Understand how the NCCI experience rating affects workers’ compensation costs.

This function of insurance allows the prediction of the probability of injuries and their subsequent cost across a group of members who share similar risks.  Employers’ liabilities differ depending on safety and prevention.  Experience Rating spreads the cost of a losses, hence the insurance costs, with all members of a specific group (class).

The NCCI calculates what is called Experience Rating Modification (mod).  The NCCI rates employers based on their experience when compared to other employers who perform the same type of work.  By using the payroll and loss records, the NCCI can compare the experience of individual employers to that of others in their same class.  This creates a Mod, or Exmod that may increase, decrease, or have no change in the insured’s premium.  This Experience Modification incentivizes employers to manage expenses via safety and loss prevention programs.

“Manual rating” is the simplest way to rate employers for their workers’ compensation liability insurance.  All employers are given a ‘classification’ based on the type of business.  Similar businesses are grouped together into classes.  The estimated costs for each classification are created to create an average cost per class.  These rates reflect the average for each classification.  However, every employer is unique.  The experience rating is applied to adjust the cost for each employer.  It is calculated based on their payroll and loss experience over three years as compared to other similar employers in their same class. 

‘Experience Rating’ is more beneficial than ‘Manual Rating’ because it is a more accurate cost prediction.  Employers with a better, than the average, loss experience receive a credit to their net premium.  While employers with a worse, than the average, will pay higher premiums.  Employers either have a ‘credit mod’ or a ‘debit mod’. 

This Experience Rating system provides incentives for loss prevention and for the implementation of safety and loss prevention systems.  Premium costs are adjusted with this experience rating process to refine the premium determination based on an employer’s potential for losses.  These principals create insurance premiums that are customized for each and every employer.  Employers are incentivized to have health and safety promotion programs designed to prevent injuries and have injured employees return to work as soon as possible.

One characteristic of ‘Experience Rating’ is that it can better statistically predict accident frequency, than it can predict of accident severity (costs of any specific accident).  Hence greater weight is given to frequency than severity.  The occurrence of the work related accidents are more important.  Accident frequency is more reflective of potential losses.  Consider this example of 2 employers with the same classification:

• Employer A – 1 loss with a total cost of $100,000
• Employer B – 12 losses with a total cost of $100,000

Employer A had 1 total accident, hence is statistically more stable, than Employer B, which has had 12 accidents.  Any of those 12 accidents could have had higher associated costs.  Employer B will statistically have higher future workers’ compensation costs.  However, an employer that has a small number of high cost claims is also significant and must be taken into account.  A blend of both occurrence (frequency) and cost (severity) of each injury must be taken into account.  The 12 injury employer will receive a higher mod than the employer with just one injury even though the total losses are the same.

Accident frequency and severity are both measured, but a very large single loss does not develop a predictive pattern.  Large single losses are less predictive and can skew the predictability, so a state accident limitation places a cap on each individual loss.  This limitation varies by state.  Each state has a cap for which limits an individual loss to a ratable loss.  If an employer has an individual loss of $400,000 and the state has a cap of $300,000, then the limited or ratable loss is $300,000 for the purposes of calculation of the experience modification. 

Excess and primary loss in split point
A split point is used to take into account frequency and severity of losses.  The split point of an individual loss is each state’s rate.  The primary loss reflects frequency whereas the amount in excess of the split point is the excess loss, which reflects severity.  Single losses below the split point are simply primary losses with no excess loss.  The formula gives greater weight to primary losses than to excess losses.  However both factors are considered thus employers have incentives to reduce both frequency and severity of work injuries.  The weighing of losses are designed to be sure that the experience modification is an accurate reflection of predicted loss.  Experience modification is most influenced by a large employer’s loss history.  In the case of a small employer, who may have had many years without a loss, then suddenly incur a large loss, the debit due must be modified to reflect said loss. 

Experience Rating Adjustment (ERA)
 Most states use the Experience Rating adjustment (ERA) which limits medical-only claim losses in the calculation of the Exmod.  Only 30% of actual primary and excess portions of medical only claims are used in the experience modification calculations.  This 70% reduction in medical only claim encourages employers to accurately report medical only claims rather than paying the medical expenses out of pocket.  This leads to accurate reporting of work place injuries.

Experience rating is mandatory and applies to employers who meet the each state’s criteria for eligibility.  Each state has its own eligibility criteria which is specific to each individual state and is based on the employer’s payroll and losses over their experience period.

Experience Period
An employer’s experience period begins at their rating effective date.  Generally, the period of time for calculation is for three years payroll and claims loss data.  New employers who qualify to be experience rated, short-term policies and policies with different effective dates may change the three years of data as short as 12 months to as long as 45 months depending on those aforementioned factors.

Rating Effective Date
The rating effective date is the effective date of the experience modification and is the earliest date that the modification percentage is applied to the policy premium.  This experience modification is generally applied for one year, but can be applied for a time period of three months up to fifteen months.  If the policy effective date falls within 57 and 21 months prior to the rating effective date, then those policies will be used in the calculation of the experience modification. 

