Background The purpose of the experience-rating system is to hold employers accountable for their individual performance (experience) and to provide an equitable distribution of the cost of work injuries within each industry sector. Experience rating adjusts premiums to make individual employers responsible for their experience performance. This promotes injury prevention and disability management through financial incentives. An employer s experience record attaches to the individual or corporation responsible for the business at the time the record was created and is used to determine premiums. An employer s experience record includes: the number of claims claims costs insurable earnings and personal coverage amounts, and the employer s premium and premium rate. In certain situations, experience records may be combined to determine applicable premium adjustments, such as with some changes in ownership of a business or when related companies do business with each other. WCB policy discusses when combinations of experience are required and when they are optional. An employer who purchases the assets of an existing business will not assume the experience record of the vendor unless the transaction is between related persons (not at arm s-length). Related persons can be directors, shareholders, family members, and legal entities under the actual control of the same person or persons. Continuity in ownership is a significant factor when combining experience. However, strict reliance on this factor has sometimes led to inconsistent application and potential pricing inequities. For the experience rating system to run fairly and effectively, appropriate employer experience needs to be identified and properly analyzed. Employers should not be able to evade a poor experience record or sustain a good record by the form of the sale or transfer of businesses. However, employers should be able to benefit from another employers good experience, if the business they purchase remains substantially unchanged. To establish a premium commensurate with the insured business and its health and safety practices, experience may need to be transferred from one account or employer to another. In the transfer of both good experience and poor experience, clear and consistent policy and processes are required to ensure fair and consistent premium rate determination. The WCB is reviewing policy and processes with the intent of placing less emphasis on continuity of ownership and more on the management of the business, while at the same time supporting the following principles: 1 of 7
Discussion (A) Each legal entity that is an employer requires a WCB account. Employers may establish more than one legal entity that shares common ownership. Employees may be transferred from one company to another without the actual sale of a business or transfer of any assets. WCB must take into consideration the corporate structure, inter-dependent activities and contracting practices of a business, to ensure the intent of experience rating (accountability, injury prevention, and assessment equity) is maintained. Three commonly owned companies have their own WCB accounts, which are experience-rated separately. A clear pattern emerges over the years where the oldest account incurs a 36.55 % surcharge for deteriorating experience and goes from reporting more than a million dollars in insurable earnings to reporting $140,000. The insurable earnings reported under the third company, which is industry rated, moves from $600,000 to $2.9 million and then subcontracts the work or fulfills it through the other company. Under current policy, the owners are able to circumvent experience rating by shifting workers payroll to the account with the better experience and lower rate, thus paying $200,000 less per year. (B) A similar situation exists when a company with poor experience incorporates a new legal entity that does not have any common directors or shareholders. The new company may have an employee of the previous company listed as the sole director. Workers may be transferred to the new legal entity without the sale of the business or assets. The new company, unrelated by common ownership, in effect, becomes a payrolling company. Without common ownership or the sale of a business, the payrolling entity would be assigned the industry rate unless actual control can be established. When a company is under the actual control of another, policy allows WCB to combine experience. However, this is quite onerous to prove and sometimes it is not clearly apparent or easy to define. A company establishes an account with $2.5 million for insurable earnings. The director indicates that this is a new business. However, similarities are discovered between this company and another company operating in the same industry. The legal names are very similar; they operate from the same office building and share the same administrative staff. There is no continuity in terms of ownership. However, the director of the new company is the General Manager of the previous company. The established company is at the maximum surcharge of 80%. Under the existing policy, the poor experience record would not be combined unless actual control is 2 of 7
established. Proving these unrelated entities are dependent on one another to essentially conduct the same business may be difficult and time consuming. As a result, the unrelated company could be assigned the industry rate rather than be subject to the 80% surcharge, for a difference of $116,000 less in premium. A. No change. Proper experience rating will continue to be challenged by the form of corporate/account restructuring. The risk with retaining the status quo is that some employers will evade paying the surcharges that they have earned by restructuring their business. These costs will be passed on to other employers and the poor performers will remain unaccountable for their own experience. Conversely, companies may restructure their business for reasons unrelated to workers compensation (such as expanding or diversifying, addressing labour situations, etc.) and if there is no sale/transfer of assets, the new companies face the prospect of losing the discount earned under the parent/previous company. B. Change policy so that: related legal entities operating within the same industry must demonstrate independent business operations. In cases where workers and contracts are interchangeable, experience records should be combined on an ongoing basis. In the case of interdependent companies, the experience of all companies involved should be used to determine an appropriate performance-based premium. unrelated legal entities that are dependent on each other to conduct a single business, will have their experience records combined. Employers who establish unrelated corporations simply to evade poor experience records would no longer be able to accomplish this task. When there is a change in ownership of a business, the experience record of the vendor can be transferred to the buyer if there is continuity between the two parties. Continuity means a non-arm s-length relationship exists between the vendor and the buyer and is generally interpreted to mean that there is at least one common director between the entities. Under current policy, without continuity of ownership, the experience is not transferred. Nevertheless, there have been situations where the purchaser is at arm s-length from the vendor and the change in ownership has not changed the existing management structure or business operations. Without the flexibility to consider factors other than ownership, good performance and significant efforts in time and financial investment in building a successful health and safety program are ignored in pricing. Conversely, where there is poor performance the WCB may be limited in the ability to carry forward experience, 3 of 7
