Report on Dual Classification by Wage Level Program

Transcription

1 Workers Compensation Insurance Rating Bureau of California Workers Compensation Insurance Rating Bureau of California Report on Dual Classification by Wage Level Program Excerpt from the WCIRB Classification and Rating Committee Minutes June 12, 2007 About this Report The WCIRB prepares and presents reports to the WCIRB s Classification and Rating Committee to assist in the formulation of proposed changes to the Insurance Commissioner s regulations. Once adopted by the Classification and Rating Committee, the recommendations contained in the report are provided to the WCIRB Governing Committee and may be included in a WCIRB regulatory filing that is submitted to the Insurance Commissioner for approval. About the WCIRB The WCIRB is California's trusted, objective provider of actuarially-based information and research, advisory pure premium rates, and educational services integral to a healthy workers' compensation system. Learn more at

2 Notice This Report was developed by the Workers Compensation Insurance Rating Bureau of California (WCIRB) to assist in the formulation of proposed changes to the Insurance Commissioner s regulations. The WCIRB has made reasonable efforts to ensure the accuracy of this Report. You must make an independent assessment regarding the use of this Report based upon your particular facts and circumstances Workers Compensation Insurance Rating Bureau of California. All rights reserved. No part of this work may be reproduced or transmitted in any form or by any means, electronic or mechanical, including, without limitation, photocopying and recording, or by any information storage or retrieval system without the prior written permission of the Workers Compensation Insurance Rating Bureau of California (WCIRB), unless such copying is expressly permitted in this copyright notice or by federal copyright law. Each WCIRB member company, including any registered third-party entities, (Company) and agents and brokers licensed to transact workers compensation insurance in the state of California are authorized to reproduce any part of this work solely for the purpose of transacting workers compensation insurance and for no other purpose. This reproduction right does not include the right to make any part of this work available on any Website or on any form of social media. Workers Compensation Insurance Rating Bureau of California, WCIRB,, WCIRB Online, X-Mod Direct, escad and the logo (WCIRB Marks) are registered trademarks or service marks of the WCIRB. WCIRB Marks may not be displayed or used in any manner without the WCIRB s prior written permission. Any permitted copying of this work must maintain any and all trademarks and/or service marks on all copies. To seek permission to use any of the WCIRB Marks or any copyrighted material, please contact the Workers Compensation Insurance Rating Bureau of California at customerservice@wcirb.com.

3 Report on Dual Classification by Wage Level Program Final Report June 12, 2007 EXECUTIVE SUMMARY Objective As part of a broad review of the Dual Classification by Wage Level Program (Program), the Classification and Rating (C & R) Committee directed the WCIRB to study the provisions of the California Workers Compensation Uniform Statistical Reporting Plan 1995 (USRP) applicable to the determination of employees regular hourly wage with regard to construction industry classifications that require the regular hourly wage to equal or exceed a specified amount. The WCIRB was specifically directed to evaluate: (1) The extent to which the rules could be amended to reflect California s record keeping requirements specific to construction industry employees; (2) The feasibility of establishing a per-weekly minimum exposure or hours worked to be eligible for a high wage classification in lieu of clear and unambiguous records detailing hours worked; and (3) Supplementing the USRP with examples to clarify the rule s intent and application. The WCIRB was also instructed to use the Test Audit Program to both improve the WCIRB s validation of the auditing and reporting of dual wage classifications and to begin to benchmark the extent to which employers are maintaining records suitable for the proper administration of dual wage classifications. Findings and Conclusion To fully assess the relevant issues and evaluate potential solutions, WCIRB staff met with key stakeholders including employer associations, the California Department of Industrial Relations, and insurance company auditors. Additional information was collected through test audits performed for approximately 50 employers that utilize dual wage construction classifications. The WCIRB finds the following: (1) California s construction employers are subject to record keeping requirements, contained in Department of Industrial Relations Industrial Welfare Commission Order No This order requires all employers to maintain precise records of hours worked each day for each employee. (2) The applicable USRP rules should be clarified to specify that the assignment of a high wage classification is contingent upon the availability of records necessary to reconcile the number of hours worked against actual time cards or time sheets documenting the daily start and stop times for each employee. (3) With the exception of salaried employees, determination of an employee s regular hourly wage should require verification of the actual hours worked. Proxies for hours worked should no longer be acceptable. 1

4 (4) Establishing a per-weekly minimum exposure or hours worked to be eligible for a high wage classification construction classification would create a significant recordkeeping and auditing burden, and would disallow the assignment of high wage payroll to the correct high wage classification in several foreseeable instances. Establishing a per-weekly minimum is not recommended. (5) Examples to clarify the intent and application of the USRP at Part 3, Standard Classification System, Section IV, Special Industry Classification Procedures, Rule 2a, Determination of Dual Wage Construction or Erection Classification, will promote consistency in determination of employees regular hourly wage, and are included in the recommendations. (6) The WCIRB will use its Test Audit Program to help validate that insurers determinations of employees regular hourly wages have been verified against records documenting the actual hours worked. 2

