Control Costs by Understanding Experience Rating. Prepared by: Specific Software Solutions

Transcription

1 Control Costs by Understanding Experience Rating Prepared by: Specific Software Solutions

2

3 Copyright 2003 by Timothy L. Coomer All rights reserved. This book, or parts thereof, may not be reproduced in any form without permission.

4 Table of Contents Preface...iii 1. Introduction to Experience Rating The Experience Rating Process and Formula Analyzing Your Mod Controlling Your Mod Using QuickMod.com to Perform a Mod Analysis...26 Appendices...35 Glossary of Terms...35 States Using NCCI or Similar Methodology...37 States That Have Approved ERA...38 About the Author...39 i

5 Figures 1.1 The experience modification formula The experience modification worksheet Experience included for the mod computed for policy year 1/1/ Computation of expected losses for several payroll class codes. Example computation shown for code 6003 Pile Driving Computation of expected primary losses and expected excess losses for several payroll class codes. Example computation continued for code 6003 Pile Driving Simplified mod formula Impact of ballast value on mod Primary vs. excess losses Sample weighting values Example of ERA Sample Worksheet IJ Codes QuickMod.com home page QuickMod.com input screen with values entered from sample worksheet shown in Figure Display of mod formula with sample values Your minimum mod & controllable mod Analysis of your primary and excess losses Your specific loss sensitivity Your aggregate loss sensitivity...34 ii

6 Preface Master Your Workers Comp Modifier Welcome! As a business owner or financial manager, it is important to identify and understand every cost associated with doing business. The workers compensation modification factor for your business has a significant impact on the cost of workers compensation insurance. This alone is reason enough to better understand the underlying theory, formula, and data that determines your company s modification factor. However, the experience rating worksheet, which is used to communicate the modification factor, can also provide valuable insight into your company s operation. This book explains, with minimal industry jargon, the experience rating formula and the computation of the modification factor. For convenience, the workers compensation modification factor will be referred to as the mod throughout this publication. After a thorough discussion of the experience rating process and formula, a mod analysis will be demonstrated using a case study. As part of the benefit of purchasing this book, you also have access to QuickMod.com, the only online mod analysis tool. By simply logging onto QuickMod.com and entering a few summary values from your company s experience rating worksheet, you will be able to generate a valuable mod analysis. iii

7 Chapter 1 Introduction to Experience Rating The Purpose and Theory of Experience Rating Introduction to Experience Rating The experience rating process is complex, but the underlying theory and purpose of experience rating is simple. Most states utilize an organization called the National Council on Compensation Insurance, referred to as NCCI ( to gather the data necessary to manage the experience rating system and publish the mods. This book addresses those states using the NCCI formula or similar formulas. For a complete list of states utilizing this type of methodology see the Appendix. Experience rating is designed to measure whether your company s workers compensation losses (also known as experience ) are better or worse than expected. If the experience is worse than expected, you are punished with a high mod (greater than 1.0, also known as a debit mod) and you pay more for your workers compensation insurance. If the experience is better than expected, you are rewarded with a low mod (less than 1.0, also known as a credit mod) and you pay less for your workers compensation insurance. Many companies have the misunderstanding that a mod of 1.0 is good. This is like saying a C on your grade school report card is good. A mod of 1.0 is average and a company should strive to decrease their losses in order to beat the average and lower their workers compensation insurance costs. An understanding of the mod formula provides you with the information necessary to determine how to best lower your mod. Whether your mod is driven by loss frequency, severity, or misallocation of payroll, this book along with QuickMod.com, will show you how to identify the problem. The workers compensation insurance rates that are published in your state represent the average company. If the cost of everyone s workers compensation insurance were simply based on average rates, there would be no incentive for individual employers to lower their workers compensation losses and thus improve the safety of their work environment. On the other hand, making every company bear the full burden of their workers compensation claims could potentially be very damaging to some organizations. The experience rating process does an excellent job of balancing fairness vs. responsibility. This is accomplished through a complex formula that takes into consideration the size of the company, the possibility of unexpected accidents, and the differences between loss frequency and loss severity. 1

8 Chapter 1 Introduction to Experience Rating The formula used to compute your mod is shown in Figure 1.1. A detailed explanation of the components of this formula is provided in the next chapter. Figure 1.1: The experience modification formula Actual Ballast Weighting Value (1 - Weighting Value) Primary + + x + x Losses Value Actual Excess Losses Expected Excess Losses Expected Ballast Weighting Value (1 - Weighting Value) Primary + + x + x Losses Value Expected Excess Losses Expected Excess Losses The formula shown above results in a number, your company s mod, which is provided to your insurance agent and to you on an experience rating worksheet. This worksheet shows all the numbers used in the calculation and the final mod for your company. A sample worksheet is shown on the following page. The mod determines your final workers compensation cost. The premium you pay will equal the basic premium (or the premium based on the average rates) times your mod. So, if the basic premium for your company was computed to be $10,000 and your company s mod was 1.20, then you would pay a final workers compensation premium of $12,000. 2

