Exclusively from Foa & Son
Most buyers of workers compensation insurance understand that their premiums are adjusted up or down by an experience modification, either a credit or debit factor applied to base premiums to reflect better or worse than average claims history. The size threshold at which these factors apply varies from state to state, but for most jurisdictions it’s safe to assume that any workers compensation policy developing over $10,000 in annual premium will be subject to experience modification.
The National Council on Compensation Insurance (NCCI) is an organization that currently acts as the licensed rating and statistical organization in 34 states and promulgates experience modifications for eligible workers compensation policyholders in those states. The modification formula used by the NCCI has remained substantially the same for over two decades, but that’s about to change, in ways that will affect you. The NCCI is rolling out changes to the experience modification formula that will take effect with modifications effective on January 1, 2013 and thereafter. Since most of the other sixteen states that have their own independent rating bureaus tend to follow NCCI’s lead, we can expect widespread adoption of these or similar changes countrywide.
So what are the changes? Without venturing too far into the theory and arcana of experience modifications, it’s still important to have a basic understanding of how the formula attempts to differentiate between frequency and severity in calculating an experience modification.
Let’s start with a simple example. Account A has one claim for $50,000; account B has ten claims of $5,000 each, totaling the same $50,000. Which is the poorer workers compensation risk?
Well, accidents do happen; that’s the reason we have insurance. And accidents can be serious, so large claims are certainly possible; it’s a matter of luck. But one accident is not a trend, or an indication of a poor risk. Multiple accidents, even small ones, are another story. They are an indication of an underlying problem. Luck comes into play here, too, in that all the claims in this example were small, but the odds that a serious claim will happen in account B are ten times greater than in account A. The experience modification formula attempts to reflect these differences.
An experience modification calculation is nothing more than a comparison of actual claims experience to expected experience. Expected losses are determined by multiplying an expected loss rate to payroll, in exactly the same way a workers compensation premium is calculated. The expected loss rate is directly related to the basic premium rate for each classification, and generally runs around 33-35% of the premium rate. This relationship is important. Certain WC classifications have higher rates than others, reflecting the higher hazards of the jobs involved. These higher rated classifications will also have a higher expected loss rate, meaning more actual claims can be incurred before the experience modification is adversely affected. Conversely, a lower rated classification has room for fewer claims before the modification is affected.
Actual losses affect experience modifications in two ways. So called primary losses go into the formula at full value. Excess losses are discounted. Under the current experience modification formula, all claims $5,000 and under are considered primary losses and go into the formula at full value. For larger claims the first $5,000 of each claim goes into the formula as primary loss, but amounts over that are considered excess loss, and are discounted.
Back to our account examples, account A has one claim for $50,000; $5,000 goes into the experience calculation at full value, but $45,000 is considered excess loss and is discounted. Account B has all small claims, so all claims go in the formula at full value, no discounting. Result: for the same total claims experience account B with ten claims will have a higher experience modification than account A with just one large claim.
Here is where the pending change comes in. The split point of $5,000 to mark where primary loss ends and excess loss begins has remained unchanged in the NCCI formula for over twenty years. Starting with experience modifications effective January 1, 2013 the NCCI will increase that split point to $10,000. A year later it goes up to $13,500 and a year after that to $15,000, where it will then be indexed for inflation and increase yearly after that. Result: more of each large claim is considered primary loss, with its more direct impact on your experience modification.
What does all this mean for you? NCCI has done reams of research on the affect of these changes, and reports that, in general, workers compensation insurance buyers with credit experience modifications will see larger credits, while insurance buyers with debit experience modifications will see larger debits. For most, the changes will be small, with, by NCCI estimation, 74% of all modifications showing changes (in either direction) of five points or less. They estimate 6.5% of all modifications will change five to ten points, and only 7% will change by ten points or more.
Claims information for experience rating purposes is valued six months after a policy expires. You’ll most likely be reading this around the beginning of July, so the claims that will be going into January 1, 2013 experience modifications under this new formula are already valued and reported.
These changes have been in the works for a number of years, but they come at a time when the insurance market has noticeably tightened for workers compensation in particular. How a more difficult market intersects with the forthcoming changes in the modification formula is something we can’t predict at this time, but we’re keeping our eyes on it for you.