States with alternate governance for experience modification
  The NCCI is responsible for calculating the experience modification for 39 states.  Specially, in Minnesota, New York, and Wisconsin only participate with the NCCI Plan if there is exposure to the employer in two or more states. 

The NCCI plan does not apply California which has its own statistical organization, the WCIRB.  Also, Massachusetts, Indiana, and North Carolina have their own individual rating organizations which calculate their experience modifications.  Next, Michigan, New Jersey, Pennsylvania, and Delaware administer their own rates.  Finally, the four monopolistic states Ohio, North Dakota, Wyoming, and Washington have their own state plans. 

The modification is generally calculated 60-90 days before the rating effective date, which means that the current policy is not part of the calculation.  Additionally, this is the case because data is not reported for 18 months after the policy inception date.  This allows for time for the evaluation of losses to include in mandated reports to the NCCI.  These updated reports provide constant records for each employer.  The NCCI applies their formula and then issues a credit or debit modification, to eligible employers, to be applied to premiums each year.  Each year the experience modification is recalculated.

Experience Rating Qualification
 Experience rating is mandatory for all employers who meet the established eligibility requirements.  These eligibility requirements vary by state.  The qualifications for premium threshold for each state can be found in the NCCI Premium Eligibility table of their Plan.  In order to qualify employers must meet a premium threshold by one of two ways.  One, an employer has premium experience rating in the last 2 years or has reached the established premium threshold during the entire experience period.  For example, the qualification for experience rating can be met in the most recent two years, or over the average of the premium over three years meets the threshold.  If an employer’s premiums decline in future years, it may no longer qualify for experience-rating.  The NCCI contacts the insurance provider that the employer is no longer experience rated.  On the other hand, employers who do not have an experience modification, can have rising premiums which then qualify them to become experience-rated.

Types of Experience Rating –Intrastate Mod and Interstate Mod
 Intrastate mod is applied when the employer has an experience modification in exposure in one state.  An interstate mod is applied when the employers has experience rating in two or more states.  This only applies to exposure in states that are under the regulations of the NCCI.  If an employers has exposure in states that are not under the NCCI Plan, those states are considered separate and each state has its own loss experience plan.

Experience Rating Status
State-approved rating values that are used in the calculation depend on their status.  There are three distinct statuses; preliminary, final, and contingent.  Preliminary status means that the NCCI is awaiting the final rating values for each state for the year.  As a preliminary calculation, the NCCI uses the prior year rating value as they await the updated states’ new final approved rating value.  One the states approve and finalize their rating values, the experience modification in recalculated and moved to the status of final.  The other status is a contingent status.  When the NCCI is awaiting data of payroll and loss for an employer and has not received that data when the modification is calculated it is deemed contingent until the data is provided and the experience modification recalculated once the new data is received.

The Experience Rating Modification Factors: a Unity factor, Credit Mod, or Debit Mod
A unity factor is a factor of 1.00.  An employer receives a unity factor of 1.00 for several reasons.  A unity factor does not affect the premium rate.

These different reasons are as follows:

1. 1. It does not meet eligibility requirements
   2. It does not meet minimum data requirements,
   3. It is a new business with no data to produce a modification
   4. It qualifies for experience rating, but the calculation results in a factor of 1.00
   5. Data could not be provided because of an ownership change.

A credit modification is when the modification is less than a factor of 1.00.  This credit modification is applied against the premium which lowers the cost to the employer.  For example, a premium rate of $200,000 multiplied by a Mod Factor of 0.75 would yield a modified premium of $150,000.  This reflects a favorable position for employers and often reflects a safe workplace.

A debit mod is any factor greater than 1.00 which is applied to the premium rate and increases insurance premium that the employer must pay.  For example, a premium of $200,000 multiplied by a Mod Factor of 1.25 would yield a modified premium of $250,000.  Employers which a debit modification may wish to review their workplace safety programs.  Employers have a large financial incentive to create a safe workplace environment as a debit mod experience rating factor can lead to substantially higher workers compensation insurance premiums year after year.

Classifications
 Premium paid by employers are also calculated based on their classification.  Classifications are created based on the type of work an employer performs.  For example, a tree trimming code or roofing classification code will have different rates then say office work, or computer programming.  Office work is inherently a less risky class of work than roofing.  There is less inherent risk hence their initial premium rate before any modification is applied is lower.  Workers compensation initial premium rates are given for each classification, and then the unity, credit mod, or debit mod is then applied. 

Experience Rating Worksheets- Unit Statistical Reports
 Workers Compensation insurance companies are obligated to create unit reports to the NCCI for each policy they issue.  Unit statistical reports contain payroll and claim losses.  This data is then transferred to the Experience Rating Worksheet at NCCI.  The Experience Rating Worksheet takes into account the classification code, date the modification is to be applied, the expected loss rate (ELR), the discount rate (D-ratio), the expected losses, and the expected primary losses.  All of this information from the Experience Rating Worksheet is used to calculate the Experience Rating Modification.