9 Chapter 1 Introduction to Experience Rating Figure 1.2: The experience modification worksheet 3

10 Chapter 1 Introduction to Experience Rating Reasons for Understanding Your Mod As you can tell from the previous section, the experience rating system is complex. But, through an understanding of the mod formula and the data that goes into the mod, you can better control your mod, reduce costs, and gain insight into your company s operations. Workers compensation insurance costs can be several hundred dollars per employee. For a company that is able to lower its mod by twenty or thirty points (example: going from a mod of 1.20 to 0.90 would be a thirty point reduction), the cost savings are substantial. The first step to achieving a lower mod is to understand your company s mod, how it is calculated, and what is necessary to lower the mod. In addition to controlling and lowering your mod, it is possible to better understand your company s operations through mod analysis. Changes in loss frequency or severity over time may indicate problems in your operation that have not been identified. Your experience worksheet may be the easiest way to benchmark your company against other companies with similar operations. There are certain numbers on the worksheet that can help you identify if your company is experiencing more workers compensation claims or more severe losses than average. The experience worksheet will actually tell you whether or not you re beating the competition in this important cost area. There are several types of mod analysis. At QuickMod.com you can perform several analyses simply with the data available from your experience worksheet. More advanced analysis can be performed with a mod analysis software package like ModMaster software (visit for more information). The insights that can be gained from a mod analysis are numerous. A full discussion of QuickMod.com and the analysis it performs will be provided in Chapter 3 and Chapter 5. By utilizing QuickMod.com, you can generate all of the analyses shown in less than one minute. 4

11 Chapter 1 Introduction to Experience Rating Insights from a QuickMod.com Analysis A mod analysis performed by QuickMod.com can help you identify: the minimum mod for your company; the contribution of loss frequency (number of accidents) to your mod; the contribution of loss severity (cost of accidents) to your mod; whether your company s loss frequency is better or worse than the competition; whether your company s loss severity is better or worse than the competition; the impact of a specific loss on your mod and how much that loss costs you in terms of increased premium; how your mod would change with aggregate changes in losses. Mod Now that you have an overview of experience rating and an appreciation of the value of understanding your mod, Chapter 2 will explain the experience rating process and formula in detail. 5

12 Chapter 2 The Experience Rating Process and Formula The Experience Rating Process and Formula Basic Concepts Pertaining to Experience Rating Before we begin a simplified explanation of the experience rating formula, it is important to understand some underlying concepts and computations. Experience rating is a process by which a company is compared to other companies. This comparison results in a value that represents whether your company s losses were greater or less than expected. This value is called the workers compensation experience rating modification factor or mod for short. The mod is computed using data for an experience rating period. The experience used in the calculation generally covers three years. The most recently completed year is excluded. For example, the mod for 1/1/2001 would contain experience from policies that were effective 1/1/97, 1/1/98, and 1/1/99. This is better demonstrated with the calendars shown below: Figure 2.1: Experience included for the mod computed for policy year 1/1/2001 In the example shown in Figure 2.1, data for 2000 is excluded in the mod calculation for This is because the mod for 2001 is calculated before the end of The three years of data prior to that are readily available (1997, 1998, 1999). Three years are used, rather than one, to provide for a more accurate estimate. By utilizing three years in the calculation, the effect of any one bad year is dissipated. Obviously, this works the other way, too. A really good year does not have the same impact when analyzed along with years where losses were higher. 6

13 Chapter 2 The Experience Rating Process and Formula The experience rating process compares your company s actual losses to what would be expected for a company with similar operations. This comparison is achieved by using the job classification system for the states in which your company operates. For a given payroll classification code (class code), the rating bureau for your state publishes what is called an expected loss rate (ELR) and discount-ratio (D-ratio). These values are based on data that is reported by insurance companies to the rating bureau. The ELR is the expected losses per $100 of payroll. If you know the payroll for a given class code, then you can compute the expected losses for that class code. Let s look at an example. Figure 2.2: Computation of expected losses for several payroll class codes. Example computation shown for code 6003 Pile Driving Code Job Description Payroll ELR * Expected Losses 8810 Clerical $100, $ Salespersons $100, $ Contractor- $100, $1,470 Superintendent 6003 Pile Driving $100, $10,730 *All rates are for ILeffective 1/1/2000 Expected losses = (ELR 100) x Payroll Expected losses = *($100, ) = $10,730 After the expected losses are computed, a second computation occurs to split the losses into primary and excess losses. This is called split rating. The importance of split rating and the difference between primary and excess losses are discussed later in this chapter. A simple explanation is that primary losses measure frequency and are the first $5,000 of each loss, while excess losses measure severity and are those loss amounts in excess of $5,000. As mentioned previously, an ELR and D-ratio are published for each payroll classification code in each state. The D-ratio determines the percentage of the expected losses that will be classified as primary in the calculation. The table shown in Figure 2.2 is revised to show the D-ratios and the primary and excess loss computations. This revised table is shown in Figure

