04-01: New Deductible Surcharge Applied to Individual Policies

To:           Missouri Property & Casualty Insurers

From:      Scott B. Lakin, Director, Missouri Department of Insurance

Re:          The New Deductible Surcharge as Applied to Individual Policies

Date:       January 6, 2004

This bulletin is intended to provide underwriters and other insurance company employees with information regarding Missouri’s newly enacted administrative surcharge applicable to workers’ compensation policies with deductible options. This bulletin focuses on issues that relate to individual policies, such as the calculation of the surcharge as it applies to individual insureds. A separate bulletin (numbered 03-03), which focuses on how and when insurance companies should remit the surcharge to the state, has also been issued by the Department. Both bulletins can be found on our website at www.insurance.mo.gov, under “Bulletins.”

Background

Missouri initially permitted deductible workers’ compensation policies by statute in 1992, as a tool to help employers combat rising premiums. Deductible policies helped policyholders to lower their premiums by essentially letting them “self-insure” the deductible portion of their coverage.

However, the General Assembly realized that at the same time policyholder premiums would be reduced by deductible policies, so too would the tax revenue generated by those premiums. In Missouri, a workers’ compensation “administrative tax” is applied to workers’ compensation premiums and is used to fund the operations of the Division of Workers’ Compensation, the state agency which provides the administrative infrastructure for implementing the state’s workers’ compensation law. In addition to the administrative tax, a separate “second injury fund surcharge” is assessed on policyholders and provides revenue for claims made against the state’s Second Injury Fund (SIF).

Rather than receive less funding as a result of the use by employers of deductible policies, the General Assembly provided in its 1992 authorization of deductible policies that the taxes paid on such policies would be based on “…those premiums which would have been paid in the absence of the deductible option.” The Department interpreted this language to be applicable to both the administrative tax and the SIF surcharge in Bulletin 98-03.

That bulletin went on to tell insurers that the administrative tax rate for a given year should be built into their premiums as an element of their loss cost multipliers. In addition, insurers were required to document the amount of “premium reduced for deductible policies (287.310.9 RSMo)” on their annual tax statements. The SIF surcharge was to be assessed as a separate item on a policy’s declarations page as a direct pass though to the insured, and collected from the insured on the same payment schedule as premiums were collected.

New Legislation

During the 2003 legislative session, the Missouri General Assembly passed Senate Bill 385, which modified how workers’ compensation deductible policies will be assessed. The new provisions should not change the net effect of the prior law in dollar terms, but rather, will change the characterization of the assessments. Henceforth, deductible policies will be assessed as follows: 1) an administrative tax (commonly known as the workers’ compensation tax) on deductible policy premiums after the reduction of those premiums by the policy’s deductible credits; 2) a new administrative surcharge on deductible policies, assessed on those premiums that otherwise would have been paid for the deductible credit portion of the policy; and, 3) a second injury fund surcharge based on the total premiums which would have been paid in the absence of the deductible option. (Section 287.310, RSMo, subsection 9, as amended by SB 385.)

For example, assume the total premium for a policy, before the deductible credit, is $285,000, and that the premium after the deductible credit is applied is $185,000, with the deductible credit therefore being $100,000. Assume also that the “rate” for both the workers’ compensation administrative tax and the new administrative surcharge on deductible policies is 1%, and the “rate” for the SIF surcharge is 4%. (These are the rates that will be effective in Missouri for calendar year 2004.) Under the prior law and under SB 385, the administrative tax, administrative surcharge and SIF Surcharge would be calculated as follows:

  Prior Law New Law (SB 385)
Administrative Tax: $285,000 x .01 = $2,850 $185,000 x .01 = $1,850
Administrative Surcharge:   $100,000 x .01 = $1,000
SIF Surcharge: $285,000 x .04 = $11,400 $285,000 x .04 = $11,400
Total: $14,250 $14,250

Thus, in dollar terms, the amount collected before SB 385 via the single administrative tax and SIF surcharge, and the amount collected after SB 385’s revisions via the administrative tax, the new administrative surcharge and the SIF surcharge, will be identical (all other things being equal).

