A fictional account of what can happen to your workers' compensation modification factor after acquiring another company.
ABC Construction Company completed a thorough due diligence of another company's financials before acquiring it. They ensured it was a good purchase, but their insurance broker did not review the impact the acquisition would have on ABC's workers' compensation insurance experience modification.
As a result, ABC received two surprising phone calls six months after the acquisition:
Call 1: Their insurance company sent a bill for their workers' compensation audit, and it was $42,000 more than ABC had accrued due to a surprise increase in their workers' compensation experience mod.
Call 2: Their bid on a large job was rejected because their experience mod was now above a 1.00.
What Went Wrong?
Put simply, an analysis of the impact to ABC's workers' compensation experience mod was not performed as part of the acquisition due diligence.
The experience mod is a factor calculated by the state workers' compensation bureau based on a company's prior loss experience. In simple terms, if ABC Company has lower loss experience than the average company for its business class, then ABC receives a credit mod (such as 0.75). This credit mod correlates into a 25 percent discount off of the standard workers' compensation insurance rates.
On the other hand, if ABC has loss experience that is higher than the average company for its business class, ABC receives a debit mod (such as 1.40). This correlates to a 40 percent surcharge to the standard workers' compensation insurance rates.
The mistake ABC made was thinking that only their loss experience would be used in calculating their experience mod. Their insurance broker failed to inform them that when acquiring a company, you typically also acquire that company's past loss experience, and it will be included in your experience mod calculations. The two examples below illustrate how this can impact your company positively or negatively.
Example 1: Stock Purchase of a Distressed Company
ABC Construction Company purchased the stock of a distressed company (XYZ, Inc.). At the time of the acquisition, XYZ, Inc.'s experience mod was 1.58, and it was the only company included in this mod rating. ABC Company added XYZ, Inc. as a named insured on its workers' compensation policy and retained a substantial portion of XYZ's employees. The workers' compensation bureau included the bad loss experience of XYZ in ABC's mod. ABC's mod was then revised and increased 14 percent due to the negative impact of XYZ's bad loss experience, resulting in an additional cost of $42,000 the first year. This problem was further exacerbated since the impact of XYZ's bad losses was felt for a total of three years-until all XYZ's bad losses dropped out of ABC's future mod calculations. The hidden additional cost of this acquisition was a shocking $92,000 over three years, and $800,000 in work was lost due to a higher mod.
Example 2: Asset-Only Purchase of a Distressed Company
ABC Construction Company purchased only the assets of a distressed company (QRS, Inc.). At the time of the acquisition, the QRS, Inc.'s experience mod was 0.78, and it was the only company included in this mod. ABC Company took over QRS's operations and retained a substantial portion of QRS's employees. ABC did not add QRS as a named insured on its workers' compensation policy. ABC sent an Ownership Change Form to the workers' compensation bureau to revise its mod to include the positive impact of QRS's good loss experience. ABC's Mod was reduced by 11 percent, resulting in savings of $37,000 the first year, $24,000 the second year and $14,000 the third year. The hidden additional savings due to this acquisition was $75,000 over three years.
Lessons Learned When Purchasing a Construction Company
Purchasing another company will likely impact your experience mod (positively or negatively) for three years. This analysis should be reviewed by your insurance broker as part of the due diligence prior to the acquisition.
However, it is important to note that purchasing another company will not always impact your experience mod. Here are some additional items to consider:
1. Buying Only One of Two or More Companies: Our examples reviewed the impact of buying a single, stand-alone company. If, however, XYZ or QRS are part of a combined experience mod rating with other commonly owned entities and ABC only purchased one of the entities, ABC would not assume the prior loss experience of XYZ or QRS. This could have a positive or negative impact depending on the mod of the company being acquired. As part of the acquisition due diligence, it is critical to verify if there are any other commonly owned entities that are combined in the experience mod of the company being acquired.
If you buy one entity that was classified by the Rating Bureau as two combined entities for mod purposes, then do not assume Company A's prior loss experience (either good or bad). The seller will typically continue to use the prior loss experience generated by both entities. Therefore, it is worth doing a detailed analysis of the target company's experience mod.
2. Partial Sales: If an entity disposes of only part of its assets or operations but otherwise continues to operate its business, all loss experience prior to the sale will remain with the seller. The purchaser's mod will not be impacted.
3. Not Retaining Most Employees: The workers' compensation bureaus indicate that you will assume the acquired company's past loss experience if you maintain a "substantial portion"of the acquired company's employees (typically, the workers' compensation bureaus view this as retaining 51 percent or more of the company's employees). If your intent of the acquisition is not to maintain a "substantial portion" of the employees, you will likely not assume the acquired company's prior loss experience.
Keep in mind that these transactions are complex, and answers vary based upon circumstances and the procedures of the specific state workers' compensation bureaus. Prior to making an acquisition, a thorough analysis of the impact to your workers' compensation experience mod should be completed by your insurance broker based on the specific situation. This analysis may uncover extra savings created by the acquisition or prevent the surprise of additional costs that develop after the acquisition has been finalized.
Construction Business Owner, January 2011