14 Chapter 2 The Experience Rating Process and Formula Figure 2.3: Computation of expected primary losses and expected excess losses for several payroll class codes. Example computation continued for code 6003 Pile Driving. Code Job Payroll ELR * D-Ratio Expected Expected Expected Description Losses Primary Excess 8810 Clerical $100, $140 $35.00 $ Salespersons $100, $220 $52.80 $ Contractor- $100, $1,470 $ $ Superintendent 6003 Pile Driving $100, $10,730 $ $ *All rates are for ILeffective 1/1/2000 Expected primary losses = Expected losses x D-ratio Expected excess losses = Expected losses - expected primary losses Expected primary losses = $10,730 x 0.17 = $1, Detailed Explanation of the Experience Rating Formula Expected excess losses = $10,730 - $1, = $8, In a simplified form, experience rating would be the ratio of your company s losses to the average company with similar operations: Fig. 2.4: Simplified mod formula Mod= (Yourcompany slosses) (Averagecompany s losses) However, as you can see, this type of simplified comparison between your company and the average company could result in a wide range of mods. If you were fortunate enough to enjoy no losses for a period of time, your mod would equal zero. As a result, you would pay nothing for workers compensation insurance. But obviously, if you are operating a business, there is some possibility of incurring a workers compensation loss. Therefore, it is reasonable that you should pay for workers compensation insurance even if you have not incurred any losses during the past several years. At the other extreme, if you were unfortunate and incurred a severe loss, which made your company s losses many times more than the average company, your mod could be extremely 8

15 Chapter 2 The Experience Rating Process and Formula high. For example, if you were using this theoretical formula, a mod equal to 20.0 could result from an unfortunate large loss. Without any limitation on this type of loss, a company could be forced out of business due to excessive workers compensation insurance costs. Actuaries, who analyze loss data and establish experience rating formulas and rules, have invented some creative ways to modify the simple mod formula shown in Figure 2.4 to make it more fair. This is accomplished through six specific modifications that are discussed below. Individual loss limits Each state sets a single loss limit. For example, in Florida for the year 2000, the single loss limit is $124,500. This means that any loss greater than $124,500 would be limited (reduced) to $124,500 before computing the mod. This prevents a huge loss from having a dramatic impact on the mod. For example, if your company incurred an $800,000 workers compensation loss, the loss amount would be reduced to $124,500 for purposes of computing your company s mod. Mod limits Each state also has a limit on how high the mod can be for a specific-sized company. As the size of the company increases, the limit increases. This protects all size businesses from having a mod that is unreasonably high, but provides the most significant protection to smaller companies. In the state of Illinois, for mods with an effective date in the year 2000, the maximum mod ranges from 1.14 for a small company (expected losses equal to $5,000), to 1.71 for a medium-sized company (expected losses equal to $25,000), and 3.83 for a large company (expected losses equal to $100,000). Ballast value The dictionary defines ballast as material carried in a vessel to provide stability. That same principle applies to the ballast value used in the experience rating formula. The ballast value is placed in the top and bottom part of the formula to move all mods closer to 1.0. In other words, it stabilizes the values. As a result, if you have a low mod, the ballast takes away some of that good news by moving the mod higher and closer to 1.0. However, if your have a high mod, the ballast will move your mod lower and closer to 1.0. The ballast value increases as the size of the company (as measured by expected losses) increases. However, the impact of the ballast is still greatest for small companies. A table is shown (figure 2.5) which demonstrates the mod for several scenarios with and without the ballast value in the formula. 9

16 Chapter 2 The Experience Rating Process and Formula Figure 2.5: Impact of ballast value on mod Expected Losses Actual Losses Mod Impact Ballast Mod w/o of ballast ballast $ 208,378 $ 183, $ 208,378 $ 460, $ 14,540 $ 3, $ 14,540 $ 26, As is evident from the table shown above, for a large company, the ballast moves the mod a couple of points closer to 1.0. However, for a smaller company, the ballast has a more dramatic impact. The mod for our example small company was lowered twenty-five points by including the ballast value in the calculation. Also, the low mod for the small company was raised by ten points by including the ballast value. One area where the ballast value can have a surprise impact is in mergers and acquisitions. Since the ballast value changes with the size of the company, the merger of two companies may result in an unexpected change in the mod due to the change in the ballast value. Primary vs. excess losses If you were an insurance underwriter analyzing a company that had $100,000 in workers compensation losses, which scenario would cause you more concern? Company A has twenty $5,000 losses and Company B has two $50,000 losses. The underwriters and the actuaries are more worried about loss frequency. Each time a loss occurs it is like rolling the dice the severity of the loss could be significant. The company with the twenty losses is considered more risky than the company with only two losses. Theoretically, loss severity is more difficult to control than loss frequency. But, if you can reduce the frequency of losses, then you reduce the possibility of having a severe loss. An organization with numerous losses (loss frequency) increases its chance of incurring severe losses. The manner in which this is measured in the experience rating formula is fairly ingenious. The losses for a company are divided into two categories: primary losses and excess losses. For most states, the first $5,000 of each loss is called primary. If a loss is greater than $5,000, then the first $5,000 is primary and the balance is excess (example: a $7,500 loss would be divided into $5,000 primary and $2,500 excess). In the state of California, the primary portion of a loss is determined by a formula (primary loss = (loss amount x 9,000) (loss amount + 7,000)). Primary losses are a measure of loss frequency because some portion (the first $5,000) of each loss is allocated to primary losses. Excess losses are a measure of loss severity since only those loss dollars over $5,000 are allocated to excess losses. To demonstrate the effectiveness of this method, let s look at our simple case for Company A vs. Company B. 10

