Human Capital & Careers

Should CFOs Care About Workers’ Comp?

The case for finance chief involvement in workers’ compensation risks is buried in cash-flow and income statements, as well as balance sheets.
David KatzNovember 1, 2013

Relative to the rest of corporate expenses, workers’ compensation costs may often look like chump change.

For the typical company in a sample of 2,939 non-financial public issuers with current market caps of $50 million or more, studied by the Georgia Tech Financial Analysis Lab, workers’ comp insurance is under 1 percent of the company’s base pay rate, estimates Charles Mulford, the lab’s director and a Georgia Tech accounting professor.

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What’s more, for companies that buy workers’ comp insurance rather than self-insure the risk, the effect on cash flow isn’t terribly volatile. In comparison to the risk of a super storm or a cyber-attack, the claims payments that may occur are more predictable — and a good deal lower.

To be sure, if companies choose to fully insure workplace hazards, the premiums represent “an immediate, recurring drain on cash flow,” says Mulford. But annoying as workers’ comp premium payments may be — especially if they’re rising the way they are now – they are perfectly predictable.

Because the insurance payments can be so predictable, many finance chiefs may feel that their companies’ workers’ comp concerns can be largely delegated to the company’s risk manager.

Indeed, in their cost-containment efforts, CFOs should analyze all of a corporation’s expense generators, rate them by size and then “start on the biggest ones and work down,” says Bill Zachry, vice president of risk management at Safeway Inc. “And if workers’ compensation … is not one of the bigger costs that you have, then you should have the right experts to control that while you’re focusing on something bigger.” (See “The Safe Way to Slash Workers’ Comp Costs.”)

Analysis_Bug3But for big labor-intensive companies like Safeway, the food and drug retailer, workplace related risks and costs must rise to the top of mind in the C-suite. And because every company is required to cover its employees for medical costs and lost compensation resulting from a workplace injury, CFOs are inevitably aware of the expense.

In short, it’s hard for a CFO to completely avoid this area of risk. And if workplace hazards are “a big cost driver for you,” says Zachry, “then you should make sure that the focus is there to help bring down that cost.”

Lurking in the Shadows
One reason finance chiefs may not be paying much attention to workers’ comp costs and liabilities is that they tend to be undetectably buried in broader categories of financial reporting. “They’re just not something broken out in annual reports,” says Mulford.

But a bit of digging can unearth workers’ comp issues in the obscure nooks and crannies of corporate financials. In income statements, worker’s comp insurance premiums and other costs might be melded into “wages, taxes, and benefits,” Mulford says.  Liabilities might fall within “accrued expenses payable” on balance sheets.

If you search quarterly or annual statements on S&P Capital IQ, you can also find workers’ comp exposures listed under the balance-sheet category of “other long-term liabilities.” Armstrong World Industries and Nieman Marcus list them that way in their most recent 10-Qs.

The fact that workers’ comp can be located on a balance sheet doesn’t necessarily mean that it should rise to a prominent place on a CFO’s task list. But hints of potential anxieties can be found in disclosures of corporations’ significant risks — usually hedged with a statement that the company doesn’t expect them to amount to much. Typical of such reporting is Terex Corp., which recently stated that it is “involved in various legal proceedings,” including workers’ comp, for which it said it is insured.

Further, Terex, a diversified global manufacturer, disclosed that it is “subject to a number of contingencies and uncertainties” including workers’ comp liability. For this company, as well as many others, the rub is that future liabilities are based on estimates, and therefore could blow through corporate reserves or the upper limits  of workers’ comp insurance policies.

Along with Terex’s product liability, general liability, employer’s liability and property-damage exposures, the company reports that it faces potential workers’ comp litigation  that is as yetunasserted … or at a preliminary stage, and it is not presently possible to estimate the amount or timing of any of our costs. However, we do not believe that these contingencies and uncertainties will, individually or in the aggregate, have a material adverse effect on our operations.”

At other companies, however, the risk disclosures have a more alarming ring to them. United Natural Foods, in its most recent 10-K, warned shareholders, “We may fail to establish sufficient insurance reserves and adequately estimate for future workers’ compensation and automobile liabilities.”

Noting that it’s self-insured for workers’ comp and automobile losses up to a certain limit (above which it buys stop-loss insurance), the company acknowledged that such losses “could have a material and adverse effect on our business, financial condition or results of operations.”

As United Natural Foods’ annual report noted, the cost of workers’ comp insurance is based on “market trends” and “availability” as well as the individual company’s own loss history.

With the possibility of a company’s premiums rising sharply if it buys insurance pitted against the risk of underestimating its exposure if it self-insures, increasing numbers of CFOs are getting involved in workers’ comp risk-management decisions, insurance brokers say.

The Cash-Flow Conundrum
Indeed, the decision to self-insure can have an effect on one of a CFO’s most crucial concerns: cash flow. If, for instance, a company self-insures, it avoids the up-front drain on cash flow that would occur if it paid insurance premiums, Mulford explains. “It certainly helps immediate cash flow because you’re not paying it now, you’re paying it later,” he says.

The self-insuring company accrues the potential hit to cash flow over time, paying out claims to injured workers as they occur.  The downside is that “the part of the expense that’s self-insured is increasing that liability, that reserve, on the balance sheet,” he says.

While a company may or may not set aside cash to cover the liability, “the most likely scenario is that it’s just an outstanding liability that gets reduced later when [the company] pays those benefits,” Mulford adds.

The result is “a more uncertain, more uneven cash-flow stream,” than if the company paid a known and regular insurance premium, he says. Although their total payout may end up being cheaper, self-insured companies risk the uncertainty of big one-time hits to cash-flow when they pay the claims of injured workers. On the other, hand, if a company buys insurance, it takes that liability off its balance sheet and enjoys the benefits of a “smoother payment stream,” says Mulford.

The problem with that, of course, is that the insurance buyer pays a big markup on the funding of its risk so that the insurer can make a profit. And if a CFO looks at workers’ comp outlays compared to other insurance costs, rather than as a portion of the companies’ total expense line, they can amount to a pretty penny.

“At jumbo companies, insurance is going to be a pretty small percentage. But of the insurable piece, you’re talking about 50 percent for workers’ comp, depending on the industry,” says Christopher Flatt, the leader of the Workers’ Compensation Center of Excellence at Marsh, the insurance brokerage.

Mulford feels that workers’ comp can represent a hefty enough cost to merit the attention of finance chiefs, despite it being only a small piece of the corporate-expense pie. “I wouldn’t say it’s a percent; it’s an absolute dollar amount that just ought to be looked at,” he contends. “It’s like managing any expense.”

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