Lesson 3 Experience Rating

Transcription

1 Lesson 3 Experience Rating 1. Objective This lesson explains the purpose and process of experience rating and how it impacts the premium of workers compensation insurance. 2. Introduction to Experience Rating Experience Rating uses the employer s past experience (losses) to project future losses. It compares the losses of the employer to the average risk in a particular classification of business. (For more information regarding classifications, please see the Introduction to Classification lesson.) 3. Introduction to Experience Rating Why have Experience Rating? Because it: incorporates both debits and credits gives employers some influence on their final premium provides incentives for safety programs promotes occupational health and safety produces a net premium cost that is the best indicator of the employer s potential for incurring claims 4. Introduction to Experience Rating Insurance is: sharing the cost of a loss by members of a group, who are likely to experience the loss. We can predict the cost and probability of injuries for the whole group... But not which member of the group will actually be responsible for these costs.

2 5. Introduction to Experience Rating Developing the average rate: The insureds are grouped by their business operation or classification. Estimated losses of the group are added to calculate an average cost. 6. Introduction to Experience Rating The experience of the employer is usually derived from the latest available three years. The experience is then compared with the average of all employers in that classification. Equal to the average = UNITY (a Unity mod equals 1.00) Lower than average = CREDIT (a Credit mod is less than 1.00, such as 0.75) Higher than average = DEBIT (a Debit mod is greater than 1.00, such as 1.10) 7. How Does Experience Rating Work? Two Primary Advantages of Experience Rating, when compared to using only Manual Rating, are: It tailors the cost prediction and final net premium cost to the individual insured It provides added incentives for loss reduction

3 8. How Does Experience Rating Work? The more important fact to Experience Rating is that the accident did occur. Therefore, the Plan gives greater weight to accident frequency than to accident severity. Example of Frequency vs. Severity No. Of Claims Cost per Claim Total Cost Employer 1 1 $50,000 $50,000 Employer 2 10 $ 5,000 $50,000 Which company is safer? At which company would you have greater chance of having a claim? 9. How Does Experience Rating Work? Capping of Individual Claims One very large claim may be due to just bad luck. Therefore, each individual claim is capped by a state accident limitation. For most states, the state accident limitation is approximately $100, How Does Experience Rating Work? Primary = The First $5,000 of each claim (Reflects claim frequency) Excess = any ratable individual loss greater than $5,000 (Reflects claim severity) Individual State Accident Limitation Ratable Individual Primary Excess $1,234,567 $100,000 $100,000 $5,000 $95,000

4 11. How Does Experience Rating Work? The Size of the Insured Matters. Why? The larger employer is statistically more likely to show its true colors than the smaller employer. 12. How Does Experience Rating Work? Experience ratings are not made by the insurance carriers. The experience ratings are computed by the appropriate advisory organization, such as the National Council on Compensation Insurance, Inc. (NCCI) The employer qualifies for experience rating if the manual premium exceeds an eligibility point. (Eligibility criteria differ by state.) 13. How Does Experience Rating Work? The Experience Period is usually the three years ending one year prior to the modification effective date. EXAMPLE: If the modification is effective January 1, 2003, the experience rating uses injury experience under policies for: 1/1/ /31/1999 1/1/ /31/2000 1/1/ /31/ How Does Experience Rating Work? Essentials of Experience Rating: It is mandatory for all insureds that meet the premium eligibility requirements. It is prepared according to a fixed formula. The formula is designed to measure how an employer s performance differs from the average of other employers in that classification.

5 15. How Does Experience Rating Work? Experience Rating is based on Two Statistical Laws: 1. The larger the base, the more reliable the actual record is. (As the size of the employer increases, the actual historical record is given more weight/ credibility.) 2. The cost of an injury varies over a very large range. (The cost is less predictable than the fact that an injury occurred.) Experience Rating Plan Adjustment (ERA) Reduced the weight applied to medical-only losses Increased the weight applied to excess losses Implemented inflation-sensitive primary/ excess split of actual losses Experience Rating Plan Adjustment (ERA) Reduced Impact of Medical-Only Claims: The determination of actual losses both primary and excess has changed. Under the ERA adjustment, 30% of actual primary and excess portions of individual medical-only claims will be included in the calculation of the modification factor. Medical-Only Claim of $7,000 Prior to Plan Adjustment: After Plan Adjustment: Primary = $5,000 Primary = $1,500 (30% x $5,000) Excess = $2,000 Excess = $600 (30% x $2,000)

6 Experience Rating Plan Adjustment (ERA) Adjustments to Improve Plan Performance: Increases reliance on the excess portion of the actual losses Includes factor for the impact of inflation 19. The URE Report An URE Report is reported by the insurer for each policy. This report includes the audited data from that policy. The data on these reports is used for preparing and calculating the experience rating. The following data is included from the URE Report (seen above): 1. Insured s Name 2. State 3. Policy Effective Date 4. Risk ID Number 5. Class Code 6. Exposure (Payroll) Amount 7. Rate 8. Premium Amount 9. Claim Number 10. Accident Date 11. Claim Amounts 12. Claim Status 20. Calculating The Experience Rating Once the data from each of the three policy years has been transferred to the worksheet (Items 1-3 & 5-13 on Exhibit B), the experience rating calculation begins. 1. The actual primary losses (Item 14) are calculated. (Column 10) 2. Total the actual losses (Item 15 & Box H) and actual primary losses (Item 16 & Box I), using ERA if applicable. 3. Actual excess losses (Item 17 & Box F) are calculated by subtracting the actual primary from the total of all actual losses. We have calculated how the employer fared. Now, it s time to compare this to the average losses of businesses in the same classification.

7 21. Calculating The Experience Rating To calculate the average losses, we turn our sights to the expