The Workers' Compensation Policy and Premium Computation

A workers’ compensation policy is written on a standard form that does two different jobs, and its premium follows a fixed sequence of steps. The sections below walk through the standard policy, WC 00 00 00 (Ed. 1-15), part by part, then builds a premium the way an underwriter, auditor or producer would: payroll by classification, rate per $100, experience modification, premium discount and final audit. The Michigan material comes from the manual of the Michigan Workers Compensation Placement Facility, the assigned risk plan administered by the Compensation Advisory Organization of Michigan (CAOM). A voluntary-market insurer files its own rates, plans and discount tables, so the Facility’s figures show how the steps work and are not every insurer’s numbers.

The Policy in Six Parts

The General Section makes the policy the Information Page, the form and every endorsement listed on the page; terms change only by endorsement. The insured is the employer named in Item 1. “Workers compensation law” means the compensation and occupational disease law of each state named in Item 3.A, and it excludes any federal compensation law.

Part One: Workers Compensation Insurance

Part One applies to bodily injury by accident or by disease, death included. The triggers differ:

• Accident. The injury must occur during the policy period.
• Disease. The disease must be caused or aggravated by the conditions of the employment, and the employee’s last day of last exposure must fall within the policy period.

A worker who breathes a dust for nine years and is diagnosed after the employer changes insurers is charged to the policy in force on the last day of exposure, not the policy in force at diagnosis.

The insurer agrees to pay promptly when due the benefits the compensation law requires of the employer. The Facility’s manual says the standard policy places no limit on Part One. In Michigan the employer’s duty includes furnishing reasonable medical, surgical and hospital services and medicines when needed (MCL 418.315(1)). The insurer has the right and duty to defend any claim or suit for benefits, and no duty to defend one that is not covered.

Four provisions decide real claims.

• Payments you must make. The employer, not the insurer, bears amounts above the regular benefits that result from its serious and willful misconduct, knowing employment of a worker in violation of law, failure to comply with a health or safety law, or discharge, coercion or discrimination against an employee in violation of the compensation law. If the insurer advances such an amount, the employer reimburses it promptly.
• Recovery from others. The insurer takes over the rights of the employer and of the persons entitled to benefits to recover from anyone liable for the injury. A defective press that injures a worker can lead to the insurer’s recovery action against its maker.
• Statutory provisions. Where the law requires, notice to the employer is notice to the insurer, the employer’s bankruptcy does not relieve the insurer after an injury, and the insurer is directly and primarily liable to the person entitled to benefits. An injured worker whose employer has closed can still collect.
• Conformity. A term that conflicts with the compensation law is changed to conform to it.

Part Two: Employers Liability Insurance

Part One pays benefits without regard to fault. Part Two answers a lawsuit for damages. It applies to bodily injury arising out of and in the course of employment by the insured, and the suit must be brought in the United States, its territories or possessions, or Canada. The insurer pays all sums the employer legally must pay as damages because of bodily injury to employees, “where recovery is permitted by law.” The form names four kinds of claim:

1. A third party sues the employer to recover what the third party owed the employee (a third-party-over claim).
2. Care and loss of services.
3. Consequential bodily injury to the employee’s spouse, child, parent, brother or sister.
4. A claim against the employer in a capacity other than as employer.

State law decides whether such suits are allowed. Part Two insures the cases the law lets through. Its main exclusions:

Exclusion	What it removes
Liability assumed under a contract	Indemnity the employer promised, except a warranty that work will be done in a workmanlike manner
Employment in violation of law	Injury to an employee employed in violation of law with the employer’s actual knowledge, and punitive damages for it
Compensation and similar laws	Any obligation imposed by a compensation, unemployment or disability benefits law (Part One’s job)
Intentional injury	Injury intentionally caused or aggravated by the insured
Personnel practices	Damages arising out of discipline, demotion, harassment, discrimination, termination and similar acts
Federal acts and vessels	Work subject to the Longshore and Harbor Workers’ Act, the Federal Employers’ Liability Act and other federal laws, and a master or crew member of a vessel
Fines and penalties	Fines or penalties under federal or state law

Limits appear in Item 3.B as three figures: bodily injury by accident for each accident, by disease for the policy, and by disease for each employee. A disease that results directly from an accidental injury falls under the accident limit.

