Buyer Beware: Transferring Your Workers’ Compensation Experience Rating in a Business Transaction
The “experience modifier” is a method of adjusting an employer’s premium for workers’ compensation policy based upon the employer’s previous loss experience. The premise behind an experience modifier is that the employer’s historical workers’ compensation claims will be a good forecast for its future losses.
The experience rating is typically assigned by a rating bureau based upon information supplied by an employer’s insurance company. Depending on the employer’s jurisdiction, the rating bureau may be the National Council on Compensation Insurance (NCCI), which is the rating bureau in the majority of states, or a rating bureau established for the state in which the employer has workers.
Insurance companies submit statistical reports to the rating bureau for each employer that they insure, including the payroll classification code for each of the employer’s workers, payrolls for each classification, and premium and claim information. The rating bureau uses this information to apply the same rate to all employers in a state, based on an industry class. The rate applied to each class is an average rate that does not recognize the individual characteristics of a particular employer.
The experience modifier is calculated based upon a comparison of the employer’s own experience to the industry average. The individual employer’s experience modifier is calculated using historical claims data based upon claim frequency and claim amount. This experience is measured against the experience of companies of a similar size in the employer’s class. A value of 1.00 is average, meaning an employer’s losses equaled the expected losses of similarly situated businesses during the rating period. An experience modifier greater than 1.00 means the employer experienced worse than expected losses during the rating period, and a modifier of less than 1.00 indicates better than expected losses during the rating period. Experience modifiers may be intrastate or interstate depending on whether a company has operations in two or more states where NCCI is the rating bureau. The workers’ compensation premium is adjusted based upon the employer’s experience modifier.
From the perspective of the insurance company, the experience rating allows the workers’ compensation insurer to collect the appropriate premium to cover the insured risk. From the perspective of the employer, the experience rating creates an incentive for the employer to reduce its losses. Finally, the experience rating may be considered by third parties as an indicator of the employer’s safety record.
This raises the issue of what effect a business purchase will have on the experience rating of the acquiring company. The size of the acquiring company may increase by adding additional employees to the payroll. In addition, the acquiring company’s classification may change depending on whether the acquired company was in the same line of business. However, is the loss history of the acquired company an accurate forecast of the anticipated future loss experience of the acquiring company?
When a business is purchased, or where two companies combine, the loss history of the acquired company will typically affect the experience modifier of the acquiring company. This will often come as an unwelcome surprise for the unprepared, resulting in an unanticipated cost in the form of higher premiums.
The general rule is that the experience rating of the acquired business will be transferred to the acquiring company. The transfer is triggered by a change in ownership, which can take the form of: a transfer of an entity’s ownership interest, the transfer of the assets of one entity to a new entity, the entities undergoing a merger, formation of a new entity that is effectively a successor to another entity, or a proceeding in which a trustee or receiver is appointed to operate a business. The terms of the workers’ compensation policy typically require that notification is provided within 90 days after an ownership change event occurs. The experience modifiers of the two companies are combined on a weighted basis to calculate a new modifier.
The premise of this general rule is that the acquiring company’s experience rating should reflect the acquired company’s past experience. In addition, this general rule is intended to protect insurers from an employer changing the form of ownership or structure of a company in order to avoid the consequences of a poor experience rating. This general rule does not apply across all jurisdictions; there are variations on a state level that need to be considered depending on the locale of the acquired company.
Planning goes a long way in dealing with the potential impact resulting from acquiring the experience rating of another employer as a result of a business transaction. The first step is to be aware of the issue. The second is to engage in due diligence on the issue by reviewing the workers’ compensation history of the entity being acquired and its experience modifier. The third is to make an estimate of the new experience modifier, and therefore new worker’s compensation premium, after giving effect to the transaction. This estimate will permit the weighing of the cost of acquiring the experience rating, which may be factored into the purchase of the business.