5 Introduction In his decision on the WCIRB s January 1, 2006 pure premium rate filing, the Insurance Commissioner directed the WCIRB to review the application and propriety of the Dual Classification by Wage Level Program (Program). Pursuant to this directive, at its meeting of August 1, 2006, the C & R Committee adopted a report that provided analysis and background on the Program. (The report, submitted to the California Department of Insurance (CDI) on September 26, 2006, is attached as Exhibit 1.) The report included a finding that while the Program remains an important tool for properly classifying employers in certain construction classifications, issues remain in the insurers ability to accurately audit and report payrolls by dual wage classification. The report noted that: High pure premium rates and a wide differential between the high and low wage rate for a classification create a financial incentive for employers to report hourly wages that equal or exceed the indicated threshold. The ability of insurer auditors to verify the actual hourly wage becomes especially complex when dealing with employees who are paid on a commission or piecework basis. To this end, concerns have been expressed that some employers create payroll records that show a number of hours worked such that the computed hourly wage will meet the applicable wage threshold. To the extent that premium abuse or fraud exists in the construction industry, it threatens the statistical credibility of the dual wage classifications. The C & R Committee report noted the following regarding the WCIRB s role in the Program: The WCIRB s other major responsibility in administering the Program is helping to ensure that payroll and loss data is accurately collected and reported. The WCIRB s primary tools for accomplishing this are administering the relevant regulations included in the USRP and conducting payroll and claims test audits. The C & R Committee report also recommended further analysis as to how the Program can be more equitably administered. Specifically, the report recommended further analysis of the following: (1) The extent to which the USRP rules could be amended to reflect the status of California s record keeping requirements specific to construction industry employees; (2) In lieu of clear and unambiguous records detailing hours worked, the feasibility of establishing a per-weekly minimum exposure or hours worked to be eligible for a high-wage classification; and (3) Supplementing the USRP with examples to clarify the rules intent and application. The C & R Committee report recommended reviewing WCIRB test audit procedures to assess whether those procedures can be modified to improve the WCIRB s validation of insurer auditing and data reporting related to employers with operations in the dual wage classifications. Pursuant to the above, the WCIRB has reviewed various aspects of the administration of the Program. 3

6 Scope of Current Rules Part 3, Section IV, Rule 2.a., Determination of Dual Wage Construction or Erection Classification, of the USRP, provides that the assignment of the high wage classification requires that employers maintain (c)omplete and accurate records supported by original time cards or time book entries that show by individual employee the operations performed, the hours worked, and remuneration earned by such employees The rule then provides instruction for determining an employee s hourly wage for employees that are paid on basis other than hourly wage such as piecework, production, commissions, or salary. (See Exhibit 2.) Calculating an hourly wage is dependent on two factors: remuneration and hours worked. While the rule s instructions regarding the types of remuneration to be included when calculating the regular hourly wage are specific, the requirements for supporting records to establish the number of hours worked are not as clear. Specifically, the requirement for time book entries showing the number of hours worked can be ostensibly met by recording a number of hours that, when divided into the remuneration earned, appears to produce an hourly rate above the high-wage threshold for a dual wage classification. Insurance company auditors have expressed concern that records provided by employers to support an hourly wage determination sometimes appear suspect due to very low hours worked, hourly wage rates that appear high based on the work performed, numerous corrections to the number of hours worked, and other factors. However, it can be difficult to conclusively establish that such records do not constitute complete and accurate records as required in the rule. These concerns are frequently raised in determining the regular hourly wage for employees paid on a piecework basis. In such circumstances, it is not unusual to be presented with payroll records similar to those in Table 1 below: Table 1 Sample of Employee Payroll Records on Piecework Basis Week Ending 3/1 Employee Gross Pay Hourly Wage Hours Worked John Smith $ $ Jane Doe $ $ Jack Washington $ $ Based upon the indicated hourly wage, all employees would meet a high wage threshold of $20.00 per hour. If the analysis ended here, the payroll and losses for all these employees would be reported in the high wage classification. However, a verification sample taken from the actual time cards might provide information similar to that in Table 2: Table 2 Example of Information Reflected on Employee Time Card Time Card: John Smith Day Start Stop Start Stop Hours 25-Feb 7:30 11:30 12:30 4: Feb 7:30 11:30 12:30 4: Feb 7:30 11:30 12:30 3: Feb 9:00 11:30 12:30 5: Mar 7:30 11:30 12:30 3: Total

7 Table 3 shows the regular hourly wage as a function of the documented remuneration and verified hours worked. Table 3 Regular Hourly Wage Calculation Based on Documented Remuneration and Verified Work Hours Employee Gross Pay Hours Worked Regular Hourly Wage John Smith $ $14.94 As indicated above, once the number of hours worked is reconciled against the worker s actual time card, the hourly wage determination changes from $20.00 to $14.94 thus falling below the wage threshold. The above notwithstanding, the WCIRB s discussions with insurer auditors found that there is a lack of uniformity with respect to the records used to validate an employee s hourly wage. While some auditors would accept the records as provided in Table 1, other auditors require a validation of actual hours worked. In view of the above, the WCIRB further explored ways to clarify the rule s specifications regarding the records required to verify an employee s regular hour wage. California s Wage and Hour Standards In order to research California s record keeping requirements specific to construction industry employees, WCIRB staff conferred with Deputy Labor Commissioners from the California Department of Industrial Relations, Industrial Welfare Commission (DIR). These representatives confirmed that DIR s responsibilities include (a) verifying that California employers are in compliance with minimum wage and overtime requirements, and (b) publishing regulations that specify the payroll records needed to document compliance with those requirements. Rules that specifically apply to construction industry employers are contained in Industrial Welfare Commission Order No This order is sent to all new California construction employers and must be posted where employees can read it easily. As such, the DIR considers all construction industry employers to be notified of, and subject to, the recordkeeping requirements contained in Order No (See Exhibit 3.) Order No contains numerous wage, hour and working condition requirements. With regard to California s recordkeeping requirements specific to construction industry employees, Section 6, Records, requires that every employer who has control over wages, hours, or working conditions shall keep accurate information with respect to each employee, including: Time records showing when the employee begins and ends work each day including meal periods, split shift intervals, and total daily hours worked; Total wages paid each payroll period, including value of board, lodging, or other compensation actually furnished to the employee; and Total hours worked during the payroll period and applicable rates of pay. 5

