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Don't Overlook Your Experience Modification Factor In Your Due Diligence Analysis

Updated: Jan 24



 

Our Recent Due Diligence Success


While shopping online for a 3rd car my wife expanded her search regionally. There's a car brand, model and year we have previously owned and loved, but not too many of these vehicles were available locally.


She found two candidates out of town that sounded like great opportunities; right price, mileage, etc. And, coincidentally, at the same time we discovered a 3rd-party inspection service one can hire to perform pre-sale inspections for buyers.


Both dealerships spent time on the phone with us, told us what great shape the cars were in, etc. At the end of each conversation my wife finished by explaining "we want to send an independent inspector to see the car before we make a decision." Dealer A said something like "that's great, have the inspector ask for me, I'll put the car up on our lift so he can inspect the undercarriage, etc."


Dealer B, upon hearing our intention, said "you know what...don't bother. We're probably going to just sell this to a wholesaler anyway." We ended up having Dealer A's car inspected, purchased it, and are very happy.


But, doing our due diligence paid dividends, and, most likely, helped us avoid a disaster. Just the anticipation of our plan to perform due diligence fleshed out a lot of information; like Dealer B's car has problems and the salesman we were dealing with was most likely a scoundrel (he was interested in selling us the vehicle until we disclosed our desire to use a local inspector).


How does this story relate to workers compensation insurance?


Avoid a disaster. Twice in the last year I’ve worked with clients who came to me with similar experience rating problems involving the sale of a division. And neither thought to perform any due diligence on their Experience Modification Rate beforehand.


In one instance - let’s call it Company A - a client bought a division of another company.  In the other - Company B - my client sold one of their two divisions.


Ownership Rulings

Generally, a company’s “experience” follows it. When you purchase a company or division of another company you are, in many circumstances, acquiring it’s claim history, payroll history, and classification history; for better or worse. That history can be incorporated into your existing experience modification factor (Mod) after NCCI (or another state rating bureau) makes it's Ownership Ruling. A company that sells a division can likewise lose that experience from its own experience modification rate and receive a revised mod minus that history.


Client A - Acquisition

Company A bought a division of another company and started operations, in their minds, as a new entity (they thought a new name and ownership would "reset" everything).


However, once NCCI (the rating bureau who produces experience modification factors in most states) caught up and issued it’s ownership ruling, Company A had its own mod. And, it wasn’t good. The division Client A purchased and formed into a new company had a very poor prior claims history. And now Company A has work comp premiums significantly higher than anticipated due to it, essentially, acquiring the experience modification rate of the company it purchased.


Client B - Divestiture

Company B had two divisions and the owners decided it was time to slow down and downsize. The larger and more time consuming of the two divisions was sold, and this should have been a good fit for their lifestyle. 


However, while their experience mod from both of the combined divisions was pretty good (just under a 1.00) the division they sold had most of the payroll and very few of the claims. After the transaction it took NCCI a little while to catch up and issue its ownership ruling related to the experience mods. Once they did, though, Company B got clobbered. The experience of the entity they sold was carved out of their experience modification rate, their new EMR went through the roof.


Company B was punished in two ways. First, their premiums skyrocketed for their remaining business due to their revised, much higher EMR. And, second, they are in an industry where you have to submit your mod for new business proposals and contract renewals. Since the new mod was significantly higher than what is generally acceptable to developers and general contractors, they found themselves in jeopardy of losing a considerable number of existing customers.


Conclusion

Keep in mind that the outcomes of ownership rulings can vary depending on the circumstances of these complex transactions. But, due diligence analysis can include potential impact on the acquiring company’s mod, seller's EMR, or both. Even if you’re selling, it’s wise to do your own analysis to see how the mod of your continuing operations may be impacted as well. Your broker may be able to help produce test mods for this analysis as part of your due diligence prior to a transaction. Otherwise, we can certainly perform this analysis for you.


You could very well prevent additional costs or uncover extra savings.


Stuart Cytron, MBA has been published in trade journals such Construction Forum St. Louis and St. Louis Business Journal among others. You can read more about Stuart and how he developed a passion for helping businesses reduce work comp expenses on his website.

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