The Workers’ Compensation experience modification is a rating element applied to an employer’s premium calculation. An employer must first meet a minimum Worker’s Compensation premium threshold to qualify for experience modification rating. The minimum premium needed to qualify varies by state. If an employer qualifies for experience rating, its usage is mandatory in their premium calculation.
The experience modification factor contemplates an individual employer’s historical losses versus the average expected losses of employers in the same industry. Normally, the policy period used in the experience modification rating calculation is three years. The factor that is developed can be either a debit or credit, above or below a 1.00 “unity” factor.
This article provides an understanding of the data elements used in the development of an experience rating factor and the basics of how this factor is derived. We will then discuss ways an employer can impact their experience rating.
The Basic Experience Modification Equation for an Employer:
“Employer’s” Actual Loss (Numerator)/“Industry” Total Expected Loss (denominator) = Experience Modification
How the denominator is derived: The Expected Loss is based on an employer’s audited payrolls for the applicable policy terms. The employer’s historical payroll for each Workers’ Compensation class code is multiplied by the Expected Loss Factor “ELR” and the Discount Ratio “D-Ratio” to determine the Expected Loss and the Expected Primary Loss values.
For our purposes here, it is more important to only understand that these are the factors used to derive the Expected Loss and the Expected Primary Loss. It is not as important to understand the “ELR” or the “D-Ratio” factoring itself, as these are not variables which the employer can directly influence. The Total Expected Loss is the sum of the Expected Primary Loss, Stabilizing Value and Ratable Excess (loss). The Stabilization Value is derived by multiplying the Expected Excess Loss and a weighting value plus a Ballast Value. The Ballast Value limits the effect of any single loss on experience rating. It increases as an employer’s Expected Loss increases. The Stabilizing Value is added to both the denominator and numerator to limit potentially significant fluctuations in the experience modification rating due to large (severe) losses. The Ratable Excess is derived by subtracting the total Expected Loss from the total Expected Primary Loss.
Expected Primary Losses + Stabilizing Value + Expected Ratable Excess = Total Expected Loss (denominator)
15,500 + 60,000 + 2,600 = 78,100
We will use an Expected Loss value of 78,100 for the example in this article.
The employer’s audited payrolls for the policy terms in the experience period is the only employer data utilized in development of the Expected Loss Value. Therefore, an employer should review their audited payroll by Workers’ Compensation classification code used in each policy term for accuracy. Many of our agents and brokers review this data as part of their service.
Now we will focus on the Total Actual Loss, which is the driven by an employer’s incurred losses. The incurred loss amount is where an employer can impact their experience rating.
How the numerator is derived: The incurred losses of an employer are the basis for calculating the numerator or Actual Loss. The employer’s individual losses are listed on the Experience Modification Worksheet by policy term. The claims are assigned an Injury Code “IJ”. Most claims fall into one of two Injury Code classifications, (06) Medical Only or (05) Medical with Temporary Indemnity. It is the addition of temporary payroll payments to the injured worker that cause the claim to be coded (05). The temporary payroll is paid to replace lost wages when the treating physician believes continuing work would hamper recovery or cause further injury.
There are other less commonly used Injury Codes. For the purposes of this article, we will only be addressing codes (05) and (06). The Injury Code is an important part of the Experience Modification calculation. Claims that are assigned Injury Code (06) Medical Only are discounted 70% for experience modification calculation. The discount is referred to as the Experience Rating Adjustment “ERA”.
Experience Rating Adjustment Example:
A claim coded to (05) Medical with Temporary Indemnity (payroll) with a total incurred loss of $3,000 will have the full $3,000 used in the modification calculation. If the same claim qualified to be coded to (06) Medical Only with a total incurred loss of $3,000 ($3,000x 30% = $900), only $900 of the $3,000 is used in the modification calculation due to the application of the ERA.
Each claim’s incurred amount is recorded as the Actual Incurred Loss Value. The first $18,500 of the loss is also recorded under the Actual Primary Loss. The Actual Primary Loss is also referred to as the “frequency” layer.
For our example:
Claim “A” has a total incurred loss of $3,000 and Claim “B” has a total incurred loss of $25,000. The claims would be recorded as follows:
Claim Actual Incurred Loss Actual Primary Loss
A 3,000 3,000
The $18,500 per claim cap on the Actual Primary Loss Value is referred to as the “split point.” The split point is evaluated each year and is adjusted based upon inflationary-type cost increases. The Actual Primary Loss total amount is one of the Actual Loss’s (numerator) three rating elements.