8 In addition, employers are required to keep records on file at the place of employment or at a central location for at least three years. The DIR representatives noted that based on their field enforcement operations some employers in the construction industry, especially small employers that pay piecework or commissions, are regularly found to have records that do not comply with Order No To further assess the availability of these detailed records, WCIRB test auditors, when conducting test audits of construction risks, requested original time cards or time book entries. Of the 45 audits sampled, while 31 employers (68.9%) provided time cards or time book entries, only 23 employers (51.1%) provided records detailing the start time and end time of each work period. It is important to note, however, that there is a strong correlation between the detail in records, and the hourly wages: employers paying wages above the threshold consistently had complete and accurate records including daily start and stop times for all workers. Conversely, in most cases, the employers unable to provide complete and accurate records paid an hourly wage below the threshold. Put another way, in general, the employers that qualify for the high wage classification already have the required systems in place. (An exception to this correlation may be industries such as the rooter plumbing industry where employees are compensated largely on commissions and billable hours and may effectively receive a regular hourly wage that is above the threshold. This industry, however, has not typically maintained detailed records of hours worked.) Findings and Analysis The WCIRB s review found that while the existing rule requires that determination of an employee s regular hour wage be based upon complete and accurate records supported by original time cards, this requirement is not sufficiently direct with respect to what is needed to verify the number of hours worked. Accordingly, to directly address the recognized weakness in administering the dual wage program, the WCIRB explored the feasibility of revising the rules to: (1) Direct auditors to validate the number of hours worked by sampling an employee s daily time records; and (2) Rather than allowing a proxy for hours worked, absent the employer s ability to provide verification of actual hours, the employees would be assigned to the low-wage classification. In other words, irrespective of whether the employee is paid on an hourly, piecework, production, or commission basis, the regular hourly wage shall be determined essentially by dividing the total remuneration by the hours worked. The sole exception to the hours worked requirement is for employees who are paid on a salary and are exempt from California s wage and hour requirements. Since construction industry employers are currently required to maintain the records specified in Order No , amending the USRP in this manner would not place a new requirement on employers but could create an increased recordkeeping burden on employers not currently in compliance. As Order No refers to records kept on a daily basis and summarized for each payroll period, the regular hourly wage for classification purposes should generally be verified by sampling hours worked and remuneration earned by payroll period. This is consistent with the existing portion of Part 3, Section IV, Rule 2.a. of the USRP that states, Commissions and incentive payments that are calculated and paid each pay period shall be included with salary, piecework or hourly pay compensation to determine the employee s regular hourly wage. 6

9 Based on the above, the regular hourly wage will generally be an employee s average wage by pay period. Staff notes, however, that when an employee performs more than one separately classifiable operation in a pay period, it should be permissible to separately calculate a regular hourly wage for each classifiable operation, when complete and accurate records exist. Similarly, when an employee works in connection with a prevailing wage job, for which federal, state or local prevailing wage laws stipulate that contractors pay specified minimum wage rates and specified fringe benefit rates, USRP rules should permit that the employee s regular hourly wage be separately calculated for each prevailing wage job. For the purposes of this rule, salaried employees are defined as employees who are principally remunerated at an established level of compensation without regard to hours worked; sales volume; production levels; or similar variables. Since salaried employees are by definition not required to track hours worked, a proxy for hours worked is required in determining a regular hourly wage. It is therefore recommended that the regular hourly wage for salaried employees be determined by dividing the total annual remuneration by 2000 hours. If an employee is salaried for less than 12 months, the regular hourly wage should be calculated for the salaried period on a prorated basis. (2000 hours provides an appropriate proxy of actual hours worked over the course of a year.) WCIRB Test Audit Program: Central to the WCIRB s data quality efforts is the Test Audit Program. As such, should the recommended changes to the Dual Classification by Wage Level Program be adopted, the WCIRB will incorporate the validation of hours worked into its test audit practices. Specifically, the Test Audit Program will be used to validate that insurers determinations of employees regular hourly wages are verified against records documenting the actual hours worked. In other words, the insurer audit will be expected to demonstrate, through an appropriate sampling, that actual time records showing when the employee begins and ends work each day including meal periods, split shift intervals, and total daily hours worked were used to validate the employee s regular hourly wage. It is expected that a test audit difference may be charged if the insurer audit does not include the required validation of hourly wages and either: 1. Assigns the incorrect dual wage classification as determined by the Test Audit s validation of hourly wages; or 2. Assigns the high wage classification when the Test Audit determines that the required hourly wage records are not available. This approach should help to ensure the application of proper auditing procedures. Employer Outreach: In connection with this effort, the WCIRB sent letters to 99 associations of construction industry employers and employees, notifying them of our study and offering to meet and provide a forum for input. Six associations contacted the WCIRB, two of which sought meetings to discuss the issues and implications. All six associations expressed general support for aligning the USRP with the requirements of Order No Of particular note is the feedback received from an association of rooter plumbers. After discussing the study matter among its members, the association indicated its general support for the proposed changes, and advised the WCIRB that nearly all of its members have adopted recordkeeping practices that comply with the applicable provisions of largely to ensure compliance with overtime 7