Notifying and Charging Policyholders

As was the case in the past, insurers will pay the “old” administrative tax (workers’ compensation tax) through quarterly assessments and on their annual tax reports; the policyholder will not see the tax broken out as a separate line item on the declarations page. Rather, the tax will be built into the base class code rate charged by the insurer. Insurers are to include this tax in the rate as part of the “loss cost multiplier” reported to the Department in insurer rate filings under regulation 20 CSR 500-6.950.

The new administrative surcharge (on deductible policies) and SIF surcharge (on all workers’ compensation polices) are to be passed onto the employer and collected at the same time the premium is collected. In the past, policyholders have been notified of the SIF surcharge though a separate line item on the declarations page. The same procedure should be followed for the new administrative surcharge, but only for policies with a deductible option. Non-deductible policies should never be assessed for a separate administrative surcharge, only the administrative tax and the SIF surcharge. The new administrative surcharge should be collected from policyholders in the same manner as the SIF surcharge, meaning, for example, that if the policyholder is paying in installments, the two surcharges should be collected as pro rata portions of each installment.

(Note: While the deductible credit portion of the policy was subject to the administrative tax under the old law, this is no longer the case. Under the new law, the deductible credit portion of the policy will now be subject only to the new administrative surcharge, not both the administrative tax and the administrative surcharge.)

The changes contained in SB 385 apply to all workers compensation policies with a deductible option that are written or renewed on or after January 1, 2004. The “rates” for both the administrative tax and the new administrative surcharge on deductible policies will be set annually by the Division of Workers’ Compensation in accordance with Section 287.690 and 287.716, respectively. Under Section 287.716, the rate for the administrative surcharge on deductible policies will always be the same as the rate for the administrative tax selected by the Division under Section 287.690. Based on an October 7, 2003 Memorandum issued jointly by the Missouri Department of Labor and Industrial Relations and the Missouri Department of Insurance, the rate for both the administrative tax and the new deductible surcharge for 2004 will be “1%.” The rate for the SIF surcharge for 2004 will be at “4%.” See www.dolir.mo.gov/wc/ for this memorandum.

Calculations Relative to the NCCI’s Premium Algorithm

Given the many different factors used to “rate” workers’ compensation policies in Missouri, it seems necessary to discuss the new provisions of SB 385 in light of the Missouri Workers’ Compensation Premium Algorithm developed and published by the National Council on Compensation Insurance, Inc., (NCCI). The Premium Algorithm, which is included in the NCCI’s Basic Manual, is the standard methodology for calculating a policy’s premium. Readers are invited to refer to a copy of the Algorithm as they work through this section of the bulletin; the current version of the Algorithm is included at page 18 of the Missouri pages of the Basic Manual, and is dated “22 Jan 2003 (1)”.

The terminology used by the NCCI in the Algorithm differs from that used by the Missouri General Assembly in SB 385. The key provision of SB 385 is the new subsection 9 of Section 287.310, RSMo, the first three sentences of which now read (separately) as follows:

In calculating the administrative surcharge owed pursuant to the provisions of this chapter for workers’ compensation policies with deductible options, the administrative surcharge owed will be based upon the total premiums, which would have been paid for the deductible credit portion of the policy.

The second injury fund surcharge owed by the employer who purchases a deductible policy will be assessed upon the total premiums which would have been paid in the absence of the deductible option.

The premium taxes owed pursuant to this chapter for workers’ compensation policies with deductible options shall be assessed upon those total premiums paid upon the insurance policy excluding the deductible credit portion of the policy.

The first sentence concerns the new administrative surcharge. It is to be assessed upon the total premiums which would have been paid for the deductible credit portion of the policy. In the Premium Algorithm, the last step before one reaches “Total Subject Premium” is the subtraction of any small deductible credit. The NCCI references only “small” deductibles because they themselves have no large deductible plans on file with the Department. Their small deductible plan applies a straight credit to Total Manual Premium. Individual insurers may have more complicated formulas to calculate their deductible credits. Whatever the methodology, the resulting credit is the amount against which the new administrative surcharge rate should be applied.