especially when a business transaction is deliberately structured to circumvent experience. Therefore, consideration should be given to other factors in determining whether the experience record of the vendor should be used to determine the premium rate for the purchaser such as: the nature of ongoing business and continuation of existing contracts relation to existing operations of the purchaser at the time of the transaction continuity of senior management and operations personnel from the vendor continuity of health and safety programs of the vendor Company A has its western operations headquartered in Calgary with a General Manager who reports to the head office in Toronto. Company A has an established health and safety program in Alberta and, through disability management efforts, has earned a 40% discount. Company A decides to sell the business to Company B, which is also headquartered in Toronto. Company B has no other operations in western Canada prior to the purchase of Company A. The sales transaction is at arm s-length, however, Company B decides to keep the western operations intact with no management or operational changes. Under the current policy, when there is no continuity in ownership, the vendor s 40% discount would not be carried forward to the purchaser. Company B would be assessed at industry rate, which results in an additional $450,000 in premiums. A. No change. A purchaser, unrelated to the vendor, can lose the business discount/ surcharge in experience rating despite no significant changes to the management or operations in Alberta. Even though the business costs and safety performance remain the same, the purchaser is assessed at industry rate. It can take several years for the business to build up a significant discount/surcharge for good/bad experience that has been established under the experience-rating plan. B. Change policy so that: where it is determined there is no material change in the business being conducted, experience should be carried forward from the vendor to the purchaser. In the situation outlined in the Case Study above, the experience would be transferred to establish a fair and appropriate rate for the business being insured even though there is no continuity in ownership between the two entities. 4 of 7
Each legal entity employing workers must have an established WCB account. There may be situations when legal entities in a non-arm s-length relationship are incorporated into separate administrative and management functions from the main operations of the business. In this corporate structure, workers are generally not transferred between companies on an ongoing basis. While the related companies would be classified in the same industry according to current policy, each company can also be experience rated on its own record, which is likely to result in a discount for the lower risk staff/company. The end result is pricing by occupation rather than for the overall business. This can limit the participation in experience rating for the higher risk staff/company and reduce potential surcharges. In addition, manipulating experience rating can also create a competitive advantage for contracting purposes. A company with a total payroll of $16 million separates into a Management Corporation and an Operations Corporation. As a result, $2 million in earnings for management and clerical staff is assessed under the Management Corporation. Both companies are classified in the same industry; however, each would have its own experience rating. The management company would be in a 30% discount situation given that the occupations covered have less risk. While the overall business should be in a 40% surcharge position, the surcharge for the operating company is capped at approximately 36% based on its reduced size. Due to the corporate restructuring, the employer pays $20,000 less in premium. A. No change. The practice of establishing accounts for management/service companies without combining experience will allow situations that unfairly shift the burden for poor experience to other employers. Conversely, an operating company that has good experience can limit its participation/discount by shifting part of its payroll to the management company. In situations of highly favorable experience, the practice of setting up management companies and experience rating them separately can increase overall premiums for both companies by capping what would otherwise be larger discounts if they were rated as one business. B. Change policy so that: separate legal entities in a non-arm s-length relationship that support each other in the operation of a business, should have experience records combined to reflect the overall experience. 5 of 7
Experience rating caps adjustments as a stop-loss feature for employers. However, it can also create situations where risk can be managed by account structure rather than by strong health and safety programs. In other words, employers with relatively large business operations can limit accountability for claims costs by business and account structure rather than through accident prevention and claims management. This shifts responsibility for costs to other employers. In an industry, employers may have several businesses in the same industry operating independently of each other except for centralized management and administrative support. Employers can elect to have each business rated separately and in some cases this results in relatively small business operations with limited participation in experience rating. A single legal entity offering its services in 10 facilities, with a combined payroll of $20 million, can limit accountability for its claims costs by establishing branch accounts. If all facilities were assessed under one account, the employer has full participation in experience rating and the aggregate experience would be capped at an 80% surcharge. However, if the employer establishes a separate account for each location with $2 million in payroll, the impact is limited participation and experience for each branch. Limited participation effectively reduces the maximum surcharge on a branch to 30%. As a result, the employer pays, on average, $176,000 less in premium a year, without changing claims costs. A. No change An employer with several businesses with significant claims costs may choose branch accounts in order to cap surcharges based on the size of the branch location rather than the overall business. This undermines the statistical credibility that is required to set an appropriate premium rate. B. Change policy so that in order for a company to have separate experience for branches in the same industry, each business should: be independent of each other have their own on-site management team with responsibilities that include their own health and safety program have full participation in experience rating This will ensure experience rating is being used to its maximum effect, the data is statistically credible, and each business is truly accountable for their performance. 6 of 7
Stakeholder Feedback Stakeholders are invited to provide feedback on the principles and options discussed in this paper. 1. Do you support the principles discussed in this paper? 2. For the principles below, please indicate which approach you support and why. Stakeholders are invited to provide any additional comments that may be relevant to this issue. 7 of 7