10 regulations. Further, most association members have adopted a system that requires employees to record actual hours worked with start and stop times each day. Each employee s average hourly wage is computed for the week based on the actual hours worked. Any premium overtime pay is based on the computed average hourly wage. In this manner, these employers are prepared to produce verifiable records that reconcile to an original time card demonstrating how each employee s hourly wage was determined, for each weekly pay period. Alternative Options for Qualifying for High Wage Classification: The WCIRB also reviewed the possible establishment of a weekly minimum exposure or hours worked to qualify employees for a high wage classification. As employers are already subject to a California requirement to maintain records detailing hours worked, (for all employees other than Exempt employees), the WCIRB sees no compelling reason to implement a completely new classification procedure. Further, a requirement based on a weekly minimum exposure or hours could result in the reclassification of legitimate high wage employees when, due to weather, vacation or sick days, part-time employment, or other circumstances that may be beyond the employer s control, the worker does not reach the weekly minimum exposure or hours. In summary, the WCIRB believes that a weekly minimum exposure or hours worked to qualify for the high wage classification would not align with existing recordkeeping requirements, may not prove effective in reducing or eliminating the potential for the misreporting of payrolls, and may have unintended consequences. Recommendation In order to clarify the procedure for calculating an employee s regular hourly wage, reduce the potential for the misreporting of payrolls into the high wage/low rate dual wage classification, and help ensure that payroll and loss data is accurately collected and reported, the WCIRB recommends the following: (1) The applicable rules be clarified to explicitly provide that the assignment of a high wage classification to any employee (other than a salaried employee) is contingent upon the ability to reconcile the number of hours worked against actual time cards or time sheets that document the daily start and stop times for each employee. (2) Absent the employer s ability to provide verification of actual hours worked, rather than allowing a proxy for hours worked, the employees should be assigned to the low wage classification. Irrespective of whether the employee is paid on an hourly, piecework, production, or commission basis, the regular hourly wage shall essentially be determined by dividing the total remuneration by the hours worked. (3) The rules should be supplemented with examples to clarify the rule s intent and application. In addition, it is noted that should the above recommendations be adopted, the WCIRB will use its Test Audit Program to validate that insurers determinations of employees regular hourly wages are verified against records documenting the actual hours worked. Accordingly, it is recommended that Part 3, Section IV, Rule 2.a., Determination of Dual Wage Construction or Erection Classification, of the USRP, be amended effective on policies incepting January 1, 2008 to reflect the above recommendations. Following is the complete text of the rule (as amended) to be included at the time of the next pure premium rate filing. 8

11 Classification and Rating Committee Meeting Agenda for August 1, 2006 Exhibit 1 Study of Dual Classification by Wage Level Program Draft Report to Classification and Rating Committee August 1, 2006 EXECUTIVE SUMMARY Objective Since 1986, certain construction classifications have been segregated based on the hourly wage paid to employees assigned to those classifications. For many years, regular adjustments to the wage thresholds used to segregate each pair of dual wage construction classifications have been adopted based on wage inflation in the construction industry. In the January 1, 2006 pure premium rate filing, the WCIRB recommended one dollar increases in the thresholds for many of the dual wage classifications. However, in the Decision on the January 1, 2006 pure premium rate filing, the California Department of Insurance (CDI) rejected the proposed threshold increases citing several concerns as to the impact of the threshold increases on employers. This report provides the needed background on the dual classification by wage level program, reviews areas of concern with the program including those related to the wage threshold and the need for inflationary adjustments and proposes administrative action and further research on key issues. Findings and Recommendations Based upon the review of the Dual Classification by Wage Level Program (Program) summarized in this report, the WCIRB finds the following: 1. While the Program has significant limitations with respect to the cost of administration, the potential for abuse, and potential inequities at wage levels that are very close to the wage threshold, prior WCIRB analyses have shown that the Program can reduce potential premium inequities for classifications meeting specific criteria. 2. Periodic increases in the dual wage thresholds are necessary in order to maintain relative consistency in the composition of the dual wage classifications by preventing a disproportionate shift in payrolls and losses from the low wage classification to the high wage classification. If the thresholds were never adjusted, the statistical credibility and pure premium rate relativity of the low wage classification would deteriorate as its highest paid and most experienced constituents shifted to the high-wage classification. 3. Relevant sources pertaining to both construction wage inflation and changes to prevailing wages by craft indicate that the thresholds for most dual wage classifications should be increased by at least $1.00 to reflect wage inflation since the last increase. Accordingly, in its January 1, 2007 pure premium rate filing, the WCIRB will propose a $1.00 increase to the wage threshold for most dual wage classifications. 4. In view of the concerns raised over the efficacy of the Program, the WCIRB will continue its broad based study to explore ways in which the current rules could be clarified and strengthened so as to facilitate more equitable administration of the dual classification by wage level program. Included in the scope of this review will be an evaluation of: a. The extent to which the California Workers Compensation Uniform Statistical Reporting Plan 1995 (USRP) rules could be amended to reflect the status of California s record keeping requirements specific to construction industry employees; 9

