What is the Experience Modificaton Factor? Part I

By: Steven A. Odell
Date: 1/1/2007

Workers Compensation is a class-rated insurance program. Within each state, insurance companies apply the same rate to all employers who fall into a given class. For example, all plumbers are subject to the plumbing rate, all truck drivers are subject to the truck driver rate, etc. The rate applied in each class is an average rate, and does not recognize any individual characteristics of the employer. Because of this, there is a need for a statistically supported means of differentiating one business in a given class from another for the purpose of determining policy premiums. This is where experience rating comes in.

Since no two employers in the same industry will have similar claims histories, fairness requires that the employer with the greater claims burden pay more. Not only will that distribute the cost of this insurance more equitably; it also places the employer that is less safety conscious at a competitive disadvantage.

The experience modification factor (a.k.a. experience modification rating, or EMR, or the mod) therefore provides employers with the financial incentive to improve the safety of their workplaces. When someone knows that he or she will have to contribute toward the cost of their claims, they are more inclined to operate a safe workplace.

The mod is an adjustment that is made to the workers compensation premium of companies that meet or exceed a certain size. The minimum "manual premium" can vary from state to state. The employers that qualify typically have been paying $5,000 for the past three years or have paid $10,000 or more in a single, recent year.

The mod factor is a value that compares the payroll and loss data of that particular employer to the average for all other employers who share the same class codes. A value of 1.00 is "Average" which means that the frequency and severity of actual losses equaled the expected losses. A mod factor over 1.00 means that employer had worse than expected losses during the rating period. A mod less than 1.00 means the employer's losses were better than expected.

The mod is calculated by using claims and payroll data from the four previous years, excluding the most recent. For example, to determine a 2006 mod, payrolls and claims from 2002, 2003 and 2004 will be included. The data from the 2005 policy would not be considered until the 2007 mod when the data from 2002 would drop off.

A common misconception is that the mod is calculated by the state or the insurance carrier. Mods, are calculated in most states by the National Council on Compensation Insurance (NCCI). NCCI is a private corporation created and funded by member insurance carriers.

Several states have their own rule and rate making bureaus. While these are officially independent bureaus, they all share some statistical, administrative, and rule-making functions with the NCCI. These "Independent Bureau" states are divided into two groups. The first are members of the NCCI's Interstate Rating Bureau. Employers in these states are interstate- (multi) rated when they conduct operations in another state that is also a member of the Interstate Rating Bureau. These states are Indiana, Massachusetts, Minnesota, New York, North Carolina, Ohio, Texas and Wisconsin.

The second group of states consists of California, Delaware, Michigan, New Jersey and Pennsylvania. Employers in these states are always intrastate- (single-state) rated. They are not members of the Interstate Rating Bureau. While the underlying formula in their experience-rating plans approximate the NCCI's own formula (except New Jersey, which is unique, and Michigan, where the formula is at the discretion of the insurance carrier), there are some differences. These modifiers are never calculated with payroll or claims from another state. If a company has operations in one of these states and also has operations in a NCCI or independent bureau state, their policy will contain two different modifiers (provided premium levels qualify for a modifier).

The mod is affected by small losses more than by large ones. A company with one $25,000 claim will do better than one with five $5,000 claims. This is because small losses are more frequent and predictable than larger ones.

The portions of all losses that are less than $5,000, which are termed "primary losses," have the greatest influence in determining the experience modification. Losses in excess of $5,000 are capped at levels that vary by state. The amounts of each loss over $5,000, and below the cap, are termed "ratable excess losses" and given increasing importance in experience rating for larger employers based on the level of their expected losses.

Most states have approved a 1998 adjustment to experience rating that uses only 30 percent of ratable, "medical-only" claims in the experience-rating formula. This change was made to increase the incentive to report all claims by decreasing the sensitivity of experience rating to small claims that involve no lost work time. All claims should be reported for record purposes only, but self-paying of small, medical only is acceptable by many carriers.

My next article will address some commonly asked questions about the mod and what can be done to reduce it.

Steven A. Odell is the chief executive officer of LyonsOdell. He can be contacted at 484.586.3902, or by email at LyonsOdellInfo@LyonsInsurance.com, or visit www.LyonsInsurance.com.