Part Three: Other States Insurance

Part Three applies only if states are listed in Item 3.C. It covers work the employer begins in a listed state after the effective date, as though the state were in Item 3.A, and the employer must tell the insurer at once. Work already under way on the effective date in a state not listed in Item 3.A has no coverage unless the insurer is notified within thirty days. A Michigan contractor sending a crew to Indiana for a month needs Indiana in Item 3.C before the job starts.

Parts Four to Six

Part Four sets the employer’s duties after an injury: tell the insurer at once, provide the medical services the law requires, give names of the injured and witnesses, forward every notice and legal paper, cooperate, do nothing to interfere with recovery from others, and make no voluntary payments except at its own cost. Part Six gives the insurer the right, not the duty, to inspect; the form says the inspections are not safety inspections and do not warrant that a workplace is safe. The insurer may cancel on not less than ten days’ written notice, and a term that conflicts with a controlling law on cancellation is changed to comply. Part Five carries the premium rules, applied next.

Sidenote

Part One and Part Two

Part One pays whatever the law requires, with no fault inquiry and no stated limit. Part Two pays damages in a suit and has limits. An employee’s compensation benefits are never a Part Two loss.

How Premium Is Built

Part Five says all premium is determined by the insurer’s manuals of rules, rates, rating plans and classifications. Each classification’s rate is multiplied by a premium basis, usually remuneration.

Classification

Item 4 of the Information Page lists the classifications, rates and estimated payroll. The classification describes the employer’s operations, not the employee’s title. In the Facility’s manual the object is to assign the classification that best describes the operations in Michigan. A separate classification applies to a separate and distinct operation only if separate payroll records are kept; otherwise all the payroll goes to the highest-rated classification that applies.

Two classes appear in the example below. Code 5437 covers installation of cabinet work, interior trim or finished wooden flooring or lathing. Code 8810 covers clerical office employees, those engaged exclusively in bookkeeping, record keeping and correspondence in offices separated from other operations by floors or floor-to-ceiling walls. An office employee who also visits job sites does not qualify, and the payroll is divided only where the records show the allocation actually incurred, not an estimate.

Remuneration

Remuneration is money or substitutes for money. The manual includes wages, commissions, bonuses, pay for holidays, vacations and sickness, and the value of lodging and meals received as pay. It excludes tips, employer contributions to group insurance or pension plans, severance other than for time worked, employee discounts, uniform allowances and expense reimbursements the records substantiate.

Overtime. Extra pay for overtime is excluded if the records show it. An employee paid $20 an hour, with time and one-half after 40 hours, works 45 hours.

• Records that show the extra pay separately: 5 hours at $10 extra is $50, and $50 is excluded.
• Records that show only the combined pay for the overtime hours: 5 hours at $30 is $150, and one-third of $150, which is $50, is excluded.

Only the extra half-time is removed; straight time stays in payroll. A night-shift differential during the standard week is not overtime.

Owners and officers. The manual treats executive officers of corporations as covered under the Michigan law, with premium on payroll between a minimum and a maximum in the rate pages. An officer may elect out if the corporation has ten or fewer stockholders and the officer owns at least ten percent of the stock, by endorsement WC 00 03 08. Partners and limited liability company members are covered unless excluded by that endorsement. A sole proprietor is not covered by the policy.

Subcontractors. A contractor is responsible for compensation benefits to employees of uninsured subcontractors, and the standard policy insures that responsibility. The contractor pays premium on the uninsured subcontractor’s payroll unless it shows the subcontractor has a policy from a licensed carrier or a filed exclusion. Without payroll records, the full subcontract price is the payroll, less materials where the contract is for labor and material.