12 Classification and Rating Committee Meeting Agenda for August 1, 2006 Exhibit 1 b. In lieu of clear and unambiguous records detailing hours worked, the feasibility of establishing a per-weekly minimum exposure or hours worked to be eligible for a highwage classification; and c. Supplementing the USRP with examples to clarifying the rules intent and application. This study will include using the Test Audit Program to both improve the WCIRB s validation of the auditing and reporting of dual wage classifications and to begin to benchmark the extent to which employers are maintaining records suitable for the proper administration of dual wage classifications. By making the most of the opportunities available through its Test Audit Program, the WCIRB can gather additional information to evaluate the efficacy of the provisions of the USRP related to the dual wage classifications and consider amendments that would improve the accuracy of data reporting for dual wage classifications Concerns have been raised as to the efficacy of the Program in the open rating environment as well as the lack of gradation between pure premium rates and wage levels for employers within the dual wage classifications. A complete analysis of these issues and potential alternatives to the current Program is beyond the scope of this study. 1 Prior to proposing any changes that impact either an employer s record keeping requirements or an insurer s audit practices, the WCIRB will meet with the impacted constituencies to review the nature of the problem and the proposed solutions. 10

13 Classification and Rating Committee Meeting Agenda for August 1, 2006 Exhibit 1 Introduction Since 1986, certain construction classifications have been segregated based on the hourly wage paid to employees assigned to those classifications. Currently, the California Workers Compensation Uniform Statistical Reporting Plan 1995 (USRP) includes eighteen construction classifications that are bifurcated into two distinct or dual classifications based on the employee s hourly wage. When these dual classifications were established, each wage threshold was set at a level such that (1) both the high and low wage dual classifications had statistically credible experience, (2) there were significant differences in the losses per $100 of payroll of employees paid wages below the threshold compared to those paid wages above the threshold, and (3) relatively few employees were paid an hourly wage that was at or near the threshold. Subsequent to their establishment, the wage thresholds have been periodically updated to reflect wage inflation in the construction industry. Once sufficient experience under the dual wage classifications has been reported, the rate (and later the pure premium rate) for each of the dual wage classifications is determined based only on the loss and payroll experience of employees who were assigned to that dual wage classification. In the January 1, 2006 pure premium rate filing, the WCIRB proposed a one-dollar increase to the threshold applicable to most of the dual wage classifications. 2 These increases were predicated on the WCIRB s review of (1) statewide wage growth and average construction wage level growth as projected by UCLA Anderson School of Business and (2) prevailing wage data published by the Department of Industrial Relations (DIR). In its Decision on the January 1, 2006 pure premium rate filing, the CDI rejected the WCIRB s proposal to adjust the thresholds for the dual wage classifications. Specifically, the Decision provided that: [t]he reason for the rejection of these proposed amendments is due to the concern that these increases have on requiring employers employing these classified workers having to increase the hourly wages of their employees to maintain lower workers compensation premiums. The WCIRB is directed to provide information at the next hearing on the effect such changes have on those industries for which these classifications apply and to determine whether such changes create an artificial need for employers to raise the hourly rate of their employees. In addition, an explanation as to the current need for such splits in hourly wages for similar occupations is needed and a determination as to such splits effectiveness versus the burden to employers in monitoring these wage changes and making adjustments. Following the CDI decision, WCIRB staff met with CDI representatives to clarify the concerns raised in the Decision. Among the items discussed at this meeting were the basis for the adjustments to the wage thresholds, the impact the adjustments may have on employers, and concerns regarding the potential for premium fraud based on policyholder s misrepresentation of employees hourly wages. At the meeting, it was agreed that to the extent that the WCIRB again proposes increases in dual wage thresholds as part of the next annual filing, a full analysis of the history, appropriateness, and statistical support related to such changes would be provided. In addition, to address concerns related to potential abuse of the system, it was agreed that the WCIRB would review the USRP rules regarding the documentation needed to obtain the high wage classification and, to the extent appropriate, propose revisions to those rules contained in the USRP. Finally, it was agreed that the 2 Increases were not proposed for Classifications 5183/5187, 5185/5186, 5474/5482 and 6218/

14 Classification and Rating Committee Meeting Agenda for August 1, 2006 Exhibit 1 WCIRB would also review current test audit procedures to assess whether changes in procedures can be made to better evaluate the payrolls being reported in dual wage classifications. History The Dual Classification by Wage Level Program (Program) was adopted by the Commissioner for six large construction classifications effective January 1, The Program was adopted following a WCIRB study that was conducted in response to employer and trade union concerns that the large variation in wage levels among construction contractors was resulting in significant premium inequities. The study found that in certain construction trades, employers that paid high wages were, on average, paying more manual premium per loss dollar than employers that paid low wages. To mitigate this imbalance, the Program was established for six construction classifications that survey results showed (1) were large enough to be segregated into two statistically credible classifications; (2) a significant variation in wages paid by employers within the classification and (3) a significant disparity in claim costs per $100 of payroll by wage level. Attached, as Exhibit 1, is the December 16, 1985 Bulletin announcing the Program. The Program was created to produce rates that accurately reflected the cost of insuring certain construction trades. Specifically, because workers compensation insurance is priced based upon payroll, the Program was enacted to help ensure that the cost of insurance was accurately distributed between high and low wage paying employers. The determination as to whether a classification should be segregated into dual classifications was based on the following criteria: 1. Size. The classification must be large enough to divide into two fully credible classifications. 2. Wage Distributions. The classification should have relatively large spread in the hourly wage paid to employees. 3. Loss per $100 of Payroll Differential. Differentials in losses per $100 of payroll for the classification by employer average hourly wage should be significant and generally vary inversely with the average level of wages paid. 4. Wage Thresholds. A threshold dollar amount should exist such that while there are fairly small percentages of employees paid wages very close to the threshold, the amount of payroll above the threshold and the amount of payroll below the threshold are both sufficient to create two credible classes and, in addition, there is a significant difference in indicated pure premium relativity between employers paying average wages below the threshold and those paying average wages above the threshold. Beginning with the January 1, 1991 rate filing, the WCIRB has proposed and the Insurance Commissioner has generally adopted increases in the hourly wage thresholds for the classifications in the Program. These adjustments have been predicated on wage inflation in the construction industry and have been reflected in one-dollar increments. In August 1991, the WCIRB conducted an analysis of payroll as the basis of premium at the request of the Insurance Commissioner. The analysis showed that, for the construction industries studied, the Program enhanced pricing equity over either total payroll or hours worked. However, the report suggested that, given the increased administrative burden on employers and insurers, the Program only be used for classifications meeting certain specified criteria. Attached, as Exhibit 2, is the Executive Summary of the August 1991 report. 3 3 The Report is labeled Final Draft as no final report was issued. 12