The second sentence concerns the second injury fund. Since the SIF surcharge rate is to be assessed upon the total premiums which would have been paid in the absence of the deductible option, insurers will effectively need to go through the Premium Algorithm twice, the second time to determine what the “Estimated Annual Premium” at the end of the calculation would be if the deductible credit is not subtracted out just before the “Total Subject Premium” stage. It is this second “Estimated Annual Premium” to which the SIF Surcharge rate is applied. Given the Department’s instructions in Bulletin 98-03, we presume carriers are already doing this, or are using some other methodology that yields the same result.

The third sentence concerns the administrative tax, which is applied to those total premiums paid upon the insurance policy “excluding” the deductible credit portion of the policy. Assuming carriers treat all deductible credits as the NCCI’s Premium Algorithm treats “small” deductible credits, they need merely to apply the administrative tax rate to the “Estimated Annual Premium” at the end of the normal Premium Algorithm calculation, since (small) deductible credits are already subtracted (i.e., “excluded”) as part of the calculation.

Miscellaneous Issues

The Department has already received a number of technical questions, which it will address below:

What is the exact title of the new surcharge?
SB 385 refers to the new surcharge in several ways, so there is no “statutory” title, per se. The Department suggests referring to it as “the administrative surcharge on deductible policies,” although this bulletin generally uses the terms “new deductible surcharge” or “new administrative surcharge” for convenience.
Does the new surcharge apply to policies with credits for small deductibles?
Yes. The new law applies equally to large and small deductible policies.
How should insurers treat the new administrative surcharge for purposes of rate filings?
Because the new administrative surcharge is required to be set at the same rate as the premium tax, the impact of the enactment of SB 385 is intended to be revenue neutral. However, because the new surcharge is being passed through to policyholders, it is no longer a tax on insurers that deserves to be included as a “tax” expense item in the loss cost multiplier applied by an insurer to base rates and reported to the Department as part of rate filings under regulation 20 CSR 500-950 (save any administrative expenses of collecting the new surcharge and remitting it to the state). As such, insurers are encouraged to review the size of the “tax” portion of their loss cost multipliers, and lower them proportionately to reflect what will now be paid by policyholders as the new deductible surcharge. The reductions should be the ratio of the amount of a carrier’s Missouri work comp deductible credits (less the collection and remission costs of the new surcharge) to the amount of the carrier’s total Missouri workers’ compensation premium.
Is there a special NCCI reporting code for the new administrative surcharge?
NCCI does not plan to issue a statistical code for the new workers’ compensation administrative surcharge. Carriers are free to develop their own codes as tracking devices.

Since the new surcharge is on the amount of the deductible credit, is it true this surcharge does not apply to terrorism premium charge?
The new deductible surcharge only applies to the amount of the deductible credit.
Is the new surcharge considered “premium?”
No. This point is covered under the NAIC’s Accounting Practices and Procedures Manual, Volume II, Statutory Issue Paper No. 35, paragraph 10.
Is the new surcharge subject to commissions?
No. Under Section 287.717 “…no insurer or its agent shall be entitled to any portion of the administrative surcharge as a fee or commission for its collection.”
Is the new surcharge “fully-earned?”
No. The Department believes that the statutory directive that the amount of the new deductible surcharge be based on the amount of premium means that the surcharge is due as the underlying premium is “earned,” not all at once.
Is the new surcharge subject to pro rata cancellation?
Yes, for the same reason as above. Section 287.717 of the new law provides that the new deductible surcharge “…shall be collected from deductible plan policyholders by each insurer at the same time and in the same manner that premium is collected.” Logically, the same “return-of-premium” procedures as are normally followed should be used, as well.
Are insurers required to provide notice to policyholders of this surcharge. If so, is there required text for this notice?
SB 385 does not contain any required notification language. The Department, however, suggests that a separate line item be included on the declarations page in a manner similar to the Second Injury Fund Surcharge, since both surcharges are pass-throughs to the policyholder.