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.
Posts Tagged ‘losses’
Experience Modification Alert: NCCI Changing the Rules
Monday, September 26th, 2011It’s been over 20 years since NCCI changed the rules relating to the calculation of the experience modification factor. Given that experience modification determines the cost of insurance for all but self-insured employers, these changes require careful scrutiny. While some of the details have not yet been announced, one thing is clear: employers with higher-than-expected losses are likely to pay more for insurance. [NOTE: the Insider apologizes in advance for what is inevitably a rather technical discussion. For readers who would like additional background, check out our 2004 primer here.]
Under the current system, claim dollars – what’s been paid and what’s been set aside for future payment on each claim – fall into one of three categories:
– Primary losses: the first $5,000 of each claim. These losses carry the most weight and drive up the experience mod much quicker than the losses above $5,000.
– Excess losses: the losses above $5,000 within each claim. These are discounted in the calculation, with as little as 10 percent of the total included in the calculation (depending upon the size of the premium)
– State Rating Point: the cap on individual claim dollars beyond which the losses are excluded from the calculation; this varies from state to state, generally falling between $125,000 and $200,000.
NCCI is expanding primary losses from the current level of $5,000 up to 15,000. This change will take place over a three year period, with the ceiling rising to $10,000 in the first year, $13,500 in the second year and $15,000 in the third year.
Why does this matter? Primary losses are the major cost driver in experience rating. Primary losses are not discounted: they go into the formula dollar for dollar. As a result, employers with moderately large claims (between $5,000 and $25,000) are likely to see an increase in their experience mod.
Expected Losses
Employers who have analyzed their premiums carefully understand that experience rating is essentially a comparison: the individual employer’s losses are compared to the losses for other employers performing similar work. The actual comparison is contained in the rates paid for insurance.
For example, in your state the rate for carpenters might be $10.00 per $100.00 of payroll. The total expected losses within this rate might be $5.00 per $100 of payroll. The expected primary losses (called the D Ratio) might be 20 percent of total losses: in this case, $1.00 per $100 of payroll.
As NCCI increases the ceiling for primary losses from $5,000 to $15,000, they must also increase expected primary losses. Unfortunately, they have thus far provided no information on how much expected primary losses (the D ratio) will increase. This number will determine just how much more employers with higher-than-expected losses will pay for insurance. Conversely, the revised D ratio will also determine how much of a discount will be given to employers with lower-than-expected losses. As with our changing climate, the fluctuations under the new system will be greater than in the past.
Given the trend toward very large (catastrophic) claims, it would not be surprising to see the state rating points also increase: for example, instead of capping individual claims at $200,000, the limit might be closer to $300,000. (To date, NCCI has been silent on this matter.)
Winners and Losers
NCCI actuaries are working under the requirement that total premiums within a state remain the same under the new system. In other words, when they apply the new rules, experience mods will go up or down for individual employers, but the total premium in the state will stay the same.
On an individual insured level, there will be winners and losers. Here is our advice to any employers with debit mods (above 1.0) in states managed by NCCI: follow these new NCCI developments carefully. [The easiest way to do this, of course, is to keep reading the Insider.] Primary losses remain the biggest cost driver in the workers comp system and primary losses within individual claims are about to double and soon triple. The strategies for experience mod management that were effective with the primary loss ceiling at $5,000 may no longer apply. As the rules of the game change, savvy managers will change with them.
Compare your workers compensation losses with others in your industry
Wednesday, March 3rd, 2004Marsh offers an interactive tool to let you compare your workers comp losses with others in your industry. It entails entering a few bits of information, and it then generates bar charts that depict industry numbers and your variance from the norm. Of course, it’s a rough benchmark, but it still offers an industry-specific yardstick, and most of us are eager to see how we measure up to our peers. The site has other interactive tools too – test your liability limits, or benchmark your Directors & Officers liability.
The site also has a library of articles on various business insurance issues, including one entitled Controlling Workers’ Compensation Costs. Here is an excerpt:
“The average cost of a claim involving an employee who lost time from work was $30,000 in 2002, according to data gathered by Marsh. In the aggregate, these costs have a big impact on an employer’s bottom-line. A business with $100,000 in workers’ compensation losses and a one-percent margin (such as in retail) needs to generate $10 million in sales to pay its workers’ compensation claims.”
Obviously, we think the best way to forestall these punishing costs would be to prevent claims from occurring in the first place; Marsh suggest that employers view workers comp initiatives in terms of pre-loss and post-loss initiatives. They offer their views on an effective claims management component:
“To address post-loss issues, employers may need to sharpen their focus on the injury and claims management processes. This could involve establishing consistent policies for reporting claims and procedures for dealing with workplace injuries and providing medical referrals. A key element in any employer’s post-loss activities involves implementing a return-to-work policy that gives employees an opportunity to begin working on a modified schedule as soon as they are physically able. Transitional or temporary work programs offer significant benefits to the employee and potential cost savings for the organization.”
At Lynch Ryan, we are ardent believers in the need to measure and benchmark losses against the industry and also against a company’s own performance over time, so we are happy to see this handy tool from the folks at Marsh. If you haven’t visited the Marsh site lately, you might find some valuable risk management or HR resources.
Measuring success
Thursday, December 4th, 2003I’ve always thought that a company that is serious about controlling workers’ compensation costs and losses must be serious about measuring its performance, or else how will success be known?
The problem with traditional measurement protocols is that they take years to develop in order that conclusions can be drawn with any level of actuarial certainty. The four-year development of experience modification is the standard measure. Loss data for a given year does not enter the mod calculation until eighteen months following the close of the policy year, and the modification, itself, reflects three years experience. This fails to give management a timely opportunity to reverse unfavorable trends. If you are an employer, you need something better and quicker.
There are more user-friendly methods that employers can use to keep abreast of the status of their programs at any given time. We recommend tracking the data continuously and posting results monthly.
Over the next five weeks, I’ll post some of the methods we’ve found to be most effective at Lynch Ryan. If you’re an employer, perhaps you’ll find them useful as you search for ways to track the performance of your own injury management program. Feel free to post any comments – we’d like to hear what you think.
This first posting in the series will focus on Cost of Losses per Full Time Equivalent Employees (FTE).
The single best economic indicator of the effectiveness of a workers’ compensation cost control program is Cost of Losses per FTE. It provides an economically sound snapshot of program success at any given time. Oftentimes, employers have little control over whether workers’ compensation statutory premium rates rise or fall. Yet, individual employers can control whether their own losses rise or fall. Tracking the cost of losses per FTE is the best way to measure the status of the overall cost control effort.
To determine the cost of losses per FTE, first factor out the variability of part-time and overtime work by dividing the total number of hours worked by all employees in a one year period by 2080 (a 40-hour workweek times 52 weeks) to arrive at the number of full time equivalent employees. Then, divide the total cost of losses during the same one year period by the total FTE count.
Regardless of industry or geographical location, your annual Cost of Losses Per FTE should not exceed $100.
You can track the Cost of Losses Per FTE on a quarterly or monthly basis by substituting 520 or 173 for 2,080, respectively.