15 Classification and Rating Committee Meeting Agenda for August 1, 2006 Exhibit 1 Effective January 1, 1992, the WCIRB proposed and the Insurance Commissioner adopted the creation of nine additional dual classifications by wage level. The Program was expanded following a WCIRB wage survey and study assessing eleven construction classifications as to whether they met the criteria for inclusion in the Program. Effective January 1, 1995, an additional classification pertaining to automatic sprinkler installation was added to the Program. Effective January 1, 1996, two additional classifications pertaining to steel framing were added to the Program. In December of 2000, at the request of the Commission on Health and Safety and Workers Compensation (CHSWC), the WCIRB conducted an analysis of the potential expansion of the Program. The report showed that, for the most part, the classifications best meeting the criteria for inclusion in the Program were already included in the Program. Attached Exhibit 3 is a copy of the WCIRB report to the CHSWC (excluding exhibits). The eighteen construction classifications currently included in the Program are shown in Table 1. As shown, the wage thresholds have been increased over time to reflect wage inflation in the construction industry. Table 1: Abbreviated History of Dual Wage Construction Classifications Trade Codes Year Created Original Threshold 2006 Threshold Plumbing 5183/ $17 $23 Electrical Wiring 5190/ $18 $25 Carpentry Private Residence 5645/ $17 $23 Carpentry Other 5403/ $17 $23 Sheet Metal Work 5538/ $16 $22 Painting 5474/ $17 $21 Masonry 5027/ $17 $21 Concrete/Cement 5201/ $17 $21 Wallboard 5446/ $19 $23 Glaziers 5467/ $19 $23 Plastering/Stucco 5484/ $18 $22 Roofing 5552/ $17 $20 Excavation 6218/ $21 $25 Sewer Construction 6307/ $19 $23 Water Mains 6315/ $19 $23 Automatic Sprinkler 5185/ $21 $24 Steel Framing Lt Gauge Residential 5630/ $20 $23 Steel Framing Lt Gauge Commercial 5632/ $20 $23 Basis for Adjusting Thresholds Underlying Rationale for Adjusting Thresholds: As a result of wage inflation, the wage thresholds for the dual classifications must be periodically increased to prevent a disproportionate shift in payrolls and losses from one classification to another. Put another way, as wages increase, thresholds must be adjusted to maintain the approximate conditions that existed when the wage threshold was initially established. The intended result of the periodic adjustments is to maintain 13

16 Classification and Rating Committee Meeting Agenda for August 1, 2006 Exhibit 1 the approximate constituency of each classification and to ensure that the experience in both the high and low dual classification provides a credible basis for developing pure premium rates. If the thresholds were never adjusted, the amount of payroll below the threshold would gradually shrink as wages increased and more and more employees would shift to the high wage classification. As a result, not only would the statistical credibility 4 of the lower wage classification decline, but the experience of the low wage classification would deteriorate as its highest paid and most experienced constituents shifted to the high-wage classification. Further, as the experience in the low wage classification deteriorated, there would be greater incentive for employers to move employees into the high wage/low rate classification thus accelerating the deterioration and ultimately compromising the value and relevance of the dual wage approach. The end result would be an increase in the pure premium rate relativity in both the low wage and the high wage classifications. The employers most negatively impacted by a failure to raise thresholds in response to wage inflation are those that pay the highest wages. In that these employers are clearly within the high wage/low rate classification, without inflationary adjustments to the threshold the premiums these employers pay would increase as the scope of their classification shifted towards lower wageworkers. As shown in Table 2, despite regular increases in the wage thresholds since 1991, the percentage of payroll in the low wage classifications has declined somewhat. In a number of classifications, the decline has been significant. 4 The relativity for each classification for the upcoming policy year is determined based on a comparison between that classification s actual losses to $100 of payroll and the ratio of losses per $100 of payroll underlying the current pure premium rate. The credibilities assigned to a classification are the statistical weights assigned to that classification s experience as a predictor of future claim experience relative to the loss per $100 of payroll underlying the classification s current pure premium rate. The predictability or credibilities assigned to a classification s recent historical experience depends on the volume of serious, non-serious and medical claims incurred during the experience period. The WCIRB strives to have classifications with historical experience over five or fewer years that is fully, or 100%, statistically credible, which means that the classification s relativity in the upcoming policy year can be best estimated using only the loss to $100 of payroll experience in the latest two, three, four or five years. Although there is no established minimum acceptable credibility, classifications with credibilities less than one-half have a five-year experience period that is less predictive of future experience in the classification than the loss per $100 of payroll underlying the current pure premium rate. 14

