Ownership changes and the Experience Mod

When companies contemplate mergers and acquisitions, there are a host of factors to consider. Workers' comp and risk considerations often take a back seat to the financial, operational, management, and culture fit considerations. Yet, acquiring or merging with a company that has a poor experience rating and a weak culture with respect to safety and loss control can have dire effects on the bottom line.

To ensure that companies do not play games to achieve the most desirable mods, there are strict rules related to combinability. While this discussion relates to NCCI states, the rules are similar in California, with one exception (see below).Pennsylvania rules are quite different and are explained at the end of this article. Monopolistic states have their own rules.

The Notification of Change in Ownership Endorsement (WC 00 04 14) provides that changes in ownership and/or combinability status must be reported by the employer to its carrier(s) within 90 days of the date of the change. Failure to report changes in ownership may be considered mod evasion and has serious implications for employers. If the rating bureau determines evasion, it can go back as far as it chooses - there is no statute of limitations.

What is an ownership change?

A change in ownership includes:

• Sale, transfer, or conveyance of all or a portion of an entity's ownership interest
• Sale, transfer, or conveyance of an entity's physical assets to another entity that takes over its operations
• Merger or consolidation of two or more entities
• Formation of a new entity that acts as, or in effect is, a successor to another entity that:
• Has dissolved
• Is non-operative
• May continue to operate in a limited capacity
• An irrevocable trust or receiver, established either voluntarily or by court mandate

What isn't an ownership change?

• Entities entering or leaving employee leasing arrangements
• Creation or dissolution of joint ventures
• Wrap-up projects
• Establishment of or change in a revocable trust
• Establishment of "debtor in possession" status
• Entities entering or leaving affiliation, franchise and/or management agreements
• Probate proceedings (until a disposition of the estate is complete)

Ownership changes can result in changes to:

• Experience rating modification
• Combinability status with other entities
• Premium eligibility status-an entity may or may not qualify to be experience rated. Refer to Rule 2-A for more information regarding premium eligibility
• Anniversary rating date
• Rating effective date

When do two entities need to be combined?

The combination of two or more entities requires common majority ownership. Combination requires that:

1. The same person, group of persons or corporation owns more than 50% of each entity (note this does not mean 51%, it could be 50.1%), or
2. An entity owns a majority interest in another entity, which in turn owns a majority interest in another entity. All entities are combinable for experience rating purposes regardless of the number of entities involved.
   
   Determination of majority ownership interest is based on the following:
   1. Majority of issued voting stock
   2. Majority of the owners, partners or members if no voting stock is issued
   3. Majority of the board of directors or comparable governing body if a. or b. is not applicable
   4. Participation of each general partner in the profits of a partnership. Limited partners are not considered in determining majority interest
   5. Ownership interest held by an entity as a fiduciary. Such an entity's total ownership interest will also include any ownership held in a nonfiduciary capacity

For purposes of this rule, fiduciary does not include a debtor in possession, a trustee under a revocable trust, or a franchisor. Common majority ownership is the governing factor in combinability; the only way to avoid it is to structure ownership so there is not a common majority.

There are rare circumstances when the experience does not transfer. This could occur if the acquired entity completely changes its operations, such as a warehouse converting to a skating rink.

California exception

Can exclude past experience IF:

• - More than 50% of the employees change within 90 days after change of ownership
• AND
• - More than 50% of the payroll changes as well

Pennsylvania rules are different

1. In Pennsylvania, affiliates should be combined for rating purposes if:
   1. The affiliates involved constitute the component parts of an enterprise performing a continuous and/or integrated process or operation, or
   2. There is interchange of employment (other than office and salesmen) between two or more of the affiliates involved in the combination.
      
      Separate policies may not be issued to affiliates, which are required to be combined under this rule.
2. Affiliates, which are not required to be combined under rule 8(a), may be combined upon the mutual agreement of the risk and carrier(s) involved. If such combination is agreed to, insurance may be provided either by a single policy, insuring all affiliates, or by separate policies for each affiliate issued by one or more insurance carriers. In the latter case, the experience modification established for the entire risk shall apply on each policy to each affiliate. If all affiliates are not combined, then each affiliate not otherwise subject to rule 8(a) shall be insured under a separate policy and rated on its own experience, provided it meets the qualifications for experience rating as specified in Rule 1 of this Section.

Before a merger or acquisition is consummated, it's important to have an estimate of the new mod. Risk managers and advisers should be brought into the process early on so that the cost of acquiring the experience can be weighed and factored into the agreement.

Source: PowerPoint, Ownership Changes and the Experience Mod by Kevin Ring, Lead Workers' Comp Analyst, Institute of WorkComp Professionals