The basic premise of workers' comp is an agreement to indemnify workers for injuries sustained in their employment in exchange for giving up the right to other types of recovery. Typically, there's little choice about whether an employer participates, but that's where the simplicity ends. How employers pay to keep their end of the promise may be much more complicated.

Both insured and self-insured programs start with the standard premium, which is calculated by multiplying payroll by the rate of specific job classifications. An individual firm's experience modification factor--which compares one company's historical loss experience to other businesses in that class--is applied to the standard premium.

A modification of 1.0 is neutral. Modifications higher than 1.0 reflect worse-than-average loss experience and penalize the employer for that loss history. Conversely, employers with better-than-average loss histories earn a modification lower than a 1.0 and logically, a lower workers' comp premium.

A business' bottom line, therefore, is directly impacted by the modification, particularly if it chooses to insure its workers' comp exposure.

Some programs start and end with the modified standard premium. The insured business merely pays the premium, the policy is issued, and claims are turned in to the insurer to adjust and settle. No additional money changes hands unless payrolls are higher or lower than estimated at the beginning of the policy term.

Other programs, however, feature a financial plan, or "back end," that can affect the ultimate cost of the program. Financial plans typically reward or penalize insured businesses for the frequency and severity of claims incurred during the term of the policy. They can dramatically affect the ultimate cost of workers' comp for a business.

Each type of plan reflects varying degrees of financial risk and reward for the business. Self-insurance has the highest potential risk with the highest potential reward.

For example, a guaranteed-cost program has a set premium and is the lowest-risk financial plan. It also offers the lowest return because the premium must be paid, whether there are no claims or hundreds of them.

Conversely, in a self-insured workers' comp program, the business assumes most of the risk of the exposure, subject to certain caps and aggregates that may be built into the program. The cost of claims is assumed by the business, so frequency and severity dictate ultimate cost.

Between the extremes of guaranteed cost and self-insurance are a number of financial plans that may be offered, or even required, by workers' comp insurers.

How and on what criteria can companies choose between them?

Sometimes the choice is entirely up to the insurance company willing to write the risk. There may be times when a firm's previous claim experience is so bad that insurers are forced to buy a risk-sharing program--such as a retrospectively-rated policy--so the insurer can collect additional premium to cover higher-than-expected claims. In such situations, the business typically has a debit modification (higher than 1.0) and must agree to be retroactively charged additional premium if claims are higher than anticipated by the insurer.

Sometimes, better-than-average companies choose a retro program because of the ability to reclaim some premium if they can continue to hold the line on claims.

Other financial plans that may be offered are dividend plans, retention plans, large deductible programs and other cost-plus programs.

In the Oct. 24 edition, we'll examine the main attributes of various financial plans.

Diana Reitz, CPCU, is managing editor of FC&S Online, the National Underwriter Company's online source for coverage interpretation and analysis.

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"Each type of plan reflects varying degrees of financial risk and reward for the buyer. Self-insurance has the highest potential risk with the highest potential reward."

Diana Reitz