17 Chapter 2 The Experience Rating Process and Formula Figure 2.6: Primary vs. excess losses Company Total Total * Total ** Losses Primary Excess Losses Losses Company A $ 100,000 $ 100,000 $ Company B $ 100,000 $ 10,000 $ 90,000 *Primary losses are the first $5,000 of each loss. **Excess losses are the loss dollars over $5,000. All of Company A s losses are primary, which leads the underwriter to conclude that Company A had many small losses ($5,000 or less). Company B s losses are mostly excess. This leads the underwriter to conclude that Company B had only a few large losses (>$5,000) and less loss frequency than Company A. The underwriter may want an explanation for the severity of the losses incurred by Company B, but would probably view the high level of loss frequency at Company A as the greater of the two risks. If you were to only look at total losses, it would not be as informative as an analysis of primary and excess losses. By splitting the losses into primary and excess, and then placing more emphasis on primary losses, the experience rating formula successfully discriminates against loss frequency. The experience rating formula uses all of the actual primary losses in the calculation of the mod. However, only a certain percentage of the actual excess losses is utilized. The percentage of excess losses utilized in the calculation is determined by the weighting value. Weighting value The weighting value is utilized in the experience rating formula to determine the percent of the actual excess losses to use in the calculation. This recognizes that excess losses, especially for smaller companies, are less credible (meaning directly related to the operations of the business and not just a random occurrence). Therefore, the weighting value is small for small companies and increases for larger companies. The weighting value is obtained form a table that is published for each state. Figure 2.7 provides an abbreviated sample weighting table. 11

18 Chapter 2 The Experience Rating Process and Formula Figure 2.7: Sample weighting values Sample State Effective January 1, 2000 Table of Weighting Value Expected LossesWeighting from to Values $ $ $ 878 $ 3, $ 3,551 $ 6, $ 6,220 $ 9, $ 9,080 $ 11, $ 4,248,928 $ 4,975, $ 4,975,569 $ 5,966, $ 5,966,444 $ 7,397, $ 7,397,701 $ 9,646, $ 9,646,821 $ 13,695, $ 13,695,232 $ 23,141, $ 23,141,520 $ 70,372, $ 70,372,943 $ Over 0.80 The lookup value for the weighting table is expected losses. Expected losses can be thought of as a measure of the size of the organization. As you can see, the weighting values cover a broad range from 0.04 to In the numerator (the numerator is the top part of the ratio) of the experience rating formula, there are two terms that involve the weighting value. The first term is the weight times the actual excess losses (w X actual excess losses). The next term is the complement to the weighting value (1 - w) times the expected excess losses ((1- w) X expected excess losses). As a result, the total excess losses used in the numerator are a combined number representing a percentage of what actually happened and a percentage of what was expected. If your company is small, the weighting value will be very small and your company s mod will be computed with a number very close to the expected excess losses. Conversely, if your company is large, your weighting value will be large and the mod will be computed with a number very close to the actual excess losses. The weighting value is based on the theory that as a company increases in size, its loss experience, specifically loss severity, becomes more statistically valid. 12

19 Chapter 2 The Experience Rating Process and Formula Experience Rating Adjustment (ERA) The most recent change in the experience rating formula came in 1998 with the introduction of the experience rating adjustment (ERA). ERA included three changes to the formula. These changes are listed and explained below: Change in the primary/excess split point: Presently, losses are split into excess losses at $5,000 as we discussed earlier. Under ERA, this split point may change in the future. As of publication of this book, no state has changed the split point to a value other than $5,000 (excluding California, which uses a formula to split losses). Change in the weighting value table: The table of weighting values, previous to ERA, had a maximum value of Under ERA, these values now have a maximum value of This increases the emphasis on the actual excess loss experience of larger companies. Reduction in medical-only claim amounts: Medical-only claims, injury code 6 claims, are reduced by 70% in states where ERA is approved. This is the most significant change. Historically, some companies would not report small medical-only claims in an attempt to keep their mod low. This practice, while legal in many states, concerned many of the insurance companies and actuaries. By not reporting these claims, the database of loss experience was not complete and could lead to poor statistical analysis. In an attempt to discourage the practice of not reporting these claims, ERA reduces the claim by 70% before it is utilized in the experience rating process. Also, the expected loss rate and discount ratio used to compute expected losses and expected primary losses, have also been changed to reflect the fact that medical-only claims will be reduced by 70%. Therefore, the incentive to not report medical-only claims has been eliminated in states where ERA is approved. Figure 2.8 Example of ERA Medical-Only Claim of $8,000 Before ERA After ERA Primary Loss = $5,000 Primary Loss = $1,500 (30% x $5,000) Excess Loss = $3,000 Excess Loss = $900 (30% x $3,000) Dissecting a Workers Compensation Experience Rating Worksheet There are perhaps few things pertaining to your workers compensation insurance that can be as confusing as your workers compensation experience rating worksheet (referred to as the worksheet ). However, with the understanding of the principles, the next step is an explanation of every aspect of the worksheet. The actual values from the sample worksheet shown in Figure 2.9 are referenced in the definitions. 13

