Loss Control Continued

We last discussed Loss Control in the December 2002 and March 2003 issues of Analysis & Comment (and copies are available upon request). The first article discussed workplace injuries and how to reduce them and Workers' Compensation costs. In the second, we reviewed some ways to reduce Auto, General Liability and Property losses in a hardening insurance marketplace. While we are now seeing insurance premium reductions, it is no time to reduce your loss control efforts. You are still going to pay many, if not most, of your losses. Workers' Compensation losses, in particular, are the most costly.

In this article we will discuss how costly Workers' Compensation losses are. We mentioned in our earlier article that all Workers' Compensation losses go to the bottom line of a P & L statement for employers using deductible and retention plans and self-insurance. This also applies to employers using retrospective rating plans and, as we will see later, customary experience rated Workers' Compensation policies.

First lets' discuss indirect losses. Direct losses are the medical and lost time losses an employer, or its insurer, pays for an employee injury. Indirect losses are the cost to employers for training to replace an injured employee, overtime to make up lost production, lost time of other employees responding to the immediate needs of the injured employee and talking about it later, and administrative costs reporting and following the injury. A study decades ago by Heinrich found that indirect costs were three times the direct costs of an injury.

A 2003 Liberty Mutual study reported in the August 23/30, 2004 issue of the National Underwriter determined that each $1 of direct losses generates between $3 and $5 in indirect costs. Using this formula, the Liberty Mutual study concluded that the direct costs of disabling workplace injuries in 2002 produced as much as $212 billion in indirect costs, bringing the total financial impact of workplace injuries to $255 billion in this country that year. In the same article, a loss control consultant suggested that, in addition to these economic costs, fewer injuries lead to improvements in employee morale, teambuilding and better employee relations.

Some employers think that when Workers' Compensation losses are fully insured that they are just expensing a premium instead of paying for their direct losses. This is not true for experience rated employers. The premiums they are paying are based to a significant extent on past direct losses. Experience rating formulas used by the rating organizations use paid and reserved losses during the first three of the four years prior to the effective date of a Workers' Compensation policy to develop an experience modification. This modification is then applied to the manual or "standard" premium calculated using rates for the employer's classifications times its payroll. This author has seen experience modifications as high as 250%, meaning that an employer paying a "standard" premium of $100,000 will pay $250,000 after the 2.50 experience modification is added.

Although experience rating formulas have leveling factors built in to soften the effect of large losses, most losses under $5,000 will increase the experience rated premium an employer pays by more than the amount of the direct loss. In one example, adding one $2,000 loss to an insured employer's experience rating period increased the experience modification by 1%. When applying this to the employer's $175,000 standard premium and using available discounts and adding assessments, resulted in an additional $1,600 in premium. Since this one loss will be included in the experience rating computations for three years, the insured employer will be paying nearly $5,000 for that one $2,000 loss. After adding the three to five times this loss for indirect losses, the importance of preventing losses becomes very obvious.

In addition to the free loss control services offered by some insurers and brokers, paying a loss control consultant for services and training can often make a lot of sense. In-house loss control should, of course, come first. Management should insist that loss control activities, including safety inspections, be a priority matter. We plan to discuss how best to use loss control consultant services in a future article. Watch for it.

-- Christopher B. Ashton, CEBS

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