "basically" everything, including profit, and is based on your undiscounted premium, it is called the "basic charge" (one more sign of insurance carrier creativity). This is not the end though, because insurance companies pay a state tax called a "premium tax", and because corporations do not make money if they do not pass on expenses, you pay it in the form of another roughly 5% add on factor on top of all the rest. They then compare this number to what you originally paid and either give some back, if that is possible with all those factors and charges, or ask you to pay more. This goes on for that policy year until all the claims for that year are settled, usually several years for each policy year.

You can see how this may work out. If your county had a $90,000 estimated premium, you would initially pay about $100,000 (no discount, remember?) After the year is over, let's say your paid claims were about $20,000. The company would add it's reserves on those claims, probably around $30,000. This $50,000 sum would be multiplied by the claims handling charge (the companies call it an LCF) of 12% to bring your total to $60,000. They add their basic charge, say 40% of your premium, for $40,000 more to develop a sum of $100,000. Then taxes are added bringing your total to $105,000. You would pay an additional $5,000 at year end when you could have purchased coverage originally for a flat premium of $90,000. That is what an underwriter means by a retrospectively rated policy. As you might expect, the companies really like these and try to sell them because their risk is minimized and profits practically guaranteed. The plans are sold by telling you how much you can get back if you have low losses. (Very low losses and they determine the reserves!)

Now let us look at the other types of retrospectively rated plans called dividend plans. Many dividend plans are not loss sensitive except to the extent that the insurance company does not have to pay them (flat dividends). All companies have the right not to pay dividends and some do not or pay only a portion of the dividend the policy is sold with depending upon their worker's compensation experience. The Board of Directors for a company determines what the dividends will be. Usually, customers do not go back to a company which does not pay all of the dividend percentage a policy is sold with. Trick me once, shame on you....

Another type of dividend which is loss sensitive is called a variable dividend. Much like a policy under retrospective rating plan, these dividends are paid after the experience is determined following the end of the policy period. There are many similarities between variable dividends and retro policies but there are three big differences. The first is that you only pay the discounted premium, the $90,000 in our example. The second is that, unless you sign an agreement to the contrary, a variable dividend is settled only once and is settled forever (keep in mind that the company sets the reserves though and may add another factor called the loss development factor to make sure they are keeping enough). The most important difference is that the discounted premium you paid initially is the maximum that you will have to pay. Their are no potential penalties on dividend plans, unlike the "retro" plans we discussed previously. Retention plans are a variable dividend plan whose dividends are based on a formula.

Finally, there is another type of dividend plan called a safety group dividend. This is a dividend paid to a group of insureds based on the experience of the group. This type of plan offers most of the advantages of the variable and flat dividends with the additional advantages that expenses are group determined providing volume discounts on the overhead and the experience is group determined. This makes the experience much more predictable, reduces any loss development factor (the greater the pot of premium and loss, the more predictable the result becomes and the smaller the factor), and mitigates your individual county's exposure to single large loss situations as they are shared by the group (kind of like a risk sharing pool).

There are also combinations of types of dividends such as a retro and a dividend (really hard to see the advantage here). On this type of plan you give up the premium discount and the board of directors of the carrier may pay you a dividend almost always smaller than the discount you gave up.

The Wisconsin Counties Association Safety Group Program, underwritten by Fireman's Fund is an example of another combination program. Here a flat 10% dividend (and Fireman's Fund has always paid their flat dividends) is combined with a safety group to give you the best of all worlds. You will always get at least the premium discount and flat dividend and you will probably get more. This is why this program has paid as much as a 33% dividend back to all it's participants. Initially, a flat dividend of 10% is paid at year end and the safety group component is paid at a later date so that less loss development is involved.

Hopefully, this little course on worker's compensation will give you a hand the next time you are comparing a product that is the "same for everybody". Keep in mind that the pricing, dividend, or retro plan decisions are all secondary in your worker's compensation cost containment plans to the commitment of the county to loss control and the effectiveness of the loss control services and efforts. These are your county's cost control elements hidden below the surface, 90% of the iceberg.