The sequence

The Facility’s algorithm runs in this order:

1. Manual premium: payroll divided by 100, times the rate, for each classification.
2. Increased Employers Liability limits, if bought.
3. Experience or merit modification.
4. Balance to the minimum premium, if the total is below it.
5. Premium discount, subtracted.
6. Expense constant, added.
7. Surcharges and the terrorism charge where they apply, giving the estimated annual premium.

Premiums are shown to the nearest dollar, and $0.50 or more rounds up. The minimum premium and expense constant are not subject to the experience modification, and the expense constant is not discounted.

Worked Premium

Kestrel Cabinet & Millwork, Inc., a Michigan company invented for this example, installs cabinets in houses. Estimated payroll is $540,000 for cabinet installation, class 5437, and $90,000 for clerical staff, class 8810. The rates, the $200 expense constant and the experience modification of 1.12 are examples, not published figures. Kestrel buys a $500,000 Employers Liability limit.

Step	Calculation	Premium
Cabinet installation, 5437	5,400 units ($540,000 / 100) times $9.50	$51,300
Clerical, 8810	900 units times $0.20	$180
Manual premium	$51,300 + $180	$51,480
Increased limit	1% of $51,480 = $514.80, rounded	$515
Subject premium	$51,480 + $515	$51,995
Modification 1.12	$51,995 times 1.12 = $58,234.40, rounded	$58,234
Premium discount, 4.2%	$58,234 times 0.042 = $2,445.83, rounded	-$2,446
Expense constant	Example figure	+$200
Estimated annual premium	$58,234 - $2,446 + $200	$55,988

In the Facility’s manual the increased-limit factor is 1% of manual premium for $500,000, with a $50 minimum charge, and 2% with a $75 minimum for $1,000,000. A policy with $3,000 of manual premium would produce $30 at 1%, so the $50 minimum would apply.

The Facility’s discount applies only when total standard premium exceeds $10,000. Its table is built on tiers: nothing on the first $10,000, 5.1% on the next $190,000, 6.5% on the next $1,550,000 and 7.5% above $1,750,000. A $58,234 premium falls in the table’s $53,685 to $59,999 band, which shows 4.2%. Discount reflects the lower relative cost of servicing a larger policy, and premium under a retrospective rating plan gets none.

The estimate is a deposit

The premium on the Information Page is an estimate. Final premium is set after the policy ends from actual premium basis, proper classifications and the rates that lawfully apply. If it exceeds what was paid, the employer pays the balance; if less, the insurer refunds it. It will not be less than the highest minimum premium for the classifications on the policy.

At audit, Kestrel’s records show payroll of $612,000 for cabinet installation and $96,000 for clerical.

Step	Calculation	Premium
Cabinet installation	6,120 units times $9.50	$58,140
Clerical	960 units times $0.20	$192
Manual premium	$58,140 + $192	$58,332
Increased limit	1% = $583.32, rounded	$583
Subject premium	$58,332 + $583	$58,915
Modification 1.12	$65,984.80, rounded	$65,985
Premium discount, 4.3%	$65,985 times 0.043 = $2,837.36; the table shows 4.3% for $60,000 to $67,999	-$2,837
Expense constant		+$200
Final premium	$65,985 - $2,837 + $200	$63,348

Final premium of $63,348 against the estimate of $55,988 leaves $7,360 owed. The insurer may audit all records relating to the policy, including ledgers, tax reports and payroll records, during the policy period and within three years after it ends, and the employer must keep the records needed to compute premium. Under the Facility’s rules an employer that refuses the audit can be charged up to twice the estimated annual premium after two documented attempts, and stays ineligible for assigned risk coverage until it allows the audit.

Experience Modification

The modification compares the employer’s actual losses with those expected for employers of its size in its classes. It is 1.00 for an average employer; below 1.00 is a credit and above 1.00 a debit. The Facility’s plan uses completed policy periods, normally the three years ending one year before the modification date.