20 Chapter 2 The Experience Rating Process and Formula Worksheet header items First, there are a few header items on each worksheet. These are explained below. The appropriate example from the worksheet enclosed in your kit is provided in parentheses. Name of Risk: (XYZ Company) This is the name of the company for which the mod is calculated. Risk Ident. No.: (123456) This is the identification number NCCI or other rating bureaus have assigned to your company. State: (Oklahoma): If your company operates in only one state, the state will be displayed. If your company operates in multiple states, the word Interstate will be displayed. Effective Date: (7/1/2000): This states the date on which the mod becomes effective. This date is also used to determine which tables of rating values are the appropriate ones to utilize (most rates change on an annual basis). Worksheet column items Next, look at each column found on an experience rating worksheet. Refer to the sample worksheet, shown in Figure 2.9, for example data for each column. Note that data is grouped by state and policy year. The state name is written across the columns along with the policy period and policy number. Column 1 Class Code: This column lists the payroll classification codes for each state utilized in the calculation. As discussed earlier, all jobs in a given state are categorized into more than 600 class codes. This allows for data, by class code, to be analyzed and for the computation of statistics by class code. Column 2 ELR (Expected Loss Ratio): The ELR for the given class code is displayed. The ELR is the expected amount of losses per $100 of payroll. Column 3 D-Ratio (Discount-Ratio): The D-ratio for the given class code is displayed. The D-ratio is the percent of expected losses that are classified as expected primary losses. Column 4 Audited Payroll: The amount of payroll for the given class code, state, and policy period is shown in this column. Column 5 Expected Losses: The expected losses are computed and displayed in this column. Expected losses are computed as follows: Expected Losses = (Payroll 100) x ELR 14

21 Chapter 2 The Experience Rating Process and Formula Figure 2.9: Sample worksheet WORKERS COMPENSATION EXPERIENCE RATING NAME OF RISK XYZ COMPANY RISK IDENT. NO: EFFECTIVE DATE 7/1/2000 STA OK CLASS ELR D - AUDITED EXPECTED EXP PRIM CLAIM O ACT INC ACT PRIM CODE RATIO PAYROLL LOSSES LOSSES DATA IJ F LOSSES LOSSES (2)X(4)/100 (3)X(5) POLICY PERIOD: 7/1/1996 TO 7/1/1997 POLICY NO. 7,960 5, ,000 5,687 1,251 SMALL LOSS(ES) ,000 6,237 1,310 SMALL LOSS(ES) 6 * ,250 1, ,566 5, , ,589 5,000 POLICY-TOTALS 411,750 13,675 2,899 29,565 15,450 POLICY PERIOD: 7/1/1997 TO 7/1/1998 POLICY NO ,000 5,946 1,308 SMALL LOSS(ES) ,000 7,123 1,496 SMALL LOSS(ES) 6 * ,500 1, ,450 5, , ,655 5,000 POLICY-TOTALS 456,000 14,998 3,176 19,342 11,237 POLICY PERIOD: 7/1/1998 TO 7/1/1999 TE POLICY NO ,000 6,463 1,422 SMALL LOSS(ES) ,000 6,738 1,415 SMALL LOSS(ES) 6 * 1,350 1, ,000 1, ,663 5, , ,180 5,000 POLICY-TOTALS 462,000 15,188 3,221 14,719 11,876 A B C D E F G H I (D)-(E) (H)-(I) "W" EXPECTED TOTAL TOTAL ACTUAL "B" TOTAL TOTAL VALUE EXCESS EXPECTED EXP. PRIM EXCESS VALUE ACTUAL ACT. PRIM ,565 43,861 9,296 25,063 18,150 62,035 36, AR AP 1.36 Experience Modification PRIMARY STABILIZING RATABLE ADJUSTED Calculation LOSSES VALUE EXCESS TOTALS (I) (C) x (1-W) + (G) (A) x (F) 15 ACTUAL 36,972 48,913 2,757 88,642 EXP. MOD. (E) (C) x (1-W) + (G) (A) x (C) (J) / (K) EXPECTED 9,296 48,913 3,802 62, *RATING REFLECTS A DECREASE OF 70% MEDICAL ONLY PRIMARY AND EXCESS LOSS DOLLARS WHERE ERA IS APPLIED, REFLECTED ONLY IN TOTALS (F), (H) & (I). 15

