By Brent Kelly
If you have been in business a long time with multiple employees, chances are you are aware of the experience modification rating factor. However, if you are new in business or just starting to add employees, you may be thinking, “What in the world is this guy talking about?”
The experience modification is simply a factor that insurance companies use to adjust workers compensation premiums based on your loss experience. There is a very complex formula to determine this factor, but I simply want to explain how it can affect your business. I have met with many business owners who really do not understand the experience modification rate and how it affects their business and more importantly their profits.
The basis of the experience modification concept is to determine if your workers compensation loss history is above or below average. If your business has had less claims than other related business, you will receive a credit. If you have had more claims than related businesses you will have a debit. The baseline for an experience modification factor is 1.0, but it can range well below or above 1.0. Let me provide an example.
Let’s say you run a contracting business. You have been in business for five years and your current experience modification rating is 0.90. Your manual premium (premium calculated before experience modification) is $10,000. After applying the 0.90 modification, your premium will be adjusted with a 10% credit or multiplied by 0.90 to give you a premium of $9,000.
The governing body for the experience modification rate is the National Council on Compensation Insurance (NCCI). As I mentioned earlier, the actual calculations for the experience modification rate are confusing so let me try and simplify. The rate itself is based upon your most recent three years of claims history excluding the year that just ended.
If your workers compensation insurance renewed on January 1st, 2012, your experience modification rate would be based on the three years of work comp claim experience from January 1st, 2008-January 1st, 2011. So ultimately, your last four years of workers compensation claims affect your current workers compensation rate either negatively or positively.
Without getting into formulas etc., the two major components that are used to determine your final experience modification rate are severity and frequency. Severity measures the total amount of a work comp claim and frequency measures how often claims take place. Again, these are measured against other businesses with similar classifications and job duties.
In a word, Money. I have seen experience modification factors range up to 1.70 on a large business. This means they are receiving a 70% debit! It is hard enough to compete in the business world, but trying to compete with a large debit on your workers compensation insurance is like trying to run a race with a 100 pound back-back. It puts the business owner at huge disadvantage.
Let’s say you are a business with a 1.50 experience modification factor and you are competing against a company with a 0.90 modification factor. You are 60% behind your competitor before you even start. If both companies manual premiums are $100,000 year; one company is paying $150,000 while the other company is paying $90,000. What can you do for $60,000?
Quite simply, have fewer and less expensive claims. That being said, sometimes bad things happen that are no ones fault and are very difficult to prevent. I understand freak accidents do happen, but often see very preventable accidents get reported. Every claim that is turned in will affect your experience modification. In no way I am telling a business not to turn in a legitimate claim, but I do want business owners to be aware of how claims affect their bottom line.
There are a number of really good loss control programs available that help business owners with safety training. I am not here to endorse one specific company, but your agent can usually help guide you in the right direction. Most of the insurance companies I work with have very good loss prevention materials available for your use depending on your specific level of need.
The other item I see that affects experience modification rates is open claims. Open claims are claims that have occurred, but have not been finalized. For example, an employee might have suffered a back injury at work. The insurance company may put an open reserve (cap on what the insurance company may pay) of $100,000, but the final settlement is only $50,000. Until that claim is settled for $50,000, a $100,000 claim will be reported to NCCI for the experience modification rate.
What’s the Bottom Line Regarding the Experience Modification Rate?
What this means is the business owners need to be informed and educated on how workers compensation claims and their experience modification affect their business. The experience modification rate is not just some arbitrary number that magically appears. It is a specific formula and business owners must be very aware of its consequences.
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