Modification equals Total A divided by Total B, rounded to two decimals, where:

• Total A = actual primary losses + ballast + (weighting value times actual excess losses) + ((1 - weighting value) times expected excess losses)
• Total B = expected primary losses + ballast + (weighting value times expected excess losses) + ((1 - weighting value) times expected excess losses)

Primary losses are each claim’s first slice, up to the split point, so they measure frequency. Excess losses are what lies above it. Ballast limits the effect of any single loss, and the weighting value sets how much of the excess enters the calculation. Both rise with expected losses and come from the plan’s tables. Medical-only claims are reduced by 70% before they enter.

Frequency versus severity. The numbers are an example: expected primary losses $40,000, expected excess losses $60,000, ballast $30,000, weighting value 0.25. Total B is $40,000 + $30,000 + $15,000 + $45,000 = $130,000 in both cases.

Employer	Actual primary	Actual excess	Total A	Modification
Many small claims	$70,000	$40,000	$70,000 + $30,000 + $10,000 + $45,000 = $155,000	155,000 / 130,000 = 1.19
One large claim	$45,000	$65,000	$45,000 + $30,000 + $16,250 + $45,000 = $136,250	136,250 / 130,000 = 1.05

Both employers had $110,000 of actual losses. The employer with many small claims takes the larger debit, because frequent claims enter in full as primary losses while only a quarter of the large claim’s excess enters. Loss control aimed at frequency pays at renewal.

The Facility’s plan also limits debits when losses are modest. If actual incurred losses divided by expected losses is below 83.3% and the formula gives a debit, the modification is 1.00; between 83.3% and 100%, only part of the debit applies, rising to the whole at 100%. A risk too small for experience rating is merit rated on lost-time claims: 0.95 for none, 1.00 for one and 1.05 for two. The modification applies for twelve months, and if it is not available at issue, the policy is endorsed when it arrives.

Voluntary Compensation

Voluntary compensation insures workers the compensation law does not cover. It pays benefits equal to those a named law would require, without proof of fault, in exchange for a release. The Facility’s manual includes a standard example, the Voluntary Compensation Maritime Coverage Endorsement, WC 00 02 03, and its structure shows how the coverage works:

1. Benefits measured by a named law. The insurer pays an amount equal to the benefits that would be required if the scheduled employees were subject to the compensation law named in the schedule.
2. A release. Before payment, the person entitled must release the employer and insurer in writing of all responsibility for the injury or death.
3. A transfer of rights. The person must transfer to the insurer the right to recover from others and cooperate in enforcing it.
4. The duty ends if the person sues. A claim for damages against the employer or insurer ends the duty to pay at once.
5. Few exclusions. The endorsement excludes obligations under a compensation law and injury the employer intentionally caused or aggravated.

The Facility’s manual uses voluntary compensation as “Program II” for employers with maritime or railroad exposure, whose workers’ remedy is a negligence suit. The carrier offers settlement at statutory benefit levels as if the claim were subject to the compensation law, and if the offer is rejected, employers liability applies to the suit. The employer gets a way to settle at known benefit levels instead of defending a negligence case. A voluntary compensation endorsement’s schedule names the employees and the law, so read the schedule before assuming who is covered.

Lesson summary

• WC 00 00 00 has six parts: Part One pays statutory benefits with no fault inquiry and no limit, Part Two pays damages in suits the law permits, Part Three adds listed other states, Part Four sets duties after an injury, Part Five sets premium and Part Six sets conditions.
• An accident injury must occur in the policy period; a disease is assigned to the policy in force on the employee’s last day of exposure.
• The employer bears amounts above regular benefits caused by its willful misconduct, safety violations, illegal employment or retaliation.
• Premium per class is payroll divided by 100 times the rate, followed by increased limits, the modification, any minimum, the discount and the expense constant, each rounded to the dollar.
• The expense constant and minimum premium are not modified, and the expense constant is not discounted. The Facility’s discount starts only above $10,000 of standard premium.
• The premium on the Information Page is an estimate; an audit within three years after the policy ends sets the final premium.
• An experience modification compares actual with expected losses, and frequent small claims weigh more heavily than one large claim.
• Voluntary compensation pays benefits equal to a named law’s for workers the law does not cover, in exchange for a release and a transfer of recovery rights, and it ends if the worker sues.