Workers Compensation. Premium Negotiation Tips

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1 Premium Negotiation Tips All information provided in this report and any documents ancillary thereto ("Report") are provided for information purposes only. Although the information found in this Report is believed to be reliable, no warranty, expressed or implied, is made regarding the accuracy, adequacy, completeness, legality, reliability, or suitability of any information, either isolated or in the aggregate. All information is provided "as is." Changes may be periodically made to the information contained in this Report. No notice is required with respect to any changes. If you find any errors or omissions, we encourage you to report them by e- mail to: Under no circumstances will Dragon Services, Inc., or its directors, officers, agents, contractors, employees or assigns be liable for any direct, consequential, indirect, special or punitive damages whatsoever arising out of your access to or use of this Report.

2 Contents 1. How Guaranteed Cost Pricing Works Schedule Credits The Key to Lower Costs. How they Work Experience Modification A Cost Driver(sometimes) Experience Modification How to drive your costs down today. 7 2

3 1. How Guaranteed Cost Pricing Works. Guaranteed Cost workers compensation insurance is by far the most common option selected by businesses. The business pays premium and the insurance companies pay all of the losses. There is no additional risk to the business in the short term if losses are greater than expected, and the business realizes no immediate benefit if losses are very low. For clients to understand Guaranteed Cost pricing, there are a few key terms to understand. Most people are aware that premium is determined by multiplying payroll times a rate for each particular class code. What matters is the final "net rate". Many businesses do not realize what goes into the components of a final net rate. "Pure Premium": pure premium is a term that means the premium required to cover nothing more than losses. A rate is determined by the state of California for each class code, based on the historical losses from all businesses that have employees in that same class code. When, that pure premium rate is multiplied by all payroll for that class code for all businesses in the entire state, the resulting total premium is expected to reflect the total premium needed in California for that class code simply to pay losses. When the "pure premium rate" is multiplied by the payroll in one class code for a particular business, the resulting "pure premium" is supposed to reflect the amount required to cover losses for that class code for that particular business, before contemplating the underwriting pluses or minuses of the individual business itself. "Manual Premium": manual premium is simply the pure premium plus an expense loading. The expense loading reflects the cost of insurance company underwriting, commission to brokers, tax payments to the state, and general administration of the insurance company. It is arrived at by applying a factor of about 1.50 (or a 33% increase) to the pure premium. Premium Discount: premium discount is a factor applied to reduce premium, based on the efficiencies that insurance companies realize when they write larger accounts, compared to smaller accounts. Premium discount is automatically applied by the insurance company and is not negotiable. Premium discount usually does not apply to the first $10,000. of premium. These premium discount rates are filed by each insurance company with the State of California, and typically they produce about a 10% reduction in premium. (Unfortunately, 3

4 we have had occasion to hear that brokers have represented to clients that the broker negotiated very hard and succeeded in convincing the insurance company to apply premium discount credits. In actuality, these credits are automatically applied in every case.) Schedule Credits: schedule credits (or schedule debits) are where the rubber meets the road for insurance negotiating. These are credits that are applied based on the judgment of the underwriter on the quality of the business being considered for workers compensation insurance. For most insurance companies, these credits can be very significant ranging from +50% to - 50%, depending on the judgment of the underwriter. Below we discuss the basis on which schedule credits are applied by underwriters "Net Rate": the net rate is what matters to businesses. This is the final rate for each class code, when multiplied by the payroll in each class code for that particular business, will determine the actual premium to be paid. The net rate is the manual rate multiplied times all other factors, including the experience modification, premium discount factors, and schedule credits or debits (based on underwriting judgment). The net rate will produce a final estimated premium, but will not include such additional charges as taxes and fees paid to the State of California. These taxes and fees include a payment made for fraud investigation, insolvency of any insurance companies, and for terrorism coverage. These additional charges amount to 3-5% of the premium. 4

5 2. Schedule Credits The Key to Lower Costs. How they Work. Schedule Credits, or underwriting judgment credits, are the most important factor in determining the final premium paid by anyone business. By law, every insurance company must file with the State of California a document outlining the parameters the insurance company will use to underwrite workers compensation business in California. Infrequently, the State of California will audit the underwriting files at the insurance company, to be certain that the underwriting is done within the guidelines in the rate filing that the insurance company told the State of California it would use. This "rate filing" with the state of California dictates how anyone underwriter may apply credits or debits to the premium for anyone business. For example, is typical that a rate filing will state that an underwriter can apply + or -10% credits based on the underwriter s assessment of management experience for that one business. The rate filing might also allow the underwriter to apply 10% credits if the underwriter determines that a particular business has "lighter" exposures within a class code than would be expected for most businesses within the same class code. (There might be something different about the business, the service it provides, the type of customers it has, or any number of factors that could reduce the exposure to injury.) As you can see, there is a tremendous amount of subjectivity involved when an underwriter assesses the exposures for any particular business. That is why we believe it is critical for clients to review the material in the application that is sent to the underwriter. The volume of arguments made on behalf of the client, and in particular the volume of arguments made in writing can have a huge impact on the final premium paid for anyone business. As stated elsewhere, underwriters report that the overwhelming majority of applications that they receive are without any written arguments whatsoever. A client can do themselves a service by taking control of the written material that makes as many arguments as possible on their behalf to every underwriter. 5

