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Nov 10, 2009

Improved Financing Cost By Reducing Your Work Comp Costs

It’s right in front of you on your monthly workers compensation bill, but you probably don’t pay much attention to it. It can cost you 100’s of thousands of dollars annually, but you didn’t know it was a controllable expense. As the CFO, you’ve learned how to negotiate better financing arrangements, but have you learned how you can control unnecessary additional financing costs of your workers compensation expense by reducing your Experience Modifier? Are you aware what your company’s Lowest Possible Experience Mod (LPM) is? Have you compared the impact to EBITDA, EPS, and cash flow by comparing and contrasting your current Ex Mod against your LPM?

Consider an Experience Modification as a financing mechanism very similar to your current bank lines of credit. Banks seek to finance the future borrowing requirements of a corporation based upon the past and future credit worthiness of the borrower. Experience Mods look at prior year’s work comp claims and future loss development to determine the company’s future costs from their workers compensation program.

Since much of the risk of future claims in a workers compensation policy is financed by an insurer, the Experience Modification is used by insurer’s to accurately predict the approximate future costs of claims from an individual insured’s actual claims cost.

State rating agencies such as the National Counsel of Compensation Insurers (NCCI), and other rating agencies such as California’s Workers Compensation Insurance Rating Bureau (WCIRB) are responsible for issuing Experience Mods. These rating agencies begin with the assumption that an insured’s loss experience will be the same as others who are in their specific line of work.

If the claims experience is as expected, the insured has neither a debit nor a credit to their work comp bill, and the Experience Mod remains at 100 percent. When an insured has better than average claims expense, they are rewarded with a credit Experience Modification. Conversely so, when an employer has worse than anticipated claims, they are penalized with a debit Experience Modification.

Many employers do not understand that they can control the Ex Mod and avoid unnecessary additional financing costs by actively reducing future losses, and managing and closing out outstanding claims.

Additionally, CFO’s haven’t traditionally been aware of what their Lowest Possible Mod, (or LPM) is. The LPM represents the insured’s Lowest Possible Mod which assumes there were no workers compensation claims. The individual employer’s own LPM is often available from their state Workers Compensation rating agency, or workers compensation insurer.

By comparing the difference between the LPM, and the insured’s actual Experience Modification, CFO’s can evaluate the potential impact to cash flow, EBITDA, and new company valuations. Once this evaluation is completed, the CFO can determine whether or not the improvement in cash flow, EBITDA, and valuation is material enough to proceed with implementation of a new safety, risk management, and workers compensation program.

What Is The Impact Of The Experience Mod as it relates to Earnings Per Share?

Let’s look at a recent example of an employer’s actual Experience Mod, and its impact on Earnings Per Share (EPS), cash flow, and EBITDA before, and after the Ex Mod reduction.

Prior to the Experience Mod reduction, the client had an Experience Mod of 190 percent. The client’s LPM was 65%. The valuations of the company were using a 7x EBITDA multiple. Total shares outstanding were 14,000,000, the client’s net income was $23,000,000, and the EPS was $1.64. The insured was paying $1,000,000 in workers compensation premium.

Over a 24 month period the client got aggressive and decided to pursue a course of action by improving safety at all branches, locations, and warehouses. In addition, the CFO and his Senior Vice President of Operations got actively involved in the company’s safety culture. Additionally, the Human Resources division finalized, and closed out numerous work comp claims. By closing out the claims, and significantly improving safety at the various locations, the client’s Ex Mod was ultimately reduced to their goal LPM of 65 percent.

Now let’s look at the results from the new plan..

By reducing the Ex Mod to the LPM of 65 percent, the client’s annual workers compensation premium was reduced from $1,000,000 to $342,105 thereby improving cash flow by $657,000. The client’s EPS was improved by nearly .05 per share. Net income also rose by $657,000. Using a 7x multiple, EBITDA was improved by $4,605,000.

By learning how to take control of an otherwise out of control risk financing cost, the CFO was able to directly reduce GAE, improve the bottom line and EPS without eliminating key roles vital to the future of the corporation.