It’s called Combination of Entities and Ownership Changes. A good, general workers compensation rule to remember is: When you buy my business – you buy my workers compensation experience! And in some cases it will come to the new owner as a surprise and often not a welcome one! In this post I’ll talk about the impact combining business entities, the sell of a business and general ownership changes may make on workers compensation experience rating.
The purpose of experience rating, from a workers compensation point of view, is that of developing a more accurate rate and having that rate applied to an individual business in the form of a modified workers comp premium. “Experience,” as used in this context means payroll and actual losses incurred for all of an owners operations in each state where business is conducted. This includes all current, past, discontinued or self-insured operations for the entire experience period in question. A primary foundation of workers compensation experience rating is the idea that history of an account, its losses and payroll will be a good predictor of its future actions. Taking this into consideration, its easy to see that the experience of a business is individual to that business and that if one entity purchases another who has historically poor workers compensation experience, as evidenced by a poor experience mod rate, then that poor experience will have a negative impact on the purchasing entity.
For those states who utilize NCCI as their workers compensation advisory organization Rule 3 from the Experience Rating Plan Manual provides guidance when a change in business ownership occurs. It’s the rating or advisory organizations job to review information submitted to them on an ERM 14 or narrative and make a decision as to how the change in ownership will effect the experience modification rate for both the selling and purchasing entity. They will decide, according to the rules for the purchasing entity, whether their modification factor will be adjusted to reflect the experience of the newly acquired entity. They will also decide the effect the sale or transfer may have on the selling entity if they remain in business.
Two considerations about the ownership rule are:
- It cometmplates that workers compensation experience of a business entity, its claims and payroll, is directly related to the ownership and management of that entity, that safety begins and ends with the ownership;
- To prevent owners from getting around the experience rating plan by changing ownership when experience is poor and reflected in ever increasing experience modification rates (Lets sell our business to the warehouse to our cousin and our EMR will go from 1.5 back to a 1.0! Yay!)
These situations are addressed by the rules of common ownership and change in ownership.
According to NCCI, it is rare that experience for any entity undergoing a change in ownership will be excluded. However they do indicate that three conditions must exist before experience can be excluded from future experience modification rating. They are:
- There must be a significant change in ownership where the complete ownership after the change had no interest in the entity before the change or if in the new entity there is a continuation of previous owner interest, then that interest must have been less than 1/3 before the change or 1/2 after the change;
- And the change in ownership is also a change in business operations where the new business operations will result in the reclassification of the governing class code;
- And the change in ownership results in a change in operations process and hazard as determined by the advisory organization.
NCCI states that “the experience for any entity undergoing a change in ownership will be retained or transferred to the experience ratings of the acquiring, surviving or new entity unless specifically excluded by this plan.” That is a strong statement! You should understand the goal here is to not lose the experience but to assign it and make sure it is carried forward to a new entity, if the plan rules allow.
When considering the application of transfer and ownership rules the advisory organization will refer to their “Transfer of Experience Table 1 or 2,” also found in the Experience Rating Plan Manual. This table provides guidance. For example, if the seller disposes of all of its operations and the buyer doesn’t have an existing or prior policy or experience (in other words they did not have an existing business when they bought from the seller) then the experience will be retained and used in developing future experience modification rates for the buyer. If the buyer has prior experience it will be retained and combined with the experience from the purchase to be used in developing future EMR’s. In the recent past NCCI modified their Ownership Rule. It’s now virtually impossible to avoid having the past experience excluded from future experience ratings.
For some businesses the effect of combining entities and ownership changes can be drastic. Keep these questions in mind:
- Will the purchase have a negative effect on my existing experience modification rate?
- To what extent will combining entities or purchasing another business have on my future workers compensation cost?
- Do I rely on bidding on contracts where having a EMR of 1.0 or less is a requirement?
- What will the future effect of the retained experience have on my company?
- How can I predict the effect purchasing a new entity will have on my business?
Know the impact your purchase of another entity will have on your future experience rating. Here’s a few pointers for any business buying another:
- Have a claim review performed by an independent workers compensation consultant before the transfer of ownership. This will help establish the validity of experience data being reported and used for developing the combined experience;
- Work with an independent workers comp consultant to project the ultimate effect the transfer of experience will have on your future Experience Modification Rates, EMR.
Businesses are bought and sold every day. Knowledge about the effect of transferred workers compensation experience is an important part of the acquisition of another entity. Do not be surprised after an acquisition! Learn about the effects transferred experience may have on your purchase or sell by consulting with an independent workers comp consultant!
Hope this helps you out!