Workers' Compensation Rate Reductions

					                  risk management

Workers’ Compensation Rate Reductions
Paul Hughes

Workers’ compensation is both a signifi-        rates is the portion a PEO can control—       of where rates should be and then the
cant expense and a core factor of a prof-       losses. Low loss ratios mean lower expe-      lobbying begins. As one would assume,
itable PEO. Today, the industry news is         rience modifiers, increased profitability,    the insurance carriers line up their lobby-
focused on the reduction of workers’            and more attractive workers’ compensa-        ists to fight for higher rates and the con-
compensation rates in many states.              tion programs. The statistical bureaus        sumer advocacy groups line up theirs for
Overall, rates are declining throughout         (e.g., NCCI) analyze the loss results         lower rates. Probably not shocking to
the country and many organizations are          within each classification code and prom-     many is that the politicians tend to side
reaping the benefits. In Florida, rates         ulgate an expected cost of loss (loss cost)   with the consumer groups, especially in
have dropped a cumulative 52 percent            for each code. In a loss cost state, the      election years. I do not think an election
over the last three years and in California     loss cost is multiplied by the filed loss     has ever been lost because someone
the reduction has been almost 70 percent        cost multiplier (LCM) of each insurance       delivered lower insurance rates to his
for some classification codes. While this       carrier to net the effective rate. The        constituents.
is good news for many business owners,          LCM recognizes the insurance carrier’s           Each of the factors discussed above
it reduces the amount of premium col-           expected expense burden for overhead—         are important in understanding rate set-
lected by the PEO from its client compa-        claims, commissions, tax, reinsurance,        ting and the dynamics behind the
nies and has some negative consequences         etc. In administered pricing states, the      process. The 2006 WC industry results
if not managed effectively. Once you look       statistical bureau estimates the average      are now available via A.M. Best, NCCI,
beyond the initial benefits of lower rates,     expense burden of all insurance carriers      and other organizations. In 2006, overall
you must shift your focus to the potential      providing workers’ compensation in a          industry combined ratios are predicted at
downsides of these declining rates. To          given state and multiplies that by the loss   92 percent, with a 13 percent investment
fully understand the issues, it is helpful to   cost. The difference is that in a loss cost   ratio. WC carriers are estimated to have
understand rate cycles, rate promulga-          state, by using an LCM, each carrier has      a 96.5 percent combined ratio with a 10
tion, and industry profitability.               greater flexibility in developing premi-      percent investment ratio for 2006. These
   Well, you ask, how do insurance carri-       ums by using what it thinks to be an          underwriting results are the best in many
ers make money? Carriers charge premi-          appropriate LCM, while in an adminis-         years, so rate setting organizations and
um for exposures based on a rate per            tered pricing state, the rate is the same     politicians have taken notice and contin-
$100 of payroll and they bank on the fact       for all carriers.                             ue to lower rates. Even though the insur-
that sound underwriting will yield a prof-         The preceding is a display of the num-     ance carriers still cry for higher rates, it is
it via low losses plus investment income.       bers side of the workers’ compensation        tough for them to argue that it has been
For every dollar brought in, insurance          industry—now to the politics. Insurance       unprofitable and therefore we should
carriers must pay for losses plus the           regulators and politicians love to deliver    expect further rate reductions for the
expenses to run their companies.                “low prices” to consumers and business-       foreseeable future.
   Keep in mind that the largest driver in      es. The actuaries develop their estimates        It is critical to mention at this point

