How to Avoid the Workers’ Comp Cost Cycle
With few exceptions, Workers' Compensation insurance rates are in decline across the country. Although rates are certainly an important component of Workers' Compensation insurance costs, there are other considerations companies must address during a declining rate environment.
As a starting point, it's important to have a basic understanding of the Workers' Compensation insurance price cycle, Experience Rating, as well as some history of this coverage's market.
The Workers' Compensation price cycle repeats over and over again in
an historically predictable pattern:
Historically, a decline in Workers' Compensation rates is just a calm before the next storm. Usually businesses will pay back all of their "savings," and then some, as the cycle moves to the next phase.
Relying exclusively on legislative reforms and the insurance marketplace for stable cost reduction is a fool's errand. While reforms can help in the short term, companies with a business objective to drive down Workers' Compensation costs in the long term must take a more proactive approach.
1. The first step is to understand that Workers' Compensation insurance functions like a credit line. Employers are typically financing injury costs through their Workers' Compensation policies. To understand this concept, it's necessary to have a working understanding of how the Experience Rating Plan works, since it produces an Experience Modification Factor that is applied to almost all Workers' Comp policies.
The Experience Rating Plan is an integral component of the final cost of Workers' Compensation insurance. While the underlying concepts are complex, we can simplify their application.
In effect, the Experience Rating Plan is a method for tailoring the cost of insurance to the individual characteristics of an employer. It gives employers the opportunity to manage their own expenses through measurable and meaningful cost saving programs. However, the Plan cuts both ways and high injury costs are translated into higher insurance costs.
Actual payroll and loss data for the individual employer are analyzed over a period of time. Usually, the latest available three years of data are compared to similar types of businesses to calculate the Experience Modification Factor.
In general, an employer with better than average injury expenses receives a credit, thus reducing the premium. On the other hand, employers with worse than average injury costs will carry a debit rating, and pay more.
What does the Experience Rating Plan have to do with the price cycle? Due to the inner workings of the Plan, it is more difficult for employers to lower their Experience Modification Factor during a declining rate cycle.
The Plan expects that if rates go down, so should injury costs. So, if injury costs don't track downward consistent with the rate decreases, then the Experience Modification Factor goes up. An increase in the Experience Mod can, and often does, wipe out any savings from the rate reduction. Employers may actually find their total Workers' Comp costs going up even though premium rates are going down.
2. To avoid cost increases during a period of rate decreases, it is critical for employers to be vigilant and proactive in reducing injury expenses. Ultimately, an employer's injury costs have a far greater impact on the company's eventual net cost than reforms and rate decreases. This fact shifts the responsibility of cost reduction from governmental bodies, insurance companies, and the marketplace directly to the employer.
But employers often feel helpless in managing injury costs. Unaware of processes that can dramatically improve outcomes, many view the Workers' Comp system as out of control. It often takes an act of faith before discovering that the strategies and methods for controlling Workers' Comp costs will work.
Employers should approach the objective of reducing injury costs in
much the same manner as they already do for their other business imperatives.
Once knowing what to do, the tougher part is getting proven processes
implemented and embedded into every day business practices. This task,
like so many others, is an ongoing process and not a one-time event.