22 Chapter 2 The Experience Rating Process and Formula Column 6 Expected Primary Losses: The expected primary losses are computed and displayed in this column. Expected primary losses are computed as follows: Expected Losses x D - ratio = Expected Primary Losses. Using the first line of example worksheet, the calculation is as follows: 5,687 x.22 = 1,251 Column 7 Claim Data: This column shows the claim number. The claim number is a number or series of numbers and letters that your insurance carrier has assigned to the claim. This claim number will assist you in identifying the claim if additional data or research is required into the cause or loss reserve for the claim. Column 8 IJ Code and O/F Indicator: This column indicates two key values. The IJ Code is the injury code. A list of IJ Codes is shown below: Figure 2.10: IJ codes IJ Code IJ Code 1 IJ Code 2 IJ Code 5 IJ Code 6 IJ Code 7 IJ Code 9 Medical Claim Death Permanent Total Disability Temporary Total or Temporary Partial Disability Medical Only Contract Medical or Hospital Allowance Permanent Partial Disability The important IJ code to note for experience rating purposes is IJ Code 6. This is a medicalonly claim and, as discussed earlier, is reduced by 70% in states where ERA has been approved. The O/F indicator tells you whether a claim is open or is final. An open claim (indicated by an O ) simply means that payments may still be made that are related to this claim. Therefore, the loss amount you see for this claim represents payments made to date plus a loss reserve (an estimate of additional payments that will be made). A final claim (indicated by an F ) indicates that the claim is closed and no more payments will be made that are associated with this claim. Column 9 Actual Incurred Losses: The actual loss amount for the given claim is displayed in this column. As discussed earlier, the amount will be the total paid amount for a final claim. For an open claim, the amount will be the loss reserve plus all payments to date. Column 10 Actual Primary Losses: The actual primary loss amount for the given claim is displayed in this column. The primary loss amount equals the first $5,000 of the claim or, if the claim is less than $5,000, it equals the claim amount. (NOTE: In California, the primary loss amount is computed using a formula. This formula was discussed earlier in this Chapter). 16

23 Chapter 2 The Experience Rating Process and Formula Worksheet summary information Now let s look at the summary information displayed at the end of the experience rating worksheet. These values can be divided into summary values and calculation values. Summary values are totals based on expected and actual loss information. These values are utilized in the final mod calculation. The summary values are the values you will utilize when you access QuickMod.com. Box A - W Value (011): A table of weighting values, keyed on expected losses, is published for each state. For multiple state calculations, the weighting value is looked up for each state based on the total expected losses. Then, a weighted average weighting value is calculated based on the expected losses for each state. Box C - Expected Excess Losses (34,565): This number is obtained by subtracting the Expected Primary Losses (Column E) from the total expected losses (Column D). In our example: 43,861-9,296 = 34,565 Box D - Total Expected (43,861): This number is the sum of the three years of Policy Period Totals from the Expected Losses (Column 5). In our example: 13, , ,188 = 43,861 Box E - Total Expected Primary (9,296): This box is the sum of the three years of Policy Period Totals from the Expected Primary Losses (Column 6). In our example: 2, , ,221 = 9,296 Box F - Actual Excess (25,063): This box displays the actual excess losses. It is the result of subtracting the Total Actual Primary Losses (Column I) from the Total Actual Losses (Column H). In our example: 62,035-36,972 = 25,063 Box G - B Value, Ballast Value (18,150): This box displays the computed ballast value for the company. A table of ballast values, keyed on expected losses, is published for each state. For multiple state calculations, the ballast value is determined for each state based on the total expected losses. Then, a weighted average ballast value is calculated based on the expected losses for each state. Box H - Total Actual (62,035): This box displays total actual losses. It is the result of summing the three years of Policy Period Totals for Actual Incurred Losses (Column 9). In our example: 29, , ,719 = 63,626 The amount shown in this box will reflect the impact of individual loss limits and the experience rating adjustment (reduction of medical-only claims by 70%). The amount, after adjustment for ERA, is 62,

24 Chapter 2 The Experience Rating Process and Formula Box I - Total Actual Primary (36,972): This box displays total actual primary losses. The amount shown in this box will reflect the impact of the experience rating adjustment (reduction of medical-only claims by 70%). The total is taken from the sum of Actual Primary Losses (Column 10) for each of the three years. Using the numbers provided in the worksheet: 15, , ,876 = 38,563 This total does not match the number of 36,972 provided in the box because the ERA reduction is only reflected in the total boxes (F, H, and I). Experience modification calculation section of the worksheet The calculation section of the worksheet actually displays the calculation of the mod and shows how each summary value plugs into the mod formula. This section displays the numerator (the top part of the equation labeled actual ) and the denominator (the bottom part of the equation labeled expected ). Box 11 - Primary Losses: The value in the numerator is total actual primary losses (Box I) and the value in the denominator is total expected primary losses (Box E). Box 12 - The Stabilizing Value: This value is the same in the numerator and denominator. It is expected excess losses (Box C) multiplied by (1 - weighting value) plus the ballast value. In our example, this calculation was derived as follows: 34,565 x (1 -.11) + 18,150 = 48,913 Box 13 - Ratable Excess: This value is the weighting value (Box A) times the actual excess losses (Box F) in the numerator. In the denominator, the value is the weighting value (Box A) times expected excess losses (Box C). In our example, this calculation was derived as follows:.11 x 25,063 = 2,757 (numerator).11 x 34,565 = 3,802 (demoninator) Box 14 - Adjusted Totals: This box displays the result of the numerator (Box J: 88,642) and the result of the denominator (Box K: 62,011). It is derived by adding Boxes 11, 12, and 13 for both the actual and the expected losses. In our example, this calculation was derived as follows: 36, , ,757 = 88,642 (numerator) 9, , ,802 = 62,011 (denominator) Box 15 - Experience Mod (1.43): Finally, the mod is shown for the company as the numerator (Box J) divided by the denominator (Box K). In our example: 88,642 62,011 =

