by Eric H. Spencer, Snell & Wilmer
Some contractors no doubt experienced sticker shock when their most recent workers’ compensation audit came back with a higher-than-expected Experience Modification Rate, or EMR, that raised their insurance premium despite maintaining a good safety record. In all probability, the new EMR stemmed from a change to the workers’ compensation rating formula used by most states. But, try explaining to a general contractor or project owner that the number lies and you only appear to be less safe on paper. And worse, your EMR might further increase as the new formula becomes fully phased in by next year.
The ramifications extend beyond higher workers’ compensation premiums. It also potentially means lost work opportunities, because an EMR that suddenly exceeds 1.0 will disqualify most contractors from securing work, or at least place them at a substantial competitive disadvantage. This reality has no doubt led to a recent uptick in legal actions where an EMR is at issue. In fact, the U.S. General Accounting Office (GAO) has addressed multiple EMR-related bid protests the last five months. The outcome of these decisions does not bode well for government contractors who are defending a questionable EMR, however.
Given the effect that upward-trending EMRs will have on the contracting industry, contractors should consider taking a critical look now at their company practices.
The EMR Dilemma Explained
Your EMR is a reflection of your company’s loss history compared with that of similarly situated employers. It is primarily utilized to adjust your workers’ compensation premiums upward or downward to better reflect actual risk. The benchmark EMR rating is 1.0, which theoretically reflects the average safety rating of a comparable employer in your industry. If a particular employer’s loss experience is more costly than the average, the employer’s EMR will exceed 1.0 and therefore result in a premium. For example, an EMR of 1.5 will raise a $100,000 annual premium to $150,000. The converse is true as well: if the employer’s loss experience is less costly than the industry average, the result is a discount.
Most states—including Arizona, Nevada, Colorado, Utah and New Mexico—utilize the National Council on Compensation Insurance (NCCI) to calculate an employer’s EMR. A company’s insurer provides data about the company to NCCI every year. In turn, NCCI determines your EMR according to a mathematical formula that, in essence, divides your actual losses by expected losses.
Expected losses (the denominator in the equation) are impacted by the payroll size among various job classifications. Actual losses (the numerator in the equation) are impacted by workers’ compensation claims filed against the company and the corresponding reserves established by the insurer for future payment; however, these figures are adjusted for “primary” versus “excess” losses. Further mathematical detail is unnecessary here, but suffice it to say that the “primary” component of actual losses is weighted much more heavily than the “excess” component. Every employer, therefore, seeks to minimize primary losses.
Whether a loss is considered primary or excess is determined by the “split point.” From 1993 to 2012, NCCI’s split point was $5,000. For example, a $25,000 workers’ compensation claim was considered a $5,000 primary loss and $20,000 excess loss. However, NCCI doubled the split point to $10,000 last year, which will further increase to $13,500 this year and $15,000 in 2015 (plus two years of inflation adjustment). The potential result is that, with no year-to-year change in your company’s loss history, a larger percentage of your loss will be considered “primary” based solely on the split point change. Thus, due to how the rating formula disproportionately weighs primary losses over excess losses, your EMR could increase dramatically. Some contractors no doubt began to feel the pinch last year.
Of course, the surest way to remain competitive is to reduce the EMR itself. A well-executed safety plan remains the best way to accomplish that goal. However, it is worth mentioning that most insurance brokers can provide their contractor clients with valuable advice on how to strategically reduce their EMR in other ways. For example, a contractor should consider having its broker review its carrier’s treatment of existing claims (along with the corresponding loss reserves established), the accuracy of the data provided to the rating organization, its job classification codes, and the payroll assignments to those classification codes. In some circumstances, a contractor might limit its EMR by shifting certain types of injured workers to administrative tasks on a temporary basis instead of keeping them off work completely—assuming it complies with applicable employment laws, which a knowledgeable attorney can advise upon.
The bottom line is that contractors hovering around the 1.0 mark need not roll over and passively accept a steadily-increasing EMR. If a contractor’s broker has helpful tools in its toolkit, now is the time to use them. If a contractor loses (or stands ready to lose) an important contract, however, then the contractor should consider seeking knowledgeable legal counsel. Although there are no reported legal decisions (as of yet) addressing whether a government agency can validly reject a proposal where the EMR exceeded 1.0 solely due to NCCI’s split rate change, a contractor might have to make that nuanced argument in court or before an administrative agency in the near future.