The Consequences of Intentionally Manipulating Workers’ Comp Premiums – Part 2

In part one of our blog post series “The Consequences of Intentionally Manipulating Workers’ Comp Premiums” we focused on an example of an employer intentionally manipulating the system, and how it backfired.

This week, we bring you part two of our three-part blog post, and focus on the formulas used to develop workers' comp premiums. 

Part Two - Understanding the Formulas Used to Develop Premium

Manipulating the system is not only illegal, but it can impact the employer’s bottom line. To understand the impact, you need first to understand the formulas used to develop premium; it is detailed and complicated. Workers' comp premium is calculated as follows:

Manual Premium is defined as every $100 of payroll x Class Rates.

• This results in a lesser cost in Class Rates which will reduce Manual Premium.

Standard Premium is defined as Manual Premium x Experience Modification Factor.

• This results in a lesser cost in Manual Premium which will reduce Standard Premium.

At this point, the employer who buried their payroll of higher class rates into lower class rates may feel they accomplished their goal to reduce costs.

As noted above, the development of Standard Premium is a result of Manual Premium x Experience Modification Factor.

The Experience Modification Factor either debits or credits Manual Premium based on the Employer’s Loss History.

If the employer has an Experience Modification Factor greater than the factor of 1.0, the employer is penalized and will pay more than Manual Premium. Excessive Losses will negatively impact the employer’s Standard Premium.

If the employer has an Experience Modification Factor lesser than the factor of 1.0, the employer is rewarded and will pay less than Manual Premium. A good loss history will positively impact the employer’s Standard Premium and reduce it.

The Experience Modification Factor is defined as a fraction comparing Actual Losses to Expected losses.

• Experience Modification Factor = Actual Losses / Expected Losses 

The denominator (Expected Losses) in the fraction for the Experience Modification Factor has a calculation within it whereby the Expected Loss Ratio for a Class Code is applied against every $100 of payroll. Thus, if an employer is burying payroll of higher classification rates in Class Codes with lower rates, the employer is actually reducing the denominator. As such, the fraction of Actual Losses / Expected Losses will cause the Experience Modification to be inflated or exaggerated. A simple example follows:

• 6/3 = 2 versus 6/2 = 3. A smaller denominator causes the result to be larger even if the numerator in the fraction remains the same.

Conclusion

Although the responsibilities for calculating premiums may lie with your broker, having an understanding on how these premiums are calculated can provide you with a better understanding of how your Experience Modification Factor is determined.

In part three of our series on this topic we will discuss the following:

How Can an Employer Reduce Their Experience Modification Factor?

We discuss how manipulating the system by moving payroll from class codes with higher rates into class codes with lower rates, creates a situation where there is not enough premium to cover losses. This causes an exaggerated Experience Modification Factor and increased workers’ compensation premiums that can last for several years.

We will also discuss the best practices to reduce the Experience Modification Factor that will result in lower workers’ compensation premiums.

In part three of our series on this topic:

Part 3 - How Can an Employer Reduce Their Experience Modification Factor?

We explain these formulas in more detail. To receive notification for part three of this series, simply subscribe below.