Calculating the Experience Modifier

The following section examines the basic method used to calculate the experience modifier. One common misconception concerning the experience modifier is that a high hazard industry will have a high experience modifier and a low hazard industry will have a low experience modifier. This is not the case because the experience modifier compares only companies within the same industry classification code. ABC Trucking, for example, is compared only to other trucking companies in code 7229. It is important to remember that rates vary by the hazard level of the industry, but the experience modifier varies only by a company's performance within their specific industry. Achieving a less than 1.00 experience modifier is as much an accomplishment for a restaurant or a clerical office as for a construction or logging company.

The easiest way to understand how the experience modifier is determined is to examine the loss ratio or the expected loss rate of an individual company. The loss ratio is the dollar value of a company's workers' compensation claims divided by the dollar value of the company's manual premium. The expected loss rate is simply the loss ratio expected for a particular industry multiplied by the manual rate for that industry. The expected loss rate is then multiplied by a company's payroll to determine expected losses. Expected loss rates will not be used in the following example because we can accomplish the same thing by using a loss ratio equal to 52% of a company's manual premium. If ABC Trucking had nine claims during their policy year totaling $32,295 and a manual premium of $62,106 their loss ratio would be 52%. (32,295/62,106 = .52 or 52%) The NCCI determines the actual expected loss rates for all classification codes and publishes them each year. Many of the expected loss rates are around 52% of the manual rate. For this reason, we will assume expected losses of 52% are average for the trucking industry. With this assumption, ABC Trucking will have a 1.00 or average experience modifier because they have a 52% or average loss ratio.

The next table helps illustrate how the actual loss ratio and expected loss rate affect the experience modifier. The "Actual Claims" column represents the claims ABC Trucking Company actually experienced during the policy year. The "Expected Claims" column is the premium multiplied by the expected loss rate of 52%. This rate represents $32,295 in expected losses. The following table examines three separate actual claim totals that produce three experience modifiers.

In reality, the calculation of the experience modifier is more complicated than this, but this example should help employers understand the basic calculations used to determine the experience modifier. Most importantly employers should realize that experience modifiers are not arbitrary numbers assigned by their insurance carrier, but are calculations based on the employer's actual claims history. The NCCI publishes a booklet titled The ABC's of Revised Experience Rating and other NCCI publications can also be ordered directly from the NCCI. The ABC's of Revised Experience Rating does a good job explaining the experience modifier, but lacks detail on certain aspects that are discussed next.

The experience modifier is calculated each year using a combined claims history from a three-year rolling period. By using a three-year rolling period, the experience modifier will remain more consistent and eliminate most wide variations from year to year. Each year the rolling period drops off the oldest policy year and adds the most recent policy year. If a company has unusually high claims during one policy year their experience modifier will be affected for three years. However, the effect of the high claims year will be stabilized by the experience of the other two years on the record. This stabilizing effect works the same when a company has an unusually low claims year. In order for a company to effectively lower its experience modifier, it must consistently control claims over the entire three-year period of the experience modifier.

An important detail concerning the three-year rolling period is the inclusion of a one-year lag period that precedes the actual three-year claims period. The one-year lag period is necessary because of the difficulty placing an immediate cost on claims resulting from serious injuries. A claim resulting from a serious injury may take several months or even years before it is settled. If ABC Trucking has an employee injured on June 30, 1994 and their policy ends the same day it would be impossible for their insurance carrier to determine the cost for the claim and apply it to that claims year. Since the experience modifier is required for the new policy beginning the next day, a lag period is necessary. This one-year lag period allows the insurance carrier time to settle and close most claims and more accurately estimate the cost of claims that continue for more than one year.

It is important to remember the lag period when analyzing an experience modifier and when setting goals to reduce it. If ABC Trucking has a year with an unusually high claim, it will not be reflected in their next experience modifier. It will, however, be reflected in the experience modifier two policy years away. If, for example, ABC Trucking has a claim in July 1, 1995, the first day of their 1995-1996 policy, it will not affect their experience modifier until their policy due on July 1, 1997. The experience modifier and policy due on July 1, 1996 will not be affected.

Management needs to understand the lag year in order to evaluate the effectiveness of safety programs. Suppose ABC Trucking implemented a successful safety program beginning July 1, 1995, and had no claims for the next two years. It would still be July 1, 1997 before ABC Trucking realized any monetary savings from a lower experience modifier. The full benefits of the safety program wouldn't be realized in the experience modifier until the policy due on July 1, 1999. Understanding the one-year lag period and subsequent three-year rolling claims period can help management set realistic goals for new or existing safety programs.

To gain a general idea of whether an experience modifier will be higher or lower it is necessary to analyze the oldest or first year on the current record and compare that year to the lag year. If the year dropping off the record had more claims and losses than the lag year, it is likely the experience modifier will decrease. If, however, a better year than the lag year is dropping off the record, the experience modifier is likely to increase.

An excellent estimate of the next experience modifier can be calculated as much as a year in advance. This can be accomplished using three tools: 1) the most recent loss run statements, 2) the current experience modifier worksheet, which is available from the NCCI, and 3) The ABC's of Revised Experience Rating. An insurance agent should be able to obtain all of these. The booklet will explain how to calculate the experience modifier. This will only yield an estimate, but if the loss runs are accurate and all the claims are closed, this estimate should be very close to the next effective modifier. If there are open claims on the loss runs, the estimated experience modifier can be calculated using the insurance carrier's reserves. Since it is unlikely the insurance carrier has underestimated the cost of a claim, calculations based on a reserve will likely yield an estimated modifier higher than the actual modifier.

It is only possible to lower the experience modifier by implementing a successful safety program and reducing claims over a period of at least two years. However, it takes four complete policy years for the experience modifier to truly benefit from reduced claims and better safety. There is little a company can do to have an immediate impact on the experience modifier. Patience and consistently controlling claims through safety and proper claims management will have a positive impact, but it does not happen immediately.

New companies may be confused regarding when their first experience modifier will be assigned. New companies pay their first two policy premiums without the adjustment of the experience modifier. This is the same as having an experience modifier of 1.00 because there is no surcharge for a high claims record and no discount for a low claims record. The first experience modifier will be assigned depending on the size of the first year's policy premium. The following statement is taken directly from an NCCI publication:

"A risk is eligible for intrastate experience rating when the payrolls or other exposures developed in the last year or last two years of the experience period produced a premium of at least $7,000. If more than two years, an average annual premium of at least $3,500 is required."

Index
How are Workers' Compensation Premiums Calculated?
What Determines Manual Rates?
Requesting Safety Assistance