6 3. Experience Modification A Cost Driver(sometimes). Having worked with many business clients, over time we have come to realize that clients are often told things about insurance that aren't exactly accurate. We are constantly surprised at how many clients are led to believe that a change in experience modification has a direct corresponding impact on premium. For example, clients that see a 20% decrease in their experience modification factor often convey to us that they believe they will see a 20% reduction in their premium. Conversely, the client that sees a 25% increase in their experience modification often believes there will be a 25% increase in the premium in the coming year. With certain exceptions, which we will explain below, the experience modification rarely has such a direct impact on pricing if good brokers are involved. Typically, what we see is that underwriters apply more schedule credits (as described above) when experience modifications are increasing, offsetting the impact of the higher experience modification on the new premium. Conversely, we often see underwriters try to apply less credits as experience modifications drop. We believe a good broker can often offset the impact of a rising experience modification by making strong arguments to competitive underwriters with whom the broker has a strong relationship. The exception to what is stated above has to do with an experience modification that exceeds a particular threshold, perhaps 130%. Beyond this threshold, it is often possible that underwriters will be willing to apply all of their available schedule credits, and will not be able to reach the lowest premium the underwriter feels is the right premium. In other words, the experience modification reaches a point where the underwriter simply doesn't have enough credits available to drive pricing down as far as the underwriter would like. However even with a threshold of about 130%, good brokers can often offset significantly the impact of a rising experience modification. 6

7 4. High Experience Modification How to drive your costs down today. We often work with clients that have very high experience modifications. While every client is different, we want to talk about several options that are available for consideration. Experience modification audit: most large brokerage firms are capable of performing an audit of the experience modification calculation. It is often stated that many experience modifications contain clerical errors. Some people estimate that as many as a third of all experience modification calculations include some form of mistake. While only "clerical errors" can be corrected after an experience modification is promulgated, sometimes these errors are significant. The main problem in auditing and experience modification is the volume of information that must be gathered from the client in order to perform the audit. Since the experience modification is made up roughly speaking of audited payroll and loss runs for three years prior to the most recent year, it sometimes takes some digging on the part of the client in order to gather all of this information. Furthermore, while obtaining the actual payroll audits that went into the promulgation of the experience modification is not that difficult, obtaining the loss runs that are dated precisely when submitted to the state of California for calculation of the experience modification is challenging. That being said, if a client can gather this information, it is quite easy for a broker to double check the calculation of the experience modification against the actual data, to determine whether or not a clerical error was made, and to determine if correcting that error would benefit the client. (There are firms that contact prospective clients proposing to perform an experience modification audit in return for 45% of any savings realized. For any client paying sizable premium, this can turn out to be a ripoff, considering that most brokers can perform the calculation and less than a half an hour.) Alternatives to Guaranteed Cost: another way to circumvent the problem of a high experience modification is to place insurance in other than a guaranteed cost/fixed premium policy, the traditional policy for most insureds. Alternatives clients might consider include Captive Insurance Companies, Large Deductible Programs, Professional Employer Organizations (P E Os), and Group Self Insurance. 7

8 Smaller businesses might find that a group captive insurance company is a good alternative, as most captives can determine pricing on their own, independently of any experience modification. Smaller businesses might also look at PEO's. In another section of this website, we address the pluses and minuses of PEO's., And the complications are not to be minimized. However, we have had several clients work with PEO's for many years, and some of these clients are quite large indeed, and have found that the complications involved with working with PEO's are sometimes overcome by the benefits. Larger companies can look at all of the options listed above, including captives, PEO's, large deductible programs, and group self insurance. All of these options can help a company lower their cost workers compensation, despite a high experience modification. Each of these options require a sophisticated insurance broker to properly address both the benefits and the potential pitfalls. Staffing Firms: some companies faced with a high experience modifications have decided that a good solution is to have their employees work through a staffing firm. Obviously, the charges from the staffing firm have to be low enough to offset the high experience modification that a company would realize by having all employees work directly for that business. However, some companies have used several approaches that have proven to be effective, including have some of the employees that have a higher workers compensation rate work through the staffing firm, and other employees continue to work directly for the company. Obviously, those employees that continue to report directly to the company will be those that work in the low hazard, low rate classifications for workers compensation purposes. 8