25 Chapter 2 The Experience Rating Process and Formula Box 16 - ARAP (1.36): This box would only apply to your company, if you are in an assigned risk program. Sometimes called The Pool, it is a mechanism established by individual states to make sure that employers can obtain workers compensation insurance even if insurance companies are not willing to write such insurance on a voluntary basis, due to high risk or other factors. ARAP is the Assigned Risk Adjustment Program. It is an additional adjustment to the mod, used in some states, that surcharges assigned risk employers with a record of losses greater than expected. Special Rules Master Your Workers Comp Modifier explains the mod formula and the rules that apply to loss limitations and mod limitations. However, there are a limited number of special rules that may effect a mod calculation. Explanation of these rules is outside the scope of this book. If you believe there are special rules or circumstances affecting your mod, please discuss this with your insurance advisor. 19

26 Chapter 3 Analyzing Your Mod Analyzing Your Mod A mod analysis can provide valuable insight into your business operations and workers compensation losses. This chapter will discuss two types of mod analysis: basic and intermediate. Advanced mod analysis requires a software package like ModMaster software (for more information please visit A basic mod analysis can be performed simply with the numbers found on your experience rating worksheet. An intermediate mod analysis can be performed using information from your experience rating worksheet and mathematics. An intermediate mod analysis has been designed for your convenience and is available at Access and usage of this web site will be discussed in Chapter 5. Basic Mod Analysis A basic mod analysis can be performed using the summary values contained on your experience rating worksheet and without any difficult mathematics. In the previous chapter, we defined the columns and summary values found on the worksheet. Here, we will put that knowledge to good use. Below is a list of several specific analyses you can perform quickly and easily. Expected vs. actual First, compare Box D Total Expected with Box H Total Actual. This comparison will quickly tell you if you are experiencing more or less losses than expected. Your goal should be to reduce actual losses in order to be well below expected (or average) losses. Expected losses are based upon actuarial models of how others in your industry are performing; therefore, if your losses are higher than this number, it is an indicator that the competition is outperforming you in this key area of cost reduction and can offer their products or services at more attractive prices or simply increase their own profitability. In our example, Box D is 43,861, while Box H is 62,035, which indicates that the company s actual losses are too high, which resulted in a debit (higher than 1.0) mod. Expected primary vs. actual primary Next, for a more specific loss comparison, compare Box E Total Expected Primary to Box I Total Actual Primary. Remember that primary losses are a measure of loss frequency (number of accidents) and that these losses have the greatest impact on your mod. Actual primary losses greater than expected indicate a loss-frequency problem and should be addressed immediately. Loss frequency can be an indication of more serious problems such as lack of training, poor procedures, or a hazardous work environment. These problems may lead to other business issues such as poor quality, missed production goals, etc. In our example, Box E is 9,296 and Box I is 36,972. Since Box I is almost four times Box E, this company is experiencing too many accidents. 20

27 Chapter 3 Analyzing Your Mod Expected excess vs. actual excess Excess losses are a measure of loss severity. Compare Box C, Expected Excess to Box F, Actual Excess. Actual excess losses greater than expected excess losses indicate that the average claim is larger than expected. Loss severity is more difficult to control than loss occurrence (loss frequency). However, if your severity is greater than expected, you should investigate whether or not your claims are being handled appropriately. Also, you may want to learn more about loss-reduction techniques that could be utilized to decrease the severity of the losses. Your insurance consultant should be able to assist you. Intermediate Mod Analysis With the help of mathematics, several other key observations can be made. It is not necessary to develop a spreadsheet to make all of these calculations, however. All of the analyses in this section are available to you at Chapter 5 explains how to access and use this web site. Chapter 5 also provides an example of each of these calculations using a sample worksheet and QuickMod.com. Determination of the minimum mod The minimum mod is the lowest mod possible for your company. This value can be determined by plugging in zero actual primary and excess losses into the mod formula while maintaining the values for expected losses, ballast, and weighting value. This gives the lowest mod value theoretically achievable by your company. The minimum mod is not the same for all companies. For small companies (as measured by expected losses), the minimum mod can be as high as As the size of the company increases, the minimum mod decreases. For very large companies, the minimum mod can go as low as Knowing your minimum mod is important for large and small companies. A large company with a mod of 0.95 may still be able to achieve significant savings through loss control and loss-prevention activities. The company may perceive the 0.95 mod as good. However, if the minimum mod is 0.50, there is significant room for improvement. For a small company, the minimum mod can be used for setting realistic expectations; for example, a small company that sets a goal of having a 0.80 mod will not be able to achieve it under any circumstance if the minimum mod is Determining the controllable mod The controllable mod is the difference between your current mod and your minimum mod. This is the variable piece of your mod that fluctuates with losses. The controllable mod can be broken into the contribution made by primary losses and by excess losses. This helps you to identify the exact contribution of loss frequency and loss severity to your mod. By estimating your basic premium (the premium prior to application of the mod), you can calculate the cost of primary and excess losses in terms of increased premium. You calculate this by multiplying the premium by the increase in the mod caused by primary or excess losses. This will assist you in determining the potential value of loss prevention, loss control, and safety programs. 21

