Posts Tagged ‘experience rating’

Understanding “Expected Losses”

Thursday, January 10th, 2013

This is Part 5 in 5 part series on Experience Rating changes. See Part 1: The Experience Rating Process: Significant Changes Are Imminent; Part 2 A Basic Review of Claim Losses, the Building Blocks of Experience Rating; Part 3 Primary and Excess Losses: Big Changes Beginning in 2013, and Part 4 Dealing with Reserves: When Do Losses Really Count?
We finish this series of blog posts with a brief discussion of “Expected Losses” and “Expected Loss Rates.”
The entire experience rating process is driven by “expected losses,” the total losses insurance actuaries expect you to suffer. But what exactly are “expected losses” and where do they come from?
Expected losses are contained in the premium rates you pay for each classification of worker. Expected primary loss rates and expected excess loss rates (called the “D ratio”) are a percentage of the total rate.
For example:
Class rate – $5.00
Expected losses – about 50% of the rate – $2.50
Expected primary losses about 20% of total losses – $0.50
These percentages do vary somewhat, but will be close to the above estimates.
Thus, the calculation for expected losses for $500,000 in payroll for the above class would be:
Manual premium = $500,000 times $5.00 divided by 100 = $25,000
Expected losses = $25,000 times 50% = $12,500
Expected primary losses = $12,500 times 20% = $2,500
Note that even with half a million dollars in payroll, the expected primary losses are only $2,500. This amount would be exceeded by relatively small losses or one big loss.
One final note: under the new rating plan in PY 13, expected primary losses will increase by about 50%. Using the above example, the new rating plan raises primary rates as follows:
Expected primary losses = $12,500 times 30% = $3,750
In other words, primary losses will go up as the split point goes up, but not fast enough to help employers with significant losses.
Expected losses and expected loss rates have significance in workers comp program performance measurement. Here’s why. A good way to measure how well a company manages workers comp is to track how much it spends in losses per hundred dollars of payroll. Then, one can compare that number with the expected loss rate, which is a rate per hundred dollars of payroll. If losses per hundred are running higher than expected losses per hundred, one can readily see that a problem exists, which can be immediately addressed.
After 20 years of stability, the experience rating process is about to undergo significant changes. Educated employers will track these changes and make any needed adjustments to their workers comp cost control programs.

Dealing with Reserves: When Do Losses Really Count?

Monday, January 7th, 2013

This is Part 4 in 5 part series on Experience Rating changes. See Part 1: The Experience Rating Process: Significant Changes Are Imminent; Part 2 A Basic Review of Claim Losses, the Building Blocks of Experience Rating and Part 3 Primary and Excess Losses: Big Changes Beginning in 2013. Part 5 will be posted later this week.
Did you know that a well-managed program aimed at assuring a low experience modification can produce a significant competitive advantage? In the following section, we will show you why and how.
Previously, we discussed the disproportionate impact that frequency has on an employer’s workers’ compensation premiums. The first $5,000 – soon to be $10,000 and higher – of each claim (primary losses) is counted dollar for dollar in the calculation of the experience modification. Losses above the primary level are discounted substantially. Therefore, a lot of small claims can raise premiums faster than a single large claim. Once again, for an excellent overview of experience rating, we recommend the National Council on Compensation Insurance’s (NCCI) white paper.
When are the numbers actually crunched to determine an employer’s experience mod and, ultimately, the policy year premium? Do employers have to obsess about reserves throughout the policy year or is there an optimal time to review losses?
When it comes to determining the experience rating for the next policy year, there is only one day that really counts. About six months after the end of the policy year, the insurer will prepare and submit a summary of losses spanning the prior three years (called the “unit statistical report”) to NCCI or the appropriate state rating bureau. For employers with open claims in prior years, it is essential to make sure that the numbers contained in the unit stat report are accurate and reflect an up-to-date understanding of the status and strategy for closure of each open claim. If an employer does not have access to its loss run online, a program deficiency, in our view, then the agent or broker should be tasked with getting it.
When Should you Review Losses?
So when should employers review open claims? Large employers will be doing this pretty continuously, but employers at or below the mid-level of the middle market in premium size are different. Here’s a suggestion: If your company has more than a half dozen open claims, you should review the losses at least quarterly. Get a loss run. Schedule a conference call with your claims adjuster and discuss each open claim to make sure that you have a clear and effective strategy to achieve closure.
NOTE: If there are open claims, you should be working steadily throughout the year with your adjuster to return any injured employee to full or modified duty. If, due to the severity of the injury, return to work appears unlikely, you should work toward closure by settling the claim. In the world of insurance, “the only good claim is a closed claim.” A quarterly review process ensures that you have an appropriate focus on every open claim.
For employers with few open claims, quarterly reviews are usually not necessary, although being actively involved with your claim adjuster in the management of each open claim is essential. At a minimum, request a loss run three months after the end of the policy year. This gives you plenty of time to review the status of any open claims and take action toward resolution before the unit stat review is submitted. Three months into your new policy, you have fully three months to impact reserves on old claims prior to the submission of that all-important unit stat report. Once that report is submitted, the numbers can only be changed if there is a clerical error.
The Bottom Line
Educated employers and managers don’t spend every waking moment worrying about reserve levels for open claims. There is that one time of year, however, when a laser-like focus on open claims can be very helpful in controlling losses. Make note of your policy end date, move forward three months, and place an alert in your calendar to review your loss runs. You will be taking action just ahead of that one crucial moment when reserves really count.
Even more important than all of this is a vigorous, aggressive and continuous procedure to bring injured workers back to work as soon as possible following injury, if not to full duty, then at least to modified duty. Pursuing this goal is the surest way to keep the cost of losses at an absolute minimum and experience modification at its actuarially lowest level.
That’s a true competitive advantage!

