For as long as anyone can remember, the basic method forcalculating workers' compensation premiums has been RATE x PAYROLLx EXPERIENCE MOD. Rates vary based on job classification codes(which is much more complicated than it sounds), and the experiencemod is based on prior losses. This is how premiums have beencalculated for years.

This method inevitably leads to a payroll audit at the end ofthe policy term to determine whether any audit premium is owed.This issue can lead to conflict between the carrier and thepolicyholder.

One reason there is so much conflict is because of how “payroll”is defined by the rating agencies (NCCI, WCIRB, etc.). Actual wagespaid to your employees are easy to define. But “payroll” goesbeyond wages. There is some variation by state but, for the mostpart, “payroll” used to calculate workers' compensation premiumsincludes things like vacation pay, holiday pay, bonuses (includingstock), sick pay, auto allowances and commissions. The list is veryextensive.

An area of much contention right now relates to the inclusion ofbonuses. Bonuses in the form of cash or stock are both treated aspayroll. But I have frequently heard complaints from employers whowere upset because they received a large premium audit bill becauseof these bonuses. Employers argue that these bonuses usually do notincrease carriers' claim exposures.

Each state has a maximum indemnity benefit rate, with thehighest being around $1,000 a week. That means that, if an employeeearned wages of more than $80,000 a year, there is no impact on hisbenefit rate if he has a workers' compensation claim. So a bonuswould have no material impact on the claims exposure for acarrier.

The problem arises because the payroll rules are outdated basedon the reality of the U.S. workforce today. It used to be that onlythe top executives in companies received substantial bonuses. Thepayroll rules in every state include caps for the directors andofficers of companies for this very reason: the recognition thattheir higher wages did not increase the carrier's exposures.

However, we are no longer a country where the majority of ourworkforce is in the manufacturing industry. A significantpercentage of the workforce is now in highly skilled “white collar”jobs. More and more companies are using bonuses to assist inretaining their skilled workforce. Companies are making thesebenefits available to a wide segment of their workforce, far beyondthe directors and officers who were considered in the rules forcalculating workers' compensation premium based on payroll.

The solution to this is relatively simple – extend to allemployees the director/officer payroll caps used in calculatingpremiums. Nevada has done this for several years. Implementing thischange would not be overly complex, as these payroll caps and themethods for calculating them are already in place.

This issue is currently being discussed by the NCCI UnderwritingCommittee. If NCCI were to recommend such a change, I would expectit would be quickly adopted by both NCCI states and the independentbureau states.

Would these changes result in lower premiums for employees?Perhaps for some employers, it could. But other employers could seehigher premiums as carriers adjust their rates to ensure adequatepremiums are being collected. The workers' compensation industry'scombined ratios have been more than 100% for a number of years.Because of this, carriers have to be cognizant of the impact anychanges in premiums would have on their surplus.

As workers' compensation continues to evolve, we must constantlyreview the rules and regulations governing the industry to ensurethey are still appropriate. Perhaps it is time to review one of themost basic issues, the method of calculating premiums.

Mark Walls is the vice president, communications andstrategic analysis, at Safety National. Mark is also thefounder of the Work Comp AnalysisGroup on LinkedIn, which is the largest discussion communitydedicated to workers' compensation issues.