17 Classification and Rating Committee Meeting Agenda for August 1, 2006 Exhibit 1 Table 2: Percentage of Total Payroll Reported in Low Wage Classification Low Wage as % of Total Payroll 5 Industry Codes Following Inception Plumbing 5183/ % 42% Electrical Wiring 5190/ % 40% Carpentry Private Residence 5645/ % 32% Carpentry Other 5403/ % 15% Sheet Metal Work 5538/ % 36% Painting 5474/ % 55% Masonry 5027/ % 37% Concrete/Cement 5201/ % 43% Wallboard 5446/ % 30% Glaziers 5467/ % 36% Plastering/Stucco 5484/ % 51% Roofing 5552/ % 33% Excavation 6218/ % 33% Sewer Construction 6307/ % 22% Water Mains 6315/ % 28% Automatic Sprinkler 5185/ % 45% Steel Framing Lt Gauge Residential 5630/ % 71% Steel Framing Lt Gauge Commercial 5632/ % 19% Sources of Wage Level Information: In evaluating whether a wage threshold adjustment is warranted, the WCIRB evaluates several alternative sources of wage level information. 1. General wage inflation in California, 2. Changes in average California annual construction wages as published by UCLA Anderson School of Business, and 3. Prevailing wage information published for construction trades by the DIR. Prevailing wages, which are based on collective bargaining agreements and other relevant sources, are used in awarding public contracts. For some dual wage classifications, there is a directly comparable DIR craft. For other classifications, it is more difficult to identify a good proxy from the DIR publications. However, changes in the prevailing wage applicable to many of the employers in a particular classification can be relevant as a measure of wage inflation in that classification. 7 5 It should be emphasized that this represents payrolls and not the portion of employees within these classifications. The population of employees is likely more evenly distributed between the low wage and high wage classifications. 6 Policy year 1989 for 5183/5187, 5190/5140, 5645/5697, 5403/5432 and 5475/5482. Policy year 1994 for 5027/5028, 5201/5205, 5446/5447, 5467/5470, 5484/5485, 5552/5553, 6218/6220, 6307/6308, and 6315/6316. Policy year 1997 for 5185/5186, 5630/5631, and 5632/ In assessing wage level shifts, it is noted that the regular hourly wage that is used for classification purposes is generally related to the remuneration used as the basis of premium. Some portions of remuneration, such as group insurance and employers contributions to pension funds, are excluded from the basis of premium and thus not considered as part of an employee s regular hourly wage. Accordingly, wage inflation that is isolated to these excluded forms of remuneration should not be used when establishing the need for a threshold adjustment. The WCIRB has been advised that many employers are currently experiencing large increases in the cost of group health insurance and in required contributions to pension funds. These costs, which are part of employees total compensation and which may therefore contribute to 15

18 Classification and Rating Committee Meeting Agenda for August 1, 2006 Exhibit 1 The WCIRB proposes increases in dual wage thresholds when strongly indicated by the inflation measures discussed above. Further, in order to minimize the recordkeeping burden on employers, the auditing burden on insurers and potential dislocation issues, proposed increases have been in one-dollar increments. Additional Research: Wage Level Surveys for Select Dual Wage Industries: Periodically the WCIRB has conducted follow-up wage level surveys of construction classifications whose constituents have contended that the current threshold was no longer appropriate. Past surveys have included a 1999 study of Classifications 5474/5482, Painting, a 2003 study of Classifications 5552/5553, Roofing, and a 2006 study of Classifications 6218/6220, Excavation. Below is a summary of the findings for each of these studies: 1999 Study of Painting Contractors: An association of painting contractors, stating that economic conditions in California had eroded the wage level for painters, argued that the $19 threshold was excessive. The association suggested lowering the threshold to $16 per hour, because many painters who previously earned $19.00 per hour and above were accepting lower wages to keep busy. In response to these concerns, the WCIRB conducted wage surveys of approximately 300 painting employers. While the survey data could have supported a threshold as low as $17 per hour, other wage data did not support such lowering of the threshold. 8 In addition, the survey data showed only a very slight spike in the distribution of wages in the industry at the $19 threshold, as only about 5% of the employees in the classification were paid a wage equal to the threshold. In light of the 1999 study, the WCIRB recommended retaining the current threshold of $19.00 for Classifications 5474 and (Since that time, the wage threshold for painting has been increased twice to its current level of $21 per hour.) 2003 Study of Roofing Contractors: In 2003, an association of roofing contractors requested a study to determine the feasibility of further subdividing the roofing classifications by creating additional wage thresholds. The association stated that, based on the rate disparity between the roofing classifications, the existing $20 threshold created a financial disincentive to pay wages in the range of $12 to below $20 per hour. The WCIRB studied several options including creating additional wage thresholds, lowering the existing threshold, eliminating the threshold altogether, and creating a premium adjustment plan. The study found that none of these alternatives provided a clear advantage over the current threshold structure. The survey also showed a moderately large spike in the distribution of wages in the industry at the $20 threshold with about 13% of the employees in the classification paid a wage equal to the threshold. In light of the 2003 study, the WCIRB recommended no changes to the dual wage approach for the roofing industry and to the $20 threshold. general wage inflation, are not included when analyzing threshold adequacy. DIR information on prevailing wages generally indicates that non-wage components of construction payroll have grown more rapidly than the wage payroll. For this reason, when assessing the need for adjustments to dual wage thresholds, the WCIRB reviews DIR information on changes in the basic hourly rate rather the hourly rate loaded for non-wage components (e.g. health and welfare and pension contributions). 8 Information from the Employment Development Department suggested average wages for the construction industry increased 3.7% in 1997 and 1.2% in 1998, and data obtained from the DIR demonstrated prevailing wage rates for painters had increased on average 3.7% between 1995 and

