8 major Workers Comp mistakes

Mar 7, 2008 11:55 AM, By Frank Pennachio

Throughout much of the country, declining Workers Compensation rates are music to employers’ ears. After all, that seems like long-awaited good news, particularly since Workers Compensation is, more often than not, viewed as a necessity and a significant cost of doing business.

Yet, looking at Workers Compensation as a business necessity or a commodity is a major fallacy. Although most employers fail to recognize it, Workers Compensation is a core business practice and a means for improving the bottom line.

Rather than diverting attention and finances during periods of lower Workers Compensation rates to other business priorities, employers can benefit by taking steps to guarantee long-term savings. Here are eight mistakes employers should avoid so they can achieve long-term Workers Compensation savings:

1. Confusing lower premium rates with cost reductions

Many employers are surprised to learn that a reduction in rates does not always mean a reduction in costs. Let’s begin with a basic understanding of what determines the cost of Workers Compensation insurance. Unlike other insurance, Workers Compensation functions like a credit line to finance the costs of injuries. As such, rates alone do not determine the overall cost. An Experience Modification Factor (Mod) tailors the cost of insurance to the individual loss performance of an employer. A Workers Compensation premium is calculated by this formula: Rate x $100 Payroll x Experience Modifier.

The Mod calculation is complex. But an employer generally is compared with similar employers in the same industry classification, and if past losses are lower than average, a credit rating reduces the premium. Conversely, if past losses are higher than average, a debit rating can actually increase costs in spite of lower rates.

2. Becoming complacent

Declining rates act as blinders for many employers. With lower prices, it's easy to shift focus away from injury management and cost containment to other, more pressing business matters.

While increased attention to safety led to a decline in the number of workplace accidents, which resulted in fewer claims and lower rates, claim frequency is only one part of the equation. The other part, claim cost including indemnity (lost wages) and medical care, continues to rise.

In many industries where there are tight labor markets, wage gains are expected to trend higher, suggesting further increases in indemnity severity. At the same time, medical care costs have marched relentlessly upward since the mid-1990s.

Even more disturbing is the fact that the growth in Workers Compensation medical costs has been much steeper than in the health care industry as a whole, indicating that not only medical inflation but a mix of services and overutilization are driving up costs.

If claims remain open and injury costs escalate, reserves (estimate of ultimate cost of injury) rise and adversely affect the employer’s Experience Modification Factor, thus increasing costs. Employers need to understand what is impacting medical costs and measure key metrics such as cost per claim trends adjusted for diagnosis and severity.

3. Focusing on direct costs only

Ask a businessperson how much he or she spends on Workers Compensation and almost all will respond with the price of the premium. Yet, the direct costs of Workers Compensation often represent only 20 to 30 percent of the overall injury expenses.

Indirect costs, including overtime, temporary labor, increased training, supervisor time, production delays, unhappy customers, increased stress, and property or equipment damage represent several times the direct cost of the injury. A 2002 Safety Index report by Liberty Mutual tallied the direct cost of workplace injuries at $40.1 billion. The total financial impact of both direct and indirect costs was estimated to be as much as $240 billion.

Injury costs, both direct and indirect, will have a much greater impact on an employers' overall costs than rate decreases.

4. Thinking rates will stay low

Historically, the Workers Compensation price cycle has repeated in a predictable pattern: Rates decline, insurance is purchased for a lower price, employers shift focus away from Workers Compensation, claim costs do not fall in relationship to reduced rates and employers’ Mod increases, legislative reforms erode or become ineffective, insurance company profits diminish and rates increase.

During a declining rate cycle, the plan expects that if rates go down, so should injury costs. If employers do not manage injury effectively and claims do not go down, the employers’ Mod will go up. When rates rise again, the increased Mod will wipe out any savings garnered during the declining rate cycle.

Frank Pennachio, CWCA, is the cofounder and director of curriculum for the Institute of WorkComp Professionals, an organization that tests and certifies insurance professionals with the skills and knowledge necessary to alert employers about the hidden costs and overcharges in the workers compensation insurance system. Contact him .