Actual Primary Loss for Claim A + Actual Primary Loss for Claim B = Total of all Actual Primary Loss
3,000 + 18,500 = 21,500
The difference between the total of all claims (Actual Primary Loss versus Actual Incurred Loss) is the Actual Excess Loss Value.
Actual Incurred Loss – Actual Primary Loss = Actual Excess Loss
25,000 – 18,500 = 6,500
A weighted value known as Weighting of Losses “Wt” value ranges between .07 and .63 and is based on the employer’s size. It is applied to the Actual Excess Loss Value. The smaller the employer, the greater the reduction. The weighted value is known as the Ratable Excess.
So, if we assume that Claim B from the above scenario was the only claim in the loss data that had an Actual Incurred Loss greater than $18,500, the calculation to get the Ratable Excess would be as follows.
Total Actual Excess Loss x Weighting of Losses = Ratable Excess
6,500 x .15 = 975
Actual Primary Losses + Stabilizing Value + Actual Ratable Excess = Actual Loss (numerator)
21,500 + 60,000 + 975 = 82,475
At this point, we have the basic data needed to calculate a simple modification.
Divide the Actual Loss ($82,475) by the Total Expected loss ($78,100) to get the Experience Modification rating factor:
Actual Loss (Numerator)/ Expected Loss (Denominator)= Experience Modification Factor
82,475/78,100= 1.06
As you can see, the Experience Modification Rating factor in this example is 1.06. This debit would be applied to the premium calculation of the applicable policy term.
How Can an Employer Positively Impact Its Experience Modification?
There are a number of ways an employer can have a positive impact on their experience rating.
- Review classification codes and payroll listed, as well as claim data on the Experience Modification worksheet. A good commercial lines agent or broker is a great resource in this area.
- Develop a safety-minded culture within the organization.
- Develop good hiring practices.
- Report claims in a timely manner.
- Implement a Post-Accident Drug Testing (PADT) program.
- Implementation of a Modified Duty Program for employees who were injured at work. A Modified Duty Program can help reduce or eliminate a temporary indemnity payment to injured employees.
Why Insure Your Workers’ Compensation through Prescient National
Our average Workers’ Compensation claims severity has averaged 38%* lower than the industry average over the most recent 10 years of NCCI data.
If the two losses in the above example had been managed by Prescient National and the employer had our programs and procedures in place, it is reasonable to assume that the $3,000 claim could have been limited to (06) Medical Only. We can achieve this by encouraging our insureds to report claims within 24 hours of the injury. We also recommend our employers have light-duty positions available should they need a position ready for an injured worker with physician’s restrictions.
If the employee were then placed in a light-duty position without any indemnity paid under the policy, then the claim value would have been reduced to $900 due to the Experience Rating Adjustment “ERA” applied to Medical Only losses. The modification would have been 3 points lower or a 1.03.
Actual Primary Losses + Stabilizing Value + Actual Ratable Excess= Actual Loss (numerator)
19,400 + 60,000 + 975 = 80,375
Actual Loss (Numerator)/ Expected loss (denominator)= Experience Modification
80,375/78,100= 1.03
If the severity of the $25,000 loss was reduced by 39%, to reflect our average lower cost for claims severity, then the claim value in the calculation would be $15,250. Assuming the $3,000 claim was Medical Only, the modification would have been 7 points lower or a .99 credit rather than the 1.06 debit.
25,000 x .39 = 9,750
25,000 – 9,750 = 15,250
Actual Primary Losses + Stabilizing Value + Actual Ratable Excess= Actual Loss (numerator)
16,150 + 60,000 + 975 = 77,125
Actual Loss (Numerator)/Expected loss (denominator)= Experience Modification
$77,125/$78,100= .99
Keep in mind each policy term is used in the experience modification calculation for three years. Therefore, the losses in this example would be adversely impacting the modification for three policy terms.
Prescient National helps insureds evaluate and implement strong hiring practices, timely claims reporting, Post-Accident Drug Testing and Modified and Early Return-to Work programs.
*Data Source: 2021 National Council on Compensation Insurance from 2009 – 2020
