The Cost of Workers Comp

Understanding the Cost Drivers

Workers’ compensation is a substantial cost of doing business. It depletes money and time that should be devoted to a company’s core business. Understanding the cost drivers of worker’s compensation is the first step in planning strategies to minimize this cost.

The Workers’ Compensation System

Workers’ Compensation is a form of insurance that protects employees if they are injured on the job. Before workers’ compensation existed, if an employee was injured on the job, his or her only recourse was to sue their employer to try to recoup medical costs and lost wages. In 1911, workers compensation was federally mandated, and became the exclusive remedy for workers injured on the job. Employers were mandated to pay medical expenses and lost wages for any workers who were injured on the job. In exchange for this coverage, employees lost their right to sue employers. Workers’ compensation became their exclusive remedy.
Since 1911, workers’ compensation has essentially functioned as a “no fault” insurance. Although it was enacted federally, each state has its own specific regulations and benefits. These can vary substantially from one state to another. Employers who have a multi-state business must comply with the workers compensation laws for each state in which they operate, so things can be administratively challenging for large employers.

Workers’ Compensation Benefits

Workers’ compensation affords two types of benefits: wage replacement (also called “indemnity”) and payment for medical costs and care related to treating the injury.

The amount and duration of wage replacement benefits vary based on each state workers’ compensation law. The following are the most common types of benefits:

• Temporary Total – lost wages during recovery from an injury that is temporary in nature.
• Permanent Total – lost wages for serious injuries where a return to work is not possible.
• Temporary Partial – lost wage differential when a worker returns to work at lower wages.
• Permanent Partial – future lost wage potential based on the residual of an injury.
• Death – lost wages for a fatal injury paid to a surviving spouse and/or dependent children.

Medical benefits also vary state to state, but would generally cover most of the medical costs an employee would face.

Workers’ Compensation Premiums

Workers’ compensation coverage and benefits are available through workers’ compensation policies issued by insurance companies. (Some states have their own “state funds” that compete with private insurance companies in offering workers’ compensation insurance.) Both insurance companies and state funds offer this insurance in exchange for premium dollars paid by the employer. The cost for premium varies from employer to employer and is based on the employer’s anticipated losses. It is comprised of two basic components: Manual Premium and Modified Premium

Manual Premium

Each state creates a rate for workers’ compensation insurance coverage based on the aggregate loss experience for the type of jobs people work. Each specific job type is categorized in both a “class” and “class code” so that some degree of comparison can be made between states in developing rates. For example, a file clerk works in a class of employment known as “clerical” and the loss experience associated with that class is generally very favorable. In contrast, a delivery person works in a class of employment known as “trucker” and the loss experience associated with that class is generally less favorable. It makes sense because clerical workers are less likely to be injured on the job than delivery people. Based purely on these rates, premium would be far less for an employer who employs mostly clerical workers than for an employer who employs mostly delivery people.

Since most employers have a combination of classes in their workforce, the manual premium is computed by multiplying the rate for each class by $100 of payroll in that class. For example, a manufacturer may pay the following:

Modified Premium

After an employer’s manual premium is determined, it is multiplied by an Experience Modification Factor (sometimes called a “mod”) to arrive at a modified premium which is generally the rate an employer would pay.

While classes are based on aggregate experience, the mod takes into account what each individual employer’s actual loss experience has been at their workplace. Generally, employers who keep their workplace safe and help injured employees get back to work quickly have a favorable loss experience, resulting in a mod that is less than 1.0. Conversely, employers who are careless in maintaining a safe workplace or who fail to help injured workers return to employment have a poor loss experience resulting in a mod that is greater than 1.0. Review the following example to see the impact this can have on the cost of resulting modified premium:

The mod is a critical factor in determining the final cost of an employer’s workers’ compensation policy. And much like the experience rating system used by many states to develop auto insurance rates, a bad year can haunt an employer for years to come – three consecutive years’ experience are used to develop a workers’ compensation mod. Maintaining a safe workplace is not only the right thing to do, it truly saves money.

Uninsured Expenses

Beyond the premium that employers pay for workers’ compensation, on-the-job injuries also result in costs that are not covered by workers’ compensation insurance. Some examples of these uninsured costs include:

• Production down-time and inefficiencies
• Replacement cost for temporary labor
• Training temporary labor or replacement workers

Many experts believe that the uninsured costs of on-the-job injuries can be as much as 2 or 3 times the actual premium paid for workers’ compensation insurance! Finding solutions to the cost of workers’ compensation is critical to the health of a company, both in economic as well as human terms.