Primary and Excess Losses: Big Changes Beginning in 2013

Wednesday, January 2nd, 2013

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:
Employer 1:
1 claim at $20,000 / Current Primary = $5,000 / Pending Primary = $10,000
Employer 2:
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.

A Basic Review of Claim Losses, the Building Blocks of Experience Rating

Wednesday, December 19th, 2012

This is Part 2 in 5 part series on Experience Rating changes. See Part 1: The Experience Rating Process: Significant Changes Are Imminent. Parts 3 to 5 will be posted after the holidays.
When you report a claim to your insurance carrier where outside medical bills are involved, the insurer will estimate the ultimate cost of the claim. For medical-only claims, the estimate is small; for lost time claims, it might range anywhere from a few thousand to hundreds of thousands of dollars, depending upon the severity and duration of the injury.
Your company’s claim losses are described in detail on a loss run, a written summary available through your agent or directly from your insurance company. The loss run lists what has already been paid plus what is projected for payment over the life of the claim. The projected, but as yet unpaid, amount is called the “reserve,” because it’s the amount set aside, or reserved, for future payments. The amount already paid plus the reserved amount is called the “total incurred amount.”
Example: John Doe injured his back one year ago:

Paid at the time of the loss run: $ 45,600
Reserved for future payments: $ 60,000
Total Incurred amount: $105,600

Reserves are based on the insurance claim adjuster’s investigation into the nature of the injury (diagnosis and prognosis) and the insurer’s experience with similar cases. The total incurred amount is the insurer’s best estimate of the ultimate cost of the claim: the expected payments for lost wages (indemnity), medical treatment, disability and nurse case management, rehabilitation, attorney fees and other related expenses over the duration of the claim.
The same injury to two workers might result in very different reserves. Among the factors included in setting reserves are:

  • Education level
  • Co-morbidities (medical problems which may impact recovery such as high blood pressure, diabetes, obesity, drug addiction, etc)
  • Age (younger workers generally heal faster than older workers)
  • Transferable skills (if unable to return to the original work, whether the injured worker has marketable skills)

The initial reserve is usually posted within 30 days. Once posted, reserves are periodically updated to reflect any changes in the course of the claim. The costs of a projected settlement are usually included in the reserve.
In terms of experience rating, whether a claim is medical-only or indemnity means a lot. Why? Because, with the exception of Massachusetts, medical only claims are discounted by 70% in the experience rating calculation (Massachusetts, a non-NCCI state with its own Rating Bureau, does not discount medical-only claims). However, once any indemnity payments are incurred, there is no discount for any medical costs already paid or projected to be paid, and the loss, up to its first $5,000 counts full value in experience rating. This first $5,000, the “split point,” is called Primary Loss, and it, as well as Excess Loss, all dollars above $5,000, is the subject of our next post. In it we address the imminent and upward change in the split point.