19 Classification and Rating Committee Meeting Agenda for August 1, 2006 Exhibit Study of Excavation Contractors: In response to a 2005 WCIRB staff proposal to increase the wage threshold for Classification 6218/6220, an excavating industry association expressed concern that, in recent years, the industry had not experienced increases in average hourly wages; rather, any inflationary increases were reflected in contributions to pension funds and health care. The association asserted that, if the wage threshold were increased, a significant number of employees paid just over the $25 wage threshold would be dislocated. The association also suggested that it is not unusual for an employer to engage in operations using the same employees assignable to both Classifications 6218/6220 and 6307/6308, Sewer Construction, and/or 6315/6316, Water Mains, and questioned why the thresholds differ. The current wage threshold for 6307/6308 and 6315/6316 is $23, while the current threshold for Classification 6218/6220 is $25. In response to industry concerns, in 2006, the WCIRB studied the hourly wage rates paid by 250 surveyed policyholders engaged in grading and/or excavating operations. The study concluded that because (1) the distribution of employees paid $30 and less was fairly evenly spread and (2) the ratio of losses to payroll decreases at a relatively consistent rate with wages, there was no strong evidence that one threshold amount was clearly superior to another. In addition, the study found only a small spike at the current $25 threshold for Classification 6220 (6% of surveyed employees), indicating no major shift of employees to the threshold amount had occurred and minimal dislocation would occur if the threshold were increased. The study also confirmed that, for many employers, recent inflationary increases in wages for grading and excavating were primarily reflected in contributions to pension funds and health care rather than actual wages. In light of the 2006 study, the WCIRB is recommending no change to the $25 threshold for the excavation classifications until such time as the thresholds applicable to both Classifications 6307/6308, Sewer Construction, and 6315/6316, Water Mains, are consistent with the threshold applicable to the excavation classifications. Recommended January 1, 2007 Changes to Wage Thresholds: As part of its January 1, 2007 pure premium rate filing, the WCIRB will recommend $1.00 increases to the thresholds for all dual wage construction classifications except those applicable to the plumbing and excavation industries. These proposed changes are based on the following findings: Since 2004, when all of the thresholds, except the threshold applicable to the painting classification, 9 were last increased, the cumulative increase in statewide wage levels is approximately 8%. 10 This supports at least a $1.00 threshold increase in these classifications. The average change in average California s annual construction wages as published by UCLA Anderson School of Business for 2007 is 2.4%. For the latest two-year period ( ), the UCLA projection is 5.9%. For the latest three-year period ( ), the UCLA projection is 10.6%. This index suggests that at least a $1.00 to $2.00 increase in the wage threshold is supported for all classifications. The average prevailing wages, published by the DIR for the construction classifications studied, with the exception of plumbing, have increased by $1.00 to $2.00 or more since the thresholds were last increased. The average prevailing wages for plumbing has not increased over the last three years since the threshold for this classification was increased. (Based on this information, the WCIRB is not recommending an increase in the threshold applicable to the plumbing dual wage classifications.) 9 The threshold for the painting classification was last increased in For painting, the cumulative increase in wage level since its last threshold increase in 2005 is approximately 5%. 17

20 Classification and Rating Committee Meeting Agenda for August 1, 2006 Exhibit 1 The wage threshold for Classification 6218/6220 was the subject of the earlier referenced 2006 WCIRB study. Based upon the results of the study, the WCIRB will not be recommending an increase to the threshold for Classification 6218/6220. While the wage inflation measures reviewed in many cases support greater than a $1.00 increase to mitigate the potential dislocation, the WCIRB is recommending only a $1.00 increase in the hourly wage threshold at this time. Concerns about the Program Since its advent in 1986, there have been concerns raised about the efficacy of the Program. Presented below is a summary of the primary concerns. Equity of Application Lack of Gradation between Pure Premium Rates and Wage Levels: While most industries have a single rate applicable to all employees assigned to that classification, the dual classification approach segregates the experience of employees assigned to the classification based upon whether the employee is paid wages above or below a specified wage level. As a result, rather than producing a single rate applicable to an entire industry, the Program produces separate rates for low and high wage employees. As indicated in Table 3, there is currently a significant difference between in the pure premium rates for the high and low wage classifications ranging from $1.02 per $100 of payroll for the electrical wiring classifications to $14.07 for the roofing classifications. Table 3: Current Pure Premium Rates Industry Codes July 1, 2006 Pure Premium Rate Low wage High wage Plumbing 5183/ Electrical Wiring 5190/ Carpentry Private Residence 5645/ Carpentry Other 5403/ Sheet Metal Work 5538/ Painting 5474/ Masonry 5027/ Concrete/Cement 5201/ Wallboard 5446/ Glaziers 5467/ Plastering/Stucco 5484/ Roofing 5552/ Excavation 6218/ Sewer Construction 6307/ Water Mains 6315/ Automatic Sprinkler 5185/ Steel Framing Lt Gauge Residential 5630/ Steel Framing Lt Gauge Commercial 5632/ Under the Program, a relatively small differential in hourly wages could produce a dramatically different pure premium rate level. This differential creates concerns over the equity of the Program. While WCIRB analyses have shown (see Exhibit 2) that experience rating and other rating plans might reduce this differential, the application of these plans may not eliminate it.. 18