                                         MARCH 2008 | PEO INSIDER
that rate cycles have peaks and valleys.       aged care. With rates declining and the        to take advantage of the 18 percent rate
Eventually, losses will catch up to premi-     potential of profitability for the PEO         decrease the first day of the year. If your
ums and premiums must increase.                being squeezed, there is a natural ten-        ARD is not until December 31, you are
Oftentimes, the insurance carriers feel a      dency to reduce resources in this area. As     not able to take the reduction until the
lot of pain before rates are increased.        a result, the PEO’s best low-cost              last day of the year. Needless to say,
Once profitability returns, things will        resource for education, training, and          those with later anniversary rating dates
balance out and plateau. The plateau is        development of cost containment strate-        in a soft market can be put in a tight spot
usually followed by a rate decrease and        gies can be its broker and insurance car-      from a pricing standpoint.
the cycle continues. Keep in mind that         rier.                                             The last soft insurance market
economics, investment ratios, politics,           Another critical issue is managing the      occurred in the 1990s. During that time,
and catastrophic events can shorten and        profitability in the book of business.         many PEOs fell asleep at the wheel in
lengthen these cycles.                         There is a tendency in a soft market for       the areas discussed earlier. Those PEOs
   How does this impact your organiza-         insurance carriers to be more lenient          are not with us today because once the
tion? The first and most significant           about what is allowed to be in a PEO’s         market hardened and carriers became
impact is that carriers have less money to     book of business as well as for the PEO        more selective based on poor underwrit-
pay claims, so insurance carriers may          to not identify and target client compa-       ing results, the loss performance of those
limit financial vehicles or leave the state    nies with poor losses and then set action      PEOs dictated an uncompetitive option,
altogether, especially in an administered      plans to rehabilitate or terminate those       if an option at all.
pricing state where carriers have to live      that underperform. It is understood that          As always, relationships are vital in
with the rates promulgated. Second,            workers’ compensation is not the only          business. Look to partner with your bro-
your experience modifier is a weighting        revenue stream from a client, but the          ker and carrier so open dialogue can be
factor primarily calculated by dividing        financial impact can be long lasting due       solicited. Set goals with your insurance
your actual losses by expected losses.         to experience modifier increases from          partners and celebrate when those goals
Expected losses are where the rates            underperforming risks.                         are met, and set action plans when they
impact the calculation—when rates                 Another factor to be concerned with         are not. Make sure your carrier knows
decline, the ELR (expected loss rate)          is that your workers’ compensation expe-       you are looking for a long-term relation-
increases due to the fact that there is less   rience modifier is driven by an anniver-       ship and are not going to move to a new
rate to compare to actual losses. So, in       sary rating date, or ARD. This is likely       entrant to the PEO market or one that is
most cases, if your experience was identi-     the renewal date for your policy and is set    “buying business.” Each entity is in the
cal to years past, your mod will increase      by NCCI or the applicable statistical          business to make a profit, so open com-
due to the ELR increasing. As a result,        bureau. The ARD determines what                munication is critical when developing
many PEOs feel the need to pass the rate       rates the carrier uses and it also is the      policy premiums, structures, and fea-
savings on to their clients, but do not        baseline for the data reported to the          tures. When workers’ compensation is
realize that their costs will increase in      bureau that promulgates the experience         treated as a program and not a commod-
time due to their experience modifier.         modifier. If you have an April 1 ARD and       ity, benefits will result for all parties.
This “surprise” can crush margins and          you want to take advantage of the rate         Market cycles may dictate today’s pric-
force a PEO to then increase rates,            decrease effective January 1, your ARD         ing, but a long-term approach to cost-
exposing it to outside competition.            prevents you from using the new rates          containment and partnership affords a
   The key to controlling insurance costs      prior to April 1. This rule was placed in      stable future.
in any market, but especially a soft mar-      effect to prevent policyholders from can-
                                                                                              Paul Hughes is chief executive officer of
ket, is to control losses. Overall cost con-   celing and re-writing policies every time
                                                                                              Risk Transfer Holdings, Orlando, Florida.
tainment is executed properly when it          there is a rate decrease. With that said, if
contains best of class risk analysis, loss     you are a PEO with an ARD of January
control, claims management, and man-           1 in the state of Florida, you will be able

                                          MARCH 2008 | PEO INSIDER

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