This is Part 3 in 5 part series on Experience Rating changes. See Part 1: The Experience Rating Process: Significant Changes Are Imminent and Part 2 A Basic Review of Claim Losses, the Building Blocks of Experience Rating
Parts 4 and 5 will be posted next week.
Previously, we offered a basic review of workers comp claim losses, the building blocks of experience rating. Now it's time to go deeper.
As we've seen, workers comp claims are made up of what has been paid and what has been "reserved" for future payments throughout the life of the claim. The "total incurred amount" projects total indemnity payments (lost wages), medical bills and expenses estimated to be paid for any given claim. From 1990 through 2012, the first $5,000 (called the "split point") of the "total incurred" amount of each claim is considered "primary," and all of it counts in the experience rating calculation. Any amount above $5,000 is considered "excess" loss, and is discounted in the experience rating calculation by at least 70%. Moreover, any amount above a state-specific rating point (ranging from about $125,000 to as high as $250,000) is excluded from the calculation; it does not count at all in the calculation of your experience rating.
Primary losses going up!
For the first time in 20 years, the Primary Loss split point is about to change. Beginning in Policy Year 2013 (PY 2013), primary losses will increase from the first $5,000 of each claim to the first $10,000. In subsequent years, primary losses will continue to rise, reaching $15,000 by PY 15.
So what does this mean? Experience rating places more emphasis on the frequency of injuries than on the severity. Given the increasing severity of claims over the past decade, NCCI has decided to make experience rating more sensitive to severity.
Under the current rating system, only the first $5,000 of each claim is primary; this means that one big claim will have a limited impact on the experience mod: the first $5,000 enters the calculation dollar for dollar, but all the losses above $5,000 will be sharply discounted.
The new rating system has been adopted by all NCCI states for 2013, and it will become effective concurrently with each state's approved rate/loss cost filing on or after 1 January 2013. NCCI has published a chart detailing the split point changes effective dates for each state (PDF).
Under the new system, the first $10,000 of each claim will be primary and, as in the current (and soon to be old) system, all primary losses will enter the experience rating calculation dollar for dollar. For employers with individual losses above $5,000, the experience mod is likely to run higher than under the current rating system. (And keep in mind that the primary loss split point will continue to rise to the level of $15,000 by 2015.)
Here is a simple comparison of the current and pending rating systems in action:
1 claim at $20,000 / Current Primary = $5,000 / Pending Primary = $10,000
2 claims at $5,000 / Current Primary = $10,000 / Pending Primary = $10,000
Under the current system, all other things being equal, Employer 1 would have a lower experience mod than Employer 2 for two reasons, even though total losses are $10,000 greater than Employer 2's total losses. First, Employer 1 has $5,000 less in primary losses. Second, Employer 1's excess loss of $15,000 would be discounted by 70% to $4,500 in the calculation making total calculable losses of $9,500, compared to Employer 2's total calculable losses of $10,000.
Under the new rating system, Employer 1 would be the one with the higher mod, because its primary losses would be equal to Employer 1's, but Employer 1 would also have $3,000 of excess losses included in the calculation (10,000 - [10,000 x 70%]).
The split point change will lead to some interesting, as yet unaddressed, developments. For example, consider a loss that happened in PY 2010 to a driver for ABC Limo. The loss would first appear in ABC Limo's Mod calculation for 2012. Let's say its total incurred value at that time was $15,000. In 2012, before the split point changes, $5,000 would be primary and $10,000 excess. Fast forward to the Mod calculation for 2013, and let's suppose that the claim was closed during 2012 for a total of $10,000. The 2013 Mod calculation, with the split point having been changed, effective January, 2013, will show $10,000 primary and $0.0 excess. Consequently, the closed claim of $10,000 will affect ABC Limo's mod more adversely in 2013 than the open claim of $15,000 did in 2012. This will happen to many employers, and their advisors would be well-advised to advise them beforehand.
Medium-sized Employer, Big-sized Trouble
Here's the worst-case scenario for a lot of medium-sized employers (premium in the $20-$100,000 range): if they have a frequency problem (a lot of relatively small injuries) and a severity problem (a few relatively big losses), the new split point for primary losses will more than likely increase their experience mod, perhaps substantially.
If you find yourself in this position, with an experience modification well above 1.0, you need to learn more about the intricacies of the rating process itself. There are opportunities for minimizing the impact of your losses. All of which are the subject of our next Experience Rating post.