How Your Experience Rating Affects Your Premium

Intro

If you crash your car, you can expect your insurance premiums to rise. If your company deals with a lot of work-related employee injuries, you can also expect worker’s compensation premiums to go up. With any insurance, the number of claims affects a company’s premiums, and that holds true for workers’ compensation coverage. Experience ratings are commonly used by insurance companies to determine whether a client’s losses are average, above average or below average, and premiums are charged accordingly.

What is Experience Rating

Experience rating is the amount of losses a particular company experiences compared to similar businesses. The insurance company can then determine the odds that this particular company will file a claim. The insurance company does this by comparing apples to apples, so to speak, so the comparison is between companies of approximately the same size and engaged in the same type of business. Based on the historical data, a company that produces more workers’ comp claims than its true competitors can expect higher premiums than companies with a low level of workers’ comp claims. In effect, experience ratings serve as an economic incentive for companies to improve conditions for workers and lower injury rates. Experience ratings also tailor the costs of insurance to the individual employer.

Insurance companies could use a manual rating system, in which all similar businesses are lumped together, the estimated losses are compiled and averaged, and the rates are determined by the average. That method, however, is not fair to businesses that make a real effort to keep workers safe. Experience rating examines the differences between companies when its comes to workers’ compensation claims. In experience rating, businesses with a good track record receive a credit, while those with a lesser record receive a debit. The end result is that employers are paying the premiums they deserve to pay, based on their history.

The Experience Modifier

Any company can have an unlucky year in which several workers are injured, and they can also have a terrible accident involving several workers. That’s why the insurance company generally uses three years of losses in order to determine the experience rating for a company. As another year ends, the third year’s losses are dropped and the most recent year’s added. For example, if a workers’ comp policy expired on January 1, 2018, the experience modifier reflects a timeframe from January 1, 2014 to January 1, 2018. Every business’ experience modifier is unique. Whether the state uses its own ratings bureau or the NCCI, each business receives an experience rating worksheet outlining how the modifier was calculated.

Purpose

When companies don’t have good risk management programs in place, workers tend to suffer higher rates of injury. It makes sense for an insurance company to charge higher premiums for riskier clients, but when the insured finds they are paying more in premiums because of their less than stellar internal policies, that’s an incentive to improve worker safety and education and eventually lower it premiums. Experience ratings also provides incentives for injured workers to return to the job as soon as possible. There is another reason experience ratings are important, and this may affect the business’s overall viability. Potential customers may look at a company’s experience rating to see their overall safety record, and companies with high modifiers may not be considered for the job the customer seeks. In fact, a company with a high modifier may lose the ability to bid on government contracts, so far more than the cost of premiums are at stake when it comes to experience ratings.

However, a firm with a big loss involving one employee will not face as severe a penalty as a company with a lot of smaller losses. The insurance company recognizes that the big loss may not have been preventable, but many smaller losses indicate something is not right with the business’ worker safety policies or oversight. If Company A has one loss totaling $100,000, and Company B also has losses totaling $100,000 but these losses involved ten people, the amount is the same but it is plain that Company B will likely incur higher costs in the future. When a business puts an effective safety program in place, or eliminates particular hazards in its workplace, the result should mean fewer, and even no, injuries. If that trend keeps up, the business will have its premiums lowered in time. Even more important, the business should “experience” a reduction in the amount of time lost to worker injuries.

Calculation

Experience modifiers are calculated annually by organizations known as ratings bureaus. Regulations for workers’ comp insurance vary by state, but the majority of states use the National Council of Compensation Insurance (NCCI) as their ratings bureau. Some states have independent ratings bureaus, including California, Delaware, Pennsylvania and Michigan. Other states – among them Indiana, Massachusetts, Minnesota, New York, New Jersey, North Carolina, Ohio and Wisconsin - have their own ratings bureaus, but work with NCCI for employers with operations in several states. While the different ratings bureaus use similar methods for calculation, there are some formula variations. Currently, the NCCI issues experience modifiers for employers who pay more than $10,000 in workers’ comp insurance premiums in one year, or pay more than $5,000 a year in premiums over a three-year period.

Expected losses are calculated by utilizing an employer’s past payroll information. The information from the payrolls is multiplied via Expected Loss Rates. Ratings bureaus calculate Expected Loss Rates determined by prior reported claims and their costs based on their classification.

The modifier classification system is based on the number 1, which means that a company’s loss experience is average for their industry. Those companies which receive the 1 modifier will likely not have the premium changed. When the modifier rises above 1, that indicates that the loss experience is greater than average, and such companies can expect their premiums to rise. A modifier of 1.2 means that premiums will rise 20 percent, a cost that is passed on to customers and makes the business a little less competitive, at least against those with a modifier of 1 or less. A high modifier also indicates a company should conduct a serious review of its workplace safety programs. If a company’s modifier is less than 1, that means its loss history is significantly better than average for their industry, and they may receive a lower premium.

Changes in Ownership

If a business changes ownership, that may affect its experience modifier calculations, according to the NCCI. The ratings bureau may “issue, retract, and/or revise the current modification and up to two preceding modifications due to ownership or combination changes.” Usually, the prior experience of the business is passed on to the new owner, and such changes may cause a difference in the rating’s effective date. The NCCI combines the experience of businesses with more than 50 percent common majority ownership into one experience modification.

Classification System

Prior to a business receiving workers’ comp insurance, it is assigned a classification, or several if various employees perform very different jobs. These classifications reflect the inherent risk of each job, and each classification has a class code consisting of four digits. For example, a retail business that also employs a warehouse crew will receive one classification code for its salespeople and another for the warehouse workers. Since the warehouse workers perform jobs that are more likely to result in injury than the salespeople, the payroll rate on which workers’ comp premiums are based will be separate for these two classifications of employees. The majority of businesses have a governing classification, one single code that best describes their operation.

Eligibility

Only businesses meeting a state’s eligibility requirements are eligible for experience ratings. In most states, eligibility requirements include conducting business for a specified time period, so startups won’t qualify. If an employer doesn’t meet the NCCI minimums - $10,000 in workers’ comp insurance premiums in one year, or $5,000 a year in premiums over a three years – they are ineligible. That does mean that small employers are less likely to meet eligibility standards, but a business that employs only a few people does not accurately measure the predictability of future losses, as may be accomplished with a large employer.