Freakonomics by Steven D. Levitt and Stephen J. Dubner has sat in my “to read” pile for a long time. Fortunately for me, I finally picked it up! This is a great, entertaining read. And, Freakonomics definitely developed, for me, some new, useful mental models for both personal relationships and business transactions.
The second chapter is not about workers’ compensation insurance (in fact the chapter is intriguingly titled “How Is The Ku Klux Klan Like A Group of Real-Estate Agents”), but the chapter did strike a chord for me about work comp. It touched on something called Informational Asymmetry which is defined by the authors as follows:
“It is common for one party to a transaction to have better information than another party. In the parlance of economists, such a case is known as an information asymmetry.”
The authors give examples of transactions involving real estate agents, doctors, etc. where one party clearly has superior information. An advantage that can easily be, and commonly is, leveraged for lopsided results.
The story of term life insurance products in the late 1990s was used to set the stage for much of this discussion. Term life insurance prices plummeted during that period. Other lines like auto, health, homeowners, and even whole life not only didn’t plummet, but rather rose a little.
Term life policies were relatively homogenous from one insurance company to the next. These insurance agreements differed from one another mainly on price. All the other lines of insurance are more technical agreements and require more information and expertise to evaluate.
So, during this time Quotesmith.com became the first to begin selling term life insurance online. It allowed consumers to shop numerous insurance companies based on price. Since the policies themselves were pretty much the same and evaluating one versus another straightforward, the authors note, Quotesmith was simply peddling information. In this case, price information.
The playing field between consumer and insurance company leveled vis a vis pricing information. More expensive insurance companies were forced to reduce their pricing and total sales fell by 10 figures annually due to price reductions.
The informational asymmetry that existed with term life products prior to Quotesmith and their competitors reminds me of workers’ compensation insurance (You can try the same approach for your work comp program).
Workers compensation insurance programs are technical, but the coverages and terms vary little from one carrier to another (unless your are insured through some form of large deductible/retention program). And, there are substantial differences in pricing.
Businesses have access to quotes from, at most, just a few workers’ compensation insurance companies among the many.
At this point we could go into how to remedy information asymmetry related to consumer options in the marketplace (if you want to discuss better marketing of your work comp insurance or want the names of some great brokers, I can do that. Just call or email me). But, I’d rather take a step back and focus on the information asymmetry that exists in the work comp marketplace between consumers and sellers of work comp insurance related to pricing.
Work comp pricing is very complicated because there are several different elements that combine to collectively produce your price. These elements are determined independently of one another, by different people or teams of people.
Payroll - Work comp payroll is its own measurement of payroll determined by a unique set of rules that differ from one state to the next. An insurance company auditor is responsible for this.
Classification - Properly classifying your workforce into codes that determine your rates. Classification is normally determined in concert between your broker, underwriter, and possibly you.
Experience Modification Rate - The measurement of your claims experience (frequency and severity of your work comp claims) compared to others in your industry. This is a team effort determined by your insurance carrier’s Claims Department, it’s Unit Stat Department, and your state’s rating bureau (normally NCCI).
Other Underwriting Elements - There are numerous other elements that contribute including safety programs, rate filings, deductible credits, etc.
NCCI Manuals and State Rule Compliance - Does your insurance company follow the approved rating bureau rules and state rules and regulations? These govern more than class codes and payroll audits. Data reporting standards for claims and experience mods are critical. Since all states have their own "specials" that modify the rules, this can be complex when you are doing business in two or more states.
What most of my clients understand is how these elements combine to arrive at a final premium (price). Roughly:
What clients don’t understand is how each of these is actually calculated or determined. Certainly, not at an expert level. As a result, there is considerable informational asymmetry between the insured and the insurer; very lopsided in favor of the insurance company. How can you know you’re receiving a fair or proper price? Especially considering the limited number of quotes you receive at renewal?
Take just one example; the payroll audit. The insurance company’s payroll auditors are full-time payroll auditors. That is all they do day in and day out. Payroll auditors have certifications to achieve and continuing education. Even so, costly errors are still made. To expect your broker to review the auditor’s work at the same expert level isn’t fair to you or your broker.
“Armed with information, experts can exert a gigantic, if unspoken, leverage…” From the great book Freakonomics by Steven Levitt and Stephen Dubner
If you suspect something is wrong, how do you even begin to verify or dispute the results of your audit without your own expert?
If you have your policy near you, take a look at the rating page and find the line item “Schedule Rating” or “Schedule Modification.” It’s just listed as a percentage; either a debit (additional premium) or a credit (reduced premium). No further description. Would you be interested to know that Schedule Rating is a safety program? It is supposed to be derived from an objective, filed safety program.
Wouldn’t you like to know why your premium increased through this program?
What if you received a debit for something unrelated to your operations for which you should not have been billed?
Or, if you received a credit, would it be nice to know how you could increase this discount?
“Sunlight is said to be the best of disinfectants.” Supreme Court Justice Louis D. Brandeis
I have been auditing work comp premium calculations for 20 years, and I can tell you that the informational asymmetry that exists between the insured and the insurer is significant. This is evidenced by the fact that I can routinely find overcharges from errors in premium calculations - errors that benefit the insurance carrier far more often than not.
The problem is exacerbated by the fact that the insured relies on it’s broker, normally, as the point of contact between oneself and the insurer. And, most insureds wrongly assume that a broker’s involvement is all the due diligence they need. While most brokers have a level of competency that narrows the asymmetry, there is still a significant gap. Just take the one example, above, regarding the profession of payroll auditor. It’s unreasonable to expect your broker to review a payroll audit with the same expertise - as well as with the rest of the pricing elements.
If you’ve never had and independent audit of your work comp program or have any questions about it, please call, email, or message me on Linkedin. Even if you’ve had an independent audit relatively recently, it’s always a good time for a fresh look. Consider:
NCCI has a goal of revisiting each classification code every five years for review. These reviews can result in updates, creation of additional codes, deletion of obsolete codes, etc. And, state exceptions are created and modified all the time.
COVID-19 is complicating the audit process with new emphasis on proper application of the Telecommuter Code 8871, a new code 0012 for furloughed employee payroll, the more common use of telephone audits, etc. All of which impacts your Experience Modification Factor by the way.
I look forward to speaking with you! Stuart Cytron
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.