28 Chapter 3 Analyzing Your Mod Ratio of actual to expected losses By computing a simple ratio of actual to expected losses (both primary and excess), you can measure the degree to which your company s losses differ from the expected loss values. This is a statistic that can be tracked over time to identify trends, improvements, or problems relating to loss experience. Specific loss sensitivity This analysis identifies the specific impact that a single loss has on your mod and on the premium you pay during the three years that the loss is in the calculation. This can be an extremely helpful analysis to quantify the cost vs. benefit of loss-prevention programs you are considering. For example, if your company has had an increase in carpal tunnel syndrome claims and you are trying to justify the purchase of keyboard holders to make workstations ergonomically correct, you can look at how much your mod and therefore your premium increased as a result of these claims. The results can be striking; for example, a single $4,000 claim may increase a small company s premium by $10,000 to $12,000 over a three-year period. Imagine how much more powerful your funding request for safety programs will be if you can back them up with these types of numbers. For instance, you might say to senior management, It will cost us $20,000 to install keyboards at every workstation, but we could have already saved $65,000 if we had made this change four years ago, and our claims are continuing to rise by 15% a year. To perform this calculation, you must subtract the primary and excess (if any) portions of the loss from the totals used in the mod calculation. The resulting mod will be the mod without the loss. The difference between this mod and the actual mod will be the mod impact of the loss. This difference multiplied by the estimated premium yields the cost of the loss in terms of increased premium dollars. Multiplying this value by 3 (the number of years that the loss is in the calculation) will provide an estimate of the ultimate three-year cost of the loss. QuickMod.com does all of this for you! Aggregate loss sensitivity Calculating the sensitivity of the mod to aggregate (total) changes in losses highlights the relationship between losses and your company s mod. The aggregate loss-sensitivity analysis yields a table showing how the mod would vary with increases and decreases in total losses. This analysis is generated by varying both the actual primary and excess losses and then computing the resulting mod. It will help you set a goal for a specific percentage decrease in losses and achieving the corresponding mod. 22

29 Chapter 4 Controlling Your Mod Controlling Your Mod Understanding your mod is only valuable if you use this information to control your mod. Controlling your mod means the ability to lower a high mod or to maintain a current low mod. With the information provided so far, you should have a good understanding of the components that drive a mod. First, let s look at the motivation for lowering your workers compensation mod. Obviously, a low mod helps to lower your workers compensation premium. However, a low level of workers compensation claims has a broader impact on your company. The savings you generate by controlling your mod allow you to invest more in your company s operations than competing firms. By doing so, you can improve efficiencies and quality - or reduce your price or win a bid based on coming in with the lowest number. Also, with lower workers compensation losses come healthy, happy, and more productive employees. This increases productivity and further lowers overall costs. Safety, therefore, can become its own profit center with significant payback. Now, lets focus on a few of the ways you can impact the components that control your mod. Implement a Loss-Control Program A loss-control program can be very effective at decreasing your loss frequency. You may remember from the earlier explanation of the experience rating formula that loss frequency is the main driver of your mod. Investing in a loss-control program may have benefits that far outweigh the cost of the program. A secondary benefit of a loss-control program, in addition to preventing losses, is the reduction in the severity of losses. Loss severity is the second most important driver of your mod. Also, a loss-control expert may be able to identify processes or behaviors exhibited by your employees that create unnecessary risk. This expertise is often available from your insurer at no cost to you. Other loss-prevention programs you can implement: institute a workers safety committee that meets regularly to discuss safety problems. Many states offer workers compensation discounts for companies with active safety committees; provide employee safety training; offer safety bonuses to employees for maintaining an accident-free workplace; communicate your company s commitment to reporting and prosecuting workers compensation fraud and abuse. 23

30 Chapter 4 Verify the Accuracy of the Payroll and Loss Data Controlling Your Mod There are two types of data in your mod calculation: loss data and payroll data. The majority of incorrect mods that are issued are incorrect due to erroneous data. There are several things you can do to ensure accurate data is utilized in your mod calculation. First, actually look at your mod worksheet! Compare the loss and payroll data used in the calculation to another source document. A payroll audit or a third party, such as an accountant or payroll service provider, should be used to verify payroll data. Information on losses should be obtained from your insurance company. Occasionally, a claim that has been settled for less than originally anticipated, may not have been updated to the lower amount on your mod worksheet. Also, if the insurer has received subrogation on a particular claim, the lower net claim cost may not be reflected on your mod worksheet. Subrogation is when the insurer makes a claim against a third party who is liable for a loss that has been paid by the insurer. For example, an injury results from a forklift accident. In investigating the accident, it is discovered that a defect with the forklift actually caused the accident. If the insurer then made a claim against the forklift manufacturer, the amount paid to the insurer should be deducted from the employer s loss record when calculating the mod. Take a few moments to ask your insurance advisor questions concerning the losses used in the calculation. Verify that he or she has given thought or investigation to the accuracy of the loss data. Do these classifications seem to make sense to you? You are in a position to know, better than your insurance advisor or insurer, what your employees are doing and whether or not the classification is appropriate. In this case, changing incorrect job classifications may have significant impact on both your mod and your basic workers compensation premium. When judgement is involved in determining the correct payroll classification, a careful analysis should be made of the impact of changes in the codes on the premium and mod. Also, if it is determined that a job has been misclassified, investigate the possibility of having historical mods recalculated to reflect this change. 24