Underwriting the Guessing Game of EPL Premiums

The apparent inconsistencies in the way underwriters quote Employment Practices Liability (EPL) can drive anyone crazy. We all understand why an applicant with 50 employees would get a different premium than one with 500 employees, but why do you get such varied premiums on the same account.

There are about a dozen factors that determine an EPL premium, and this article will address only three of these factors: the number of employees, the applicant’s industry group and the salary ranges of the employees. We’ll also touch briefly on third party liability and underwriting this exposure.

Let’s start with the first item underwriters look at when underwriting EPL, the number of employees.

The number of employees allows an underwriter to determine a starting point, or “base rate.” The base rate is then modified by a number of factors, some of which are discussed in this article. The tricky part is that the rate per employee can increase or decrease as the number of employees reaches certain levels. Some insurers feel that lower employee counts are more profitable, while others prefer larger employee counts.

One could argue that companies with low employee counts treat their employees better and treat them more like “family,” thus they have a lower susceptibility to EPL claims. An alternative viewpoint might be that a large company has a stronger Human Resources function, thus procedures and controls to prevent and/or mitigate EPL issues are superior to that of a small company.

For example, consider the case of a hypothetical applicant with 500 employees through two different hypothetical rating plans. Keep in mind these rates are not actual rates. The following examples are used to illustrate the wide variances in underwriting philosophies with respect to employee counts.

Using Insurance Company X’s rating plan, the rate could be determined as follows:
The first 100 employees are rated at $50 per employee, or $5,000. The next 100 employees are rated at $35 per employee, or $3,500. The next 300 employees are rated at $10 per employee, or $3,000. Therefore, the “base rate” for Insurance Company X is $11,500 ($5,000 + $3,500 + $3,000).

Now, consider how Insurance Company Y would quote it using its rating plan. The first 100 employees are rated at $80 per employee, or $8,000. The next 100 employees are rated at $5 per employee, or $500. The next 300 employees are rated at $30 per employee, $3,000. Therefore, the “base rate” for Insurance Company Y using their rating plan is $17,500 ($8,000 + $500 + $3,000).

So, there is a $6,000 difference in the base rate, and the risks still have to go through the rest of the rating plan!

The applicant’s industry is another major rating component when quoting EPL. An industry sector that is viewed as an extremely desirable book of business to one insurer may be viewed as virtually uninsurable by another insurer. Technology, real estate and financial services sectors have delivered both a frequency and severity of EPL losses to the insurance industry.

Many insurers have viewed manufacturers as desirable due to their stability; however, some companies are reviewing this philosophy. The stability of manufacturers is threatened by low-cost manufacturing options in Asia. This instability brings layoffs and disgruntled employees, which boost the chances of an EPL claim.

Some markets even break down market segments to surprising levels. One market has different ratings for different types of restaurants. A modification factor for a “white tablecloth” fine dining restaurant is different than the modification factor applied for a fast food franchisee. There is yet another modification factor for “mom and pop” type restaurants. And most are surprised which of the three gets the most favorable modification factor!

The percentage of employees in various salary ranges is yet another factor in determining an applicant’s EPL premium. This is an important risk characteristic in estimating a company’s potential damages that arise from lawsuits that are not class actions. Identifying an applicant’s exposure to class action lawsuits is an entirely different science. Compensation of employees is a factor in this process, but this discussion will focus on claims that are not driven by class action activity.

Jump ahead to the eventual end of almost all EPL claims. Some cases go all the way to trial where a jury awards damages. Most cases are settled way before that scenario becomes a reality. So, what determines the size of a settlement or jury award? The severity of the offense and jurisdiction are major contributors, but there are other factors as well.

Examples of these other factors relate to compensation. How much did the employee earn? Did they have bonuses every year, and if so how much were they? Did the employee have stock options that they can no longer exercise? How long will it take this person to find a job with similar responsibilities and compensation? Answers to these questions allow one to calculate a dollar amount that compensates the claimant for the damages they have experienced.

Higher salaried employees have a higher propensity to bring EPL related allegations against employers because they are usually more educated about the proper employee/employer relationship and what happens when that relationship is breached or damaged. Higher wage earners can demand more in lost compensation such as wages, bonuses and lost stock options. In addition, it may take a long time to find a job with similar responsibilities and compensation. They are less likely to take a small settlement offer and have a strong argument for a large jury award.

Consider two applicants with the same number of employees, but with different salary ranges.

The first employer is a construction company with 85 percent of its employees earning less than $40,000. The modification factor used by the underwriter will allow him to decrease the premium because folks that make less than $40,000 tend not to bring EPL related claims against their employers.

The second applicant is a technology consulting firm where 85 percent of the employees earn more than $100,000. If one of those higher salaried folks has an EPL claim, it will cost much more to settle the claim than if their salary was much lower. Law firms historically have paid the highest premiums for their EPL coverage. Why? Lawyers have higher than average salaries as well as a working knowledge of the legal system and insurance industry.

No discussion of EPL is complete without addressing third party liability, or claims brought against an insured by non-employees. Customers can allege that they were treated differently because of race, sex or sexual orientation or other similar classification. Here again, there is a variety of underwriting approaches.

Some insurers will not grant this coverage at all. Insurers that do provide this coverage charge for it, but the additional premiums vary depending on the industry the applicant operates in, the length of contact between employees and non-employees, as well as the nature of contact.

To illustrate, compare two hypothetical applicants. The first is a manufacturer with no outside sales force. Employee contact with outsiders is negligible. The second applicant is a property management firm that selects tenants to live in buildings it manages. Which applicant has the greater third party exposure?

Some industries, such as the hotel industry, are difficult to assesss. Hotel employees interact with hundreds of guests over the course of the business day. One may think that this poses a huge third party liability. Does it?

Take a look back at the interactions between hotel staff and guests. How long is the bellhop in a guest’s room when dropping off luggage? How about the person who drops off dry cleaning or food from room service? Generally, these types of interactions are incredibly short and both parties want it that way. Granted, there is opportunity for a hotel guest to cause problems, but EPL losses in the hotel industry don’t arise from these types of interactions.
Where do they come from? The answer isn’t surprising: class action lawsuits. If a particular class of people receives a different level of service and treatment, and this becomes a pattern, that becomes fertile ground for a class action lawsuit.

So, with this insight into how insurers underwrite and price EPL, how should insurance sales professionals use this information to obtain coverage for their clients?

Point out and emphasize the positive characteristics that make an applicant a more desirable risk. Are there strict guidelines governing interaction between employees and customers that may decrease third party exposure? Are higher salaried employees under a written contract that minimizes exposure in the event of a termination? Underwriters are not mind readers, so they won’t know these important facts unless they are told!

Underwriting Employment Practices Liability is a complex and difficult undertaking. The landscape constantly changes as jury awards and new legislation continuously create a moving target for underwriters—identifying the applicant that will have a favorable claims experience in the future. Insurance brokers should take the time to know their clients and present all the pertinent information in the best light possible. Doing so allows underwriters to transfer risk most effectively.

Mike Kizlinski is a senior broker with ARC West Coast Excess & Surplus Brokerage LLC in Pasadena, Calif. ARC West Coast Excess & Surplus is a wholesale broker specializing in
management liability coverages such as D&O, E&O and EPL. Kizlinski can be contacted at (626) 584-5050 or mkizlinski@arcxswest.com.