A recent change in the rating formula for workers' compensation insurance may impact the premium rates paid by your company. The National Council on Compensation Insurance (NCCI), who manages the nation's largest database of workers' compensation insurance information, has adjusted their rate recommendation formula for the first time in 20 years.
How does the formula work?
The NCCI formula, known as an "experience rating calculation", relies largely on the individual claims history of a company to determine premium rates. The system is designed so those companies that file claims more frequently in the past pay higher premiums in the future.
The new formula, which is slated to rollout state-by-state beginning on January 1, 2013 is focused on increasing the split point, which is currently set at $5,000. The current formula works as follows:
- The first $5,000 of any claim is lumped into the primary losses category. Primary losses are undiscounted, which means that the full cost of the claim counts against the company that files it, resulting in a higher premium.
- Individual claims that total more than $5,000 (claims in excess of the split point), go into an "excess losses" category and are discounted. This ensures that the frequency of claims is more heavily weighted than claim severity when premium is calculated.
- For two companies with total claims that equal the same dollar value, the company with the higher proportion of primary losses will pay a higher premium (See chart)
Company
|
Claim Amount
|
Primary
Losses
|
Excess
Losses
|
Total Primary
Losses
|
Total Excess
Losses
|
A
|
$5,000
|
$5,000
|
$0
|
$10,000
|
$0
|
$5,000
|
$5,000
|
$0
|
B
|
$10,000
|
$5,000
|
$5,000
|
$5,000
|
$5,000
|
With a $5,000 split point in place, Company A files two $5,000 workers compensation claims over the course of a year, while Company B files only one $10,000 claim. Despite the same total annual claim amount, Company A will have a higher premium because it has more undiscounted (primary) losses.
By increasing the split point, the NCCI hopes to make the calculation more responsive to a changing claims climate. Since the establishment of the $5,000 split point, the average claim amount has more than tripled. The NCCI hopes to mirror this increase with a tripling in the split point, to $15,000 over the next three years, after which the split point will be indexed for claim inflation.
What does this mean for your business?
The NCCI has stated that the impact will be "premium neutral" within each state, which means that, as a whole, the rating formula change will not cause premiums to increase for all businesses. However, companies that will be most at risk for premium increases are those with frequent claims in the $5,000-$15,000 range. These claims will transition into the primary losses category over the next few years and will go from being partially discounted to entirely undiscounted in the experience rating calculation.
The trick to figuring out the most likely scenario for your business lies in the NCCI "experience modifier". The experience modifier is a tool the NCCI uses to translate experience rating calculations to a meaningful value for the price of a premium.
To better understand the experience modifier, consider premium pricing as a game of averages. Your company's experience modification rate is determined by its experience rating. This is how primary and excess losses actually influence your premium.
- Within each industry, a 1.0 experience modification rate is the average. To calculate premium, a standard rate is multiplied by your company's experience modification rate. If your company has a 1.0 experience modification rate, you pay the established standard rate. The general consensus is the closer your company is to 1.0, the less likely your business will be impacted by the change in rating formula.
- If your company's experience rating is higher than the industry average, your experience modification rate creeps above the 1.0 mark, resulting in a higher rate for workers' compensation insurance. For example, a company with an experience modification rate of 1.2 would pay 20 percent more for a workers' compensation plan with the same amount of coverage. Businesses with higher modification rates are more likely to be negatively impacted than businesses with lower modification rates.
This "game of averages" means that your premium doesn't automatically increase with the increasing split point. On the surface, the changes to the NCCI experience rating calculation formula can seem confusing. However, the system is navigable, and the proposed changes to the split point can even help your company achieve a lower experience modification rate and, more importantly, a lower premium for workers' compensation insurance.
More guidance on these upcoming changes will be available later this year. For more information on how you can best prepare your business for the coming changes, contact your HUB International broker who can help you review your current mix of claims and develop a strategy to help you reduce your losses. HUB can help you implement safety programs, wellness initiatives, and improved hiring practices that can help you manage your workers' compensation costs.