Experience rating is the interaction of claims management and insurance pricing. An organization that controls its losses also controls its experience modifier and ultimately is responsible for higher or lower premiums.
With so many areas of workers’ compensation out of the control of the policyholder, the experience rating modifier is the one area where an employer’s efforts can effectively impact premium cost.
Experience rating is the interaction of claims management and insurance pricing. An organization that controls its losses also controls its experience modifier and ultimately is responsible for higher or lower premiums. Although the formula is quite complicated, an understanding of the basic components will assist the policyholder in minimizing the impact of losses.
The experience modification formula considers losses for a three year period, excluding the current policy period. The “losses” are more than just the amount that has been actually paid out on a claim. They are the “incurred” losses, which also includes the reserves that an insurance company adjuster has estimated the loss will pay out in the future, either in direct medical treatment or as indemnity payments to the injured worker while he or she is unable to return to work.
As an example, let’s consider that an experience modifier for a risk is being calculated during 2005 for a policy that will be written effective Jan. 1, 2006. Since the 2005 policy is not yet closed (expired), the loss data is not available. This one year lag period allows the insurance company the time to close most claims and more accurately estimate the cost of the open claims that will continue for more than one year. The three years that the experience modification calculation is based on are the years that began in January 2002, January 2003 and January 2004.
Action: Policyholders who focus their attention on reducing or eliminating losses occurring today, can curtail the financial impact on their rates and premium for the next three years.
Actual versus expected losses
In its simplest form, the experience rating calculation compares the actual losses for the individual employer with the expected losses for the average employer with the same amount of payroll, in the same industry, in the same state. An experience modifier of 1.00 represents an employer whose actual losses closely matched the expected losses for their business. If the actual losses were greater than the expected losses, the experience modifier would be greater than 1.00; conversely a modifier less than 1.00 means that actual losses were less than expected.
Since no two employers in the same industry will have the same claims histories, the experience modifier calculation is designed so that the employer with the greater claims pays more for their workers’ compensation. Through this system, employers have a financial incentive to improve the safety of the workplace. The following chart shows the significant impact that the experience modifier has on the actual premium an employer pays for insurance:
Action: Policyholders who focus their attention on reducing or eliminating losses, reap the benefit of an improved experience modifier resulting in a lower premium.
Frequency of claims
The last aspect of the experience rating modifier that impacts the calculation is frequency of claims. The formula places a higher penalty on an employer who has 10 injuries costing $5,000 each versus an employer who has one injury costing $50,000. Although the ultimate expense may be the same, the employer with one claim is considered a much better risk. An employer with a loss frequency history normally implies there are poor safety standards in place and little management commitment to change the outcome.
In Texas, as in most states, large claims are “capped” and the amount that exceeds the cap is not counted in the calculation (Texas state accident limit is currently $107,000). This capping process reduces the penalty to the employer when there are shock losses. The following samples show the impact of losses on the experience modification calculation as well as the impact of frequency versus severity in the calculation.
Based on the claims presented the client has a debit Experience Mod resulting in an additional 27.5 percent in premium, or $11,217.
In this example, we have removed the impact of the Lost Time claims. Had this employer been able to eliminate these claims, the experience modifier would have been .80 (in lieu of 1.275) resulting in a savings of 20 percent in premium ($8,158) from the base premium of $40,790.
In this example we have replaced three smaller losses with one loss equaling the same dollar amount. The experience modifier now reflects 1.120 indicating the impact of severity versus frequency.
Action: Policyholders who focus their attention on creating and implementing a successful safety program will reduce the frequency of their claims resulting in an improved experience modifier and a lower premium.
Not arbitrary numbers
Remember, experience modifiers are not arbitrary numbers assigned by the insurance carrier, but are calculations based on the employer’s actual losses. Help the employer make their company’s experience pay by implementing safety programs that will reduce their losses and lower their workers’ comp premium.
Reprinted with permission from Service Lloyds Connection.
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