The Experience Rating Process: Significant Changes Are Imminent

Monday, December 17th, 2012

Here at the Insider we realize that we have readers from different areas of the insurance world, some directly related to workers’ comp and others indirectly related. Some of our readers are risk managers at large Fortune numbered companies. Other readers are with agencies and brokerages, large and small. Still others work in various roles for insurers. Because in just a couple of weeks the insurance industry’s experience rating system will undergo its first significant change since 1990, we’ve decided, beginning today, to present a 5-part series aimed at those readers for whom this change will have direct and immediate impact.
For some readers, what we’ll be presenting will be old news. If you’re in this group, this is the time to hit the “delete” key. Also, to be candid, the first, and possibly second, post may appear too basic for some, but we believe we have to prime the pump before we can draw the water. For everyone else, hang around; there might be something to learn. We’re talking directly to middle and small market employers and the agents, brokers and consultants who serve them. Essentially, anyone affected by experience rating.
The goal: Reduce the cost of workers comp insurance
Other than reducing payroll, in most cases the only way for an insured employer to reduce its workers compensation premium is by reducing experience modification, which is the end result of the experience rating process. Experience rating is complex, but it contains elements responsive to strategic planning and employer control. That’s why understanding experience rating is so important.
First, some basics. Coming up with an employer’s workers comp premium is, essentially, a two-step process. The first step multiplies the employer’s premium class rate by its payroll in hundred-dollar increments. That is: rate times each hundred dollars of payroll. This is called the “manual premium.” In the second step the insurer multiplies the manual premium by the “experience modification factor,” which is derived from a mathematical calculation that examines the employer’s claim loss history over the most recent three-year period in relation to its industrial peers. The application of the “mod” will either raise or lower the manual premium, resulting in a competitive advantage or disadvantage. This is why keeping the mod low is so vital.
NOTE: For a comprehensive basic primer on experience rating, we recommend going to the source: The National Council on Compensation Insurance (NCCI) website provides a well-written document (PDF) that will walk you through the fundamentals of experience rating.
In the next four posts we offer the following:

  • First, a basic review of claim losses, the building blocks of experience rating
  • Second, an explanation of the difference between Primary and Excess Loss, as well as a description of the 2013 Split Point change
  • Third, a recommendation for dealing with Reserves
  • Fourth, a discussion of Expected Losses, Expected Loss Rates and a wrap-up.

Keep in mind that in experience rating, size matters. Large insureds with large premiums are expected to have higher losses than smaller insureds. Indeed, because their margin of error is smaller, companies with premiums in the $10,000 to $100,000 range can easily find themselves in a lot of trouble with just a few injuries.

Hurry Up and Wait: NCCI’s Slow Road to Big Changes in Experience Rating

Tuesday, November 15th, 2011

Back in September we blogged NCCI’s pending changes in experience rating plans. While initially proposed for this fall, the new implementation schedule (contained in NCCI Circular Letter E-1402) does not even begin until January 2013, at which time 18 states will kick off the program. The other 21 states will follow throughout the year, with Utah being the last, in December. We have more than a year to figure out the implications of raising primary losses from $5,000 first to $10,000 and eventually to $15,000 and even higher. The rules are going to change and, as is so often the case, there will be some winners and some losers.
Rating’s Black Box
In the course of retooling the black box that is experience modification, NCCI’s actuaries will set the numbers that determine exactly how the new plans will operate. To date, there has been no word on the D ratio – the percentage of total losses that are expected to fall below the primary split. This will be the key factor in analyzing the implications of the new rating plans.
No matter where this number is set, one thing is certain: employers with higher than expected losses will see their experience mods go up higher than under the current system; at the same time, employers with lower than expected losses may see their mods drop even lower than under the current rules. NCCI pledges that the new plans will be revenue neutral: overall premiums will remain the same. [Legislative approval in each state would be required if the new rating plans resulted in increased premiums.]
One important feature of the new system is its dynamic nature: unlike the current rating plan, where the primary loss split point remained at $5,000 for over 20 years, the split point going forward will rise as losses rise.
Educated Consumers
What does all this mean for experience-rated employers? It’s important to understand exactly how the new system will work. Sticker shock awaits those who ignore the implications of escalating primary losses. The Insider will do its best to alert employers to the details of the new calculations, along with a user-friendly walk-through of the entire experience rating process. No, it’s not our idea of fun, but with billions in insurance premium on the table, it will certainly be worth the effort. Stay tuned.