How To Understand Your Workers Compensation
Experience Modification Factor (Mod)

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Discover how to understand your workers compensation experience modification factor. Your experience mod effects how much you pay for your workers comp - the lower your experience mod - the less you pay in premiums.

How To Understand Your Workers Compensation Experience Modification Factor

How To Understand Your Workers Compensation Experience Modification Factor

The loss costs for a classification in a specific state are developed using the accumulated loss statistics for all reporting insurance companies in that state. Those pooled statistics develop an average loss cost that is then multiplied by a specific insurance company's loss cost multiplier to develop that insurance company's rate for that classification.

However, there is no consideration given as to whether the specific risk is below average or above average with that classification.

In order to encourage improved safety records, NCCI developed experience rating. This mandatory rating method encourages active and effective loss control methods by reducing premiums for those employers producing above average experience and raising premiums for those employers producing below average experience. How to understand your workers compensation experience modification factor.

Experience Rate Factors

Experience rate factors are actually credits or debits that reflect the specific risk's loss experience. They are applied to the premium developed by using manual rates. The National Council on Compensation Insurance, Inc. (NCCI) or another rating organization that has jurisdiction calculates these factors. Experience rating is mandatory for all risks that meet certain eligibility requirements. For example, a risk must be in business under the same ownership for at least two years. Minimum premium eligibility thresholds also apply and vary by state.

How to understand your workers compensation experience modification factor. Each risk pays its "fair share" of the average annual rate for the class or classes involved based on its own loss experience. The experience may be better or worse than average and the factor determined and applied reflects it. One of the most important consequences of experience rating is that it encourages the named insured to implement loss control, safety, and hazard reduction initiatives that control or reduce losses.

Experience rating applies to each risk that generates premium above a certain threshold amount for three consecutive years. The rules are very detailed and can be found in the National Council on Compensation Insurance Experience Rating Manual. The experience rating modification factor is available every year after the premium threshold is met and the insurance company accurately reports classifications, payroll, premiums, and loss information.

The anniversary date is the annual date when the experience rating modification factor is applied. It is determined by using a mathematical formula. The formula is applied to the statistics reported for the individual risk. Doing so determines how that risk's experience compares to the actuarially determined expected results for all risks in the same class or classes. If the risk's loss experience is better than the average for the class, the experience rating modification factor is a credit. If it is worse, the factor is a debit. One factor is developed for each risk for each state, regardless of the number of classes involved. The experience rating modification factor applies for one year, based on calculations and adjustments at the annual anniversary rating date.

The experience rating modification factor is applied for the policy period at the policy's inception date, based on at least three years of previous loss experience. It applies for the full annual policy term, based on the anniversary rating date that does not change during that policy period. It applies to the current policy period based on past loss experience. Improvements made in loss control initiatives and reflected in favorable loss experience are not rewarded during the policy period when they actually occur.

The Experience Rating Formula

The experience rating formula is standard for every eligible risk that qualifies. It consists of two fixed elements or factors.

Credibility: Larger risks have greater exposures, higher payrolls, and higher premiums. These factors make the loss experience of that risk more statistically credible for the formula's purposes than a smaller risk in the same class. In order for the formula to apply equally to all risks, a credibility factor is developed and applied that makes the loss experience of smaller risks more valid and statistically accurate.

Frequency Versus Severity: Loss frequency has a greater impact on overall loss exposure than loss severity. Because of this distinction, losses are divided into two separate parts. One is known as the primary amount. This represents the first $15,000 of each loss. The other is the excess amount. It represents the excess amount of loss over $15,000.

The primary amount has a higher degree of credibility than the excess amount. For this reason, the formula gives more weight to loss frequency than severity. How to understand your workers compensation experience modification factor. However, severity is still considered in its relative proportion to all losses.

