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Managing your risk by Michael Kelly

NCACC Risk Management Director Michael Kelly writes a regular column on risk management for CountyLines. With more than 41 years of risk management/ insurance experience, he holds the CPCU - Chartered Property & Casualty Underwriter, ARM-P - Associate in Risk Management for Public Entities, CRM - Certified Risk Manager, ARe - Associate in Reinsurance and CIC - Certified Insurance Counselor Professional Designations. He can be reached at michael.kelly@ncacc.org or (919) 719-1124.  For archives of this column click here.

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May 29

Changes in calculating N.C. workers compensation experience modifiers

Posted on May 29, 2013 at 10:01 AM by Chris Baucom

There is a change in process that bears some discussion regarding workers compensation experience modifier calculations, which actually was effective April 1 of this year.  Retrospectively, in June 2011, I outlined in this column the basics of how a workers compensation experience modifier is calculated and provided the formula/math behind it.  The article is archived and still readily available on the NCACC website by looking here: http://www.ncacc.org/index.aspx?NID=253.  As such, I will focus only on the changes and suggest a review of that article if necessary, to add clarity.

It is important to note, the National Council on Compensation Insurance (NCCI) experience rating plan has existed pre 1950 and has changed little since its inception.  Although they review it every one to two years, the last time any changes were made in the formula was in 1998.  Their primary goal has always been and continues to be the production of experience modification factors that are truly reflective of a given insurance client’s actual loss experience, contrasted against their expected loss experience as defined in the plan.  
 
Prior to this change, the experience rating plan used what is called a “split point” value of $5,000.  Understanding the concept of the split point is important.  In simple terms, it is the maximum dollar value of any given loss that is labeled “primary loss.” Any loss dollar value over $5,000 is labeled “excess loss.”  Without rehashing the formula in its entirety, suffice to say the experience modifier calculation is designed to apply a greater emphasis (weight) for losses falling in the primary loss total than in the excess total.  

The basic premise as to why the primary losses are more heavily weighted stems from the actuarial based knowledge that an account having a greater frequency of losses (even smaller losses all less than the split point) over time will eventually have a large enough single loss to make their cost of risk be significantly higher.  Further, primary loss totals are an indication of an account’s loss frequency.  A variation of an example I used prior to illustrate this concept was: If "County A" averages 22 workers compensation claims per year for a total loss amount of $250,000, and "County B" averages 56 claims per year for the same total loss amount of $250,000 per year, the "County B" calculation would generate a higher experience modifier and thus they would pay more in premiums each year than “County A.”  In the insurance industry, there are several articulations for this premise, but basically stated it underscores the above, as “Where there is a frequency in loss, a severity in loss will certainly follow.”
 
So what exactly are the changes?  Beginning in 2013, there is an increase in the maximum value used in the formula for the split point.  It will be transitionally increased over the next three years to what would be a current dollar value of $15,000 instead of a value of $5,000.  Then each year thereafter, the split point current value of $15,000 will be increased by using a countrywide inflation index.  Specifically, in North Carolina for 2013, (year one) the primary/excess split point will be increased from $5,000 to $10,000.  Beginning the second year (2014) the primary/excess split point will be increased from $10,000 to $13,500 and in year three (2015) the split point value will be increased to the indexed value for $15,000.    The inflation index would estimate the annual countrywide severity changes between the average modification in the initial year of implementation and the effective year.  It is also notable that the experience rating split point of $5,000 has not been changed in over 20 years, while the average cost of a claim has roughly tripled during this same timeline, so obviously the increase is long overdue. 1

What does this mean exactly to you?  The answer to this depends on how your own losses rank in size, frequency and severity.  If the majority of your losses are traditionally under $5,000 (the previous split point limit) then in all likelihood your experience modifier will in fact go down.  Conversely, if the majority of your losses exceed $5,000 then more of them will be apportioned to the heavier weighted excess loss totals and the results will be an increase in your experience modifier.  We are told however that overall, changes in the experience modification will be revenue-neutral.  There will be changes for individual employers experience modifications, but the average experience modification across ALL employers will remain the same. The NCCI goes on to state in general, the experience credits will become larger and the experience debits will become larger debits.  Bear in mind this is for all employers for all classes of business – specifically, for the NCACC Workers Compensation Pool, there was an overall improvement for the year 2013, as in the membership, 55 saw a decrease in their experience modifier, while 42 had an increase and 5 remained unchanged. Having more trend down than up is the desired results each year. 

What is to be done as the Risk Manager for your County due to these changes?  Nothing, aside from putting yourself in a position to understand how these changes in the experience modifier calculations may impact your bottom line cost of risk for workers compensation.  In addition it should allow you to double check your modification math – not to mention, placing you on a more level intellectual playing field with your carrier providing the coverage.
All of these changes were discussed during our recent Regional Meetings as described in last month’s CountyLines Managing Your Risk column. If you missed it please call us with questions.  Renewals are rapidly approaching and it is looking to be another great year for the WC and L&P Pools.

 1See NCCI.COM website: www.ncci.com/documents/exp_rating_update-2012.pdf