Premium Inequality

So, everyone's probably heard of the "income inequality" issue that's been bubbling up in the media, unless you're already so rich you don't worry about such mundane things. But no matter where on the political or economic spectrum you may reside, there's a different kind of inequality that I've been thinking about lately. And naturally, it involves Workers Compensation insurance.

Let me share with you a recent email I received from a prospective client that may illuminate my thinking on this subject. This small business owner was insured through the New York State Insurance Fund, which functions as the insurer of last resort in New York. That's the equivalent of the Assigned Risk Plan, for those of you in NCCI states like my own Illinois. It means that this is the source of Workers Compensation insurance for those who cannot get coverage from the "voluntary market". Often, small or new business ventures end up covered through such insurers of last resort.

The reason for this business owner's desperate email was that the NYSIF had just hit him with a 60% surcharge on his renewal policy, and he couldn't believe this was correct. He was hoping we would be able to tell him it was based on some error by the insurer.

Sadly, it wasn't. The NYSIF has a rating feature called a differential, and it functions much like Schedule Rating does in other jurisdictions--it's a discretionary premium adjustment that can be applied, without any statutory requirement for justification, and not subject to calculation by any particular formula. NYSIF explained that this 60% surcharge was because this particular business had incurred a couple of claims in the past year, totaling a couple thousand dollars, and this insured had been late paying his bill in the past year.

That's all it took for this insurer of last resort to unilaterally impose a 60% penalty on this employer's Workers Compensation insurance, a business expense that, need I remind you, is essentially mandated for most employers. And since this employer is already in the "insurer of last resort" it's not like he can just take his business elsewhere. I mean, it's theoretically possible he could get a voluntary market insurer to underwrite his coverage, but that seems unlikely because if insurers were really interested in his small account he likely wouldn't be covered by the "insurer of last resort".

Now, it is theoretically possible to appeal these "differential" charges to the insurance regulators in New York--but when I called them, they didn't even realize they had authority over this, so it does not seem too likely this can be successfully appealed. I'm still checking, though.

But this story just illustrates the common plight of small employers: the rates and premiums they pay for Workers Compensation insurance tend to be much, much higher than the rates for larger employers.

Small employers disproportionately tend to be covered by the various "insurers of last resort" and those insurers almost always have much higher rates and premiums.  For example, the manual rate here in Illinois for a machine shop is $6.07 per hundred dollars of payroll in the voluntary market, but $9.14 in the insurer of last resort.  And on top of that rate differential, the "last resort" employers lose the premium discount factor, are not eligible for schedule credit factors, and if their experience mod is over 1.00 they get his with an additional surcharge. So it's not uncommon for "last resort" companies to pay rates that are double what they would be in the voluntary market.

Now, of course, there are legitimate reasons for these higher costs, in the aggregate, because these last resort insurance programs often lose money, as claims exceed premiums. But that's because the "last resort" programs insure not just the small or new employers but also larger employers who can't get coverage through the voluntary market--and these larger employers often are shut out of the voluntary market because of bad claims histories.

But that is small comfort to a small employer with a spotless claim record who nonetheless is stuck in a last resort plan.

Even aside from those kinds of issues, small employers often take it on the chin because rating formulas don't give them as much credit as you would expect.

I was reviewing experience modification factors recently for another small employer, and noted that they had no claims at all for the ten years I was reviewing. Yet the lowest their experience modifier ever went in those years was a .94. So the greatest discount this employer could get from experience rating, after ten years of no losses, was a six percent discount. And that's because the experience rating formula is designed that way, to reduce big swings in mods for smaller employers.

Over the course of my almost-forty year career in Workers Compensation insurance, I've seen this trend grow. When I started, this wasn't the case--once, rates were set and uniform for all employers in the same line of work, adjusted only by experience rating based on their particular loss history. Insurers had to compete on service, as prices for each employer were essentially uniform from one insurer to another. Then competitive rating was gradually introduced, where insurers could increasingly compete on price by filing different rate schedules and using schedule rating adjustments. And this certainly did produce benefits for some employers--if you had significant premiums and decent losses, you could indeed often negotiate with your insurer over price.

But smaller employers haven't benefit from this change--in fact, they've been placed at a competitive disadvantage, because now their Workers Compensation insurance costs, on a unit cost basis, are much, much greater than their larger competitors. So competitive rating in Workers Compensation insurance serves to inadvertently handicap smaller businesses and reward larger ones.

As with many things, unintended consequences can have some of the most powerful impacts. And of course, there are now voices in some corners clamoring to allow larger employers to "opt out" of the traditional Workers Compensation system and create their own programs for addressing workplace injury and illness. I'm not a great fan of such ideas, as I fear they will harm workers who are already at a disadvantage, but another reason for my disdain of these proposals is that they increase the premium inequality between small businesses and their larger competitors.

Small business already has a difficult enough time surviving and thriving in our modern world, even though we celebrate small business in countless political speeches and chamber of commerce press releases. But the truth is, particularly in the field of Workers Compensation insurance, small employers get saddled with costs that are disproportionately high.