Expected Losses

Referring back to "average losses for the class," every risk eligible for experience rating includes a calculation for expected losses. This is based on the losses normally expected for each $100 of payroll for that class and is known as the Expected Loss Rate (ELR). The ELR uses the risk's actual payroll to determine an expected loss amount. The ELR amount is compared to the risk's actual loss experience after it is divided into primary and excess amounts and weighted according to the formula.

Modification Factor

Once the actual weighted primary and excess losses are calculated and compared to the expected losses, the individual risk modification factor is calculated. The actual losses for a specific risk are divided by the expected losses. If the actual losses are lower than the expected experience, it is a credit modification factor (lower than 1.00). If they are higher, it is a debit modification factor (higher than 1.00).

Individual risk rate modification factors are good for one year and usually apply on the risk's normal anniversary rating date. This is the date when the workers compensation insurance coverage was first purchased. The rate modification factor is calculated and re-figured annually to add updated loss experience and to apply it for the next policy term.

The modification factor applies to the insured business and to each business or entity under the named insured's common ownership.

Anniversary Rating Date

The anniversary rating date is an important element in applying the experience rating modification factor and other statistics for a risk's workers compensation insurance. It is established based on the effective date of the first policy issued. It includes both the month and the day of the month. It does not change from one year to another, even if the policy is written for a short-term, is cancelled and rewritten, or is modified in some other way to change the policy dates.

In other words, a simple rewrite of a policy or issuing a short-term policy does not change the anniversary rating date. In order for it to change, the risk must file a change request on the appropriate form with either NCCI or the rating organization that has jurisdiction.

The anniversary rating date is the date used to compile individual risk statistics and to calculate the experience rating modification factor. As stated in the experience rating section, it is valid for a one-year period and is based on the anniversary rating date.

When a policy anniversary date changes due to a cancellation and rewrite in order to have a common expiration date with other policies, one factor applies for one part of the policy term and a different one for the other if the anniversary rating date is not changed. This complicates the rating factor calculation as well as the audit process.

Changes In Ownership

An important factor that affects the experience rating modification is a change in either the insured's name or a material change in ownership that exceeds 50%. When one of these changes occurs, the insurance company, the state, and the rating organization that has jurisdiction must be notified and the change filed using the appropriate forms and procedures. Some changes in ownership result in changes to the experience rating modification factor as well as to the anniversary rating date.

Practical Application Of The Experience Rating Modification Factor

When the experience rating modification factor from the workers compensation rating formula modifies the manual class rate, the premium charged is far more credible and more accurately reflects the risk's actual exposures and losses. It gives the risk an incentive to reduce losses and implement safety procedures. Even though it is based on previous experience and applies "after the fact," it is the fairest way for a risk to pay an equitable premium relative to its exposures and loss experience, except for retrospective rating plans.

Experience Rating vs Retrospective Rating

Retrospective rating differs from experience rating in the following ways:

  1. Experience rating is a mandatory part of the workers compensation program and must be applied to all businesses that meet the premium eligibility threshold criteria. Retrospective is voluntary.
  2. Experience rating is backward looking and may not provide credit for a company making significant changes in loss control until three years after the fact. Retrospective provides adjusts premium based on the losses that occur in the current year, subject to parameters established, so that the named insured can more quickly be rewarded for positive impacts.

Each insurance company develops and implements retrospective rating plans and the named insured participates voluntarily. The plans explain how premium credits and debits are developed and applied. Retrospective rating plans are attractive because they can reward the employer with return premium if the named insured initiates an active loss control program that controls and reduces losses and that program actually reduces the losses. However, there is a risk because an additional premium is charged if the loss experience actually deteriorates. Most plans establish maximum and minimum premium criteria so that both parties know their potential obligations.

How To Understand Your Workers Compensation Experience Modification Factor - The Bottom Line

We hope this article on how to understand your workers compensation experience modification factor has been informative. Be aware that your experience mod directly effects the cost of your workers comp policy.

Further Reading On Worker's Comp Insurance

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