What is an experience modifier, how is it computed and how does it affect my premium?

The experience rating modifier is the one area where an employer’s efforts can significantly reduce insurance premium cost. Experience rating is the interaction of claims management and workers compensation 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 you in minimizing the impact of losses. The experience modification formula considers WC 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 include 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 2006 for a policy that will be written effective Jan. 1, 2007. Since the 2006 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 2003, January 2004 and January 2005.

In its simplest form, the experience rating calculation compares the actual losses for the individual employer with the expected losses for the average employer in the same industry and same state with the same amount of payroll.

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 isdesigned so that the employer with the greater claims pays more for workers’ compensation. Through this system, employers have a financial incentive to improve the safety of the workplace. The chart below shows the significant impact that the experience modifier has on the actual premium an employer pays for insurance:

 

Manual Premium

Exp Mod

Discount/Surcharge

Modified Premium

$62,106

.73

$16,769 Discount

$45,337

$62,106

1.00

No Impact

$62,106

$62,106

1.43

$26,706 Surcharge

$88,812

The last aspect of the experience rating modifier that impacts the calculation is the 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. A history of frequent losses normally implies there are poor safety standards in place and little management commitment to improving safety. In Texas, as in most states, large claims are “capped” so that the amount that exceeds the cap is not counted at all in the calculation. The current cap in Texas is $107,000. This capping process reduces the penalty to the employer when there are “shock” losses.

The examples below show the impact of losses on the experience modification calculation as well as the impact of frequency versus severity in the calculation.

 

Example #1 Hypothetical Account

Claims History

Claims

Policy Yr

Actual

Primary

Under $2000

 01

5,660

5,660

Under $2000

 02

5,303

5,303

Under $2000

 03

3,018

3,018

#51261701

 01

3,267

3,267

Lost Time Claim

BJM3976

 03

72,848

5,000

Lost Time Claim

BJM9986

 03

4,708

4,708

Lost Time Claim

94,804

26,956

Premium Calculation

Class Code

3628

8742

8810

Mod

Adj Prem

Est Payroll

1,000,000

100,000

1,400,000

Divide/100

10,000

1,000

14,000

Prem Rate

3.50

0.75

0.36

Premium

35,000

750

5,040

40,790

1.275

52,007

 

Example #2 - What IF there had been no Lost Time Claims?

Premium

Mod

Adj Prem

Example #1

40,790

1.275

52,007

Example #2

40,790

.80

32,632

 

Example #3 - What IF instead of three lost-time injuries, there was only one but the total loss was the same?

Premium

Mod

Adj Prem

Example #1

40,790

1.275

52,007

Example #2

40,790

.80

32,632

Example #3

40,790

1.120

45,684

 

 

 

 

Remember, experience modifiers are not arbitrary numbers assigned by the insurance carrier; they are calculations based on the employer’s actual losses. You can reward yourself and your business by implementing safety programs that will reduce losses.