Restricted stock units (RSUs) and other forms of equity-based compensation are creating a stir in the workers’ compensation marketplace, forcing insurance carriers to revisit whether to include them as payroll when calculating premium.
Several years ago, California clarified that equity-based compensation is considered includable remuneration, with a few notable exceptions. The National Council on Compensation Insurance (NCCI), which governs 35 other states, enacted similar regulatory and administrative changes effective January 1, 2024. This will impact workers’ compensation premiums for companies that use equity-based compensation to attract and retain employees in a competitive recruiting environment.
We’ll explain why RSUs pose a challenge for companies determining their annual payroll, how workers’ compensation carriers have been treating RSUs, and the changes by regulatory agencies and how they affect your workers’ compensation premiums.
What Is Equity-Based Compensation?
The popularity of equity-based compensation plans continues to grow. These alternative payment packages compensate employees based on the value of the organization’s stock and include restricted stock units (RSUs), phantom stock plans, stock appreciation rights, stock purchase plans, stock options, stock transfers, and more. The most commonly used plan making headlines in the workers’ compensation space is RSUs.
The Issue with RSUs
As the rating basis for workers’ compensation premium is annual payroll, budgeting for workers’ compensation premium is challenging enough for employers experiencing rapid growth. Equity-based compensation adds an additional wrinkle.
An increase in payroll from non-salary-based compensation plans like RSUs can significantly increase the final WC premium. This can happen at inception if higher estimated payroll figures are appropriately utilized per the new guidelines, or at final audit due to increases in stock price over the course of the policy period.
RSU Treatment Under Workers’ Compensation
Before California’s clarification in 2019, the rules around the treatment of stock-related plans in the payroll and premium calculation were vague and subject to varying applications by insurers. The Workers’ Compensation Insurance Rating Bureau (WCIRB) noticed that inconsistency in the treatment of this remuneration could create credibility issues with regard to statewide trends, pure premium loss rates for individual classification codes, and in experience modification calculations. California has led the way in seeking uniformity in how this compensation is treated under workers’ compensation payroll and premium calculations.
The value of the equity-based compensation to be used in the payroll calculation is the value in the year in which the grant becomes vested. However, because of the potential severe financial implications associated with a drastic increase in the value of stock and the materially adverse effect it could have on premiums, there are exceptions. This could include a non-recurring change in majority ownership event, such as an IPO or an acquisition, which could trigger accelerated vesting.
Generally, insurance carriers understand that RSUs and other equity-based compensation plans inflate the exposure base without materially affecting the exposure to loss. In the past several years, many insurers have found creative ways to avoid charging the resulting premium related to that RSU payroll. These methods include:
- Rating plans that calculate audit premiums based on headcount rather than payroll
- Agreements to waive inception and/or audited additional premium associated with RSUs
- Adjusting WC rates at inception so that RSU payroll does not have a material impact on premiums, i.e., ensuring that premium charged is commensurate with exposure to loss
These methods have worked historically because while state WC bureaus generally stipulate that RSU payroll data must be collected and reported, it is not clear that insurers must charge premium on these RSUs.
What Is Changing?
Post-pandemic, various WC regulatory agencies have ramped up audits of insurance companies. The goal of these audits is to establish and maintain data credibility to determine trends, compute loss rates, and calculate ex-mods. Bureaus are scrutinizing the treatment of RSUs and other equity-based compensation as they look for consistency with how the insurers are tracking and reporting the associated payroll.
Notable events of late include:
- California Increases Auditing and Penalties: In California, the WCIRB oversees WC rates and rules that insurers must follow. In 2023, the WCIRB increased the number of test audits performed for California insureds, specifically stating that equity-based compensation be included in remuneration, per its guidelines. Some test audits have resulted in large additional premiums for equity-based compensation, and the WCIRB has also penalized some carriers that had previously allowed the carveout of RSUs.
- NCCI Clarifies Rule for 35 Other States: After surveying insurance carriers and premium auditors for feedback around the lack of uniformity in the treatment of non-standard compensation plans, the NCCI enacted a new rule clarification. Previously silent on this issue, the NCCI now states that payroll is to include the value of equity-based compensation plans, other than stock options and stock purchase plans, at the time of vesting. This would include graded, scheduled cliff, performance goal, and milestone anniversary vestings. The plans defined as equity-based compensation include stock transfers, stock warrants, restricted stock, and the popularly used RSUs. Like in California, this would not apply to cliff vesting triggered by IPOs or a change in majority ownership.
What to Expect in 2024
The increase in California’s administrative agency audits and the rule changes by the NCCI are likely to reduce the number of carriers offering creative solutions to exclude RSU payroll and/or make concessions on premiums.
Overall, the workers’ compensation marketplace has historically been split on the issue, as there have always been several carriers that required equity-based compensation to be fully included. At least one national insurer, which was historically flexible with the treatment of equity-based compensation, has advised that beginning January 1, 2024, it would not be able to exclude RSU payroll any longer. While this is concerning, it’s too early to tell if this is a trend and how the overall marketplace will react.
What Actions Should Insureds Take?
Here are some recommendations on how to prepare for this market uncertainty in 2024:
- Identify the amount of equity-based compensation/RSU payroll your organization expects for the upcoming year. This information is crucial in negotiating any premium relief with your insurer up front.
- Find out the position your WC insurer is taking on the inclusion of equity-based/RSU payroll and how that is or will affect your premium.
- Work with your broker to identify carriers that are flexible on how equity-based compensation/RSUs impact premium and/or have rating plans that will minimize the impact.
- Start your renewal process early so you can help your organization budget for potential added costs.
To learn more about RSUs and how these changes may affect your workers’ compensation premium, contact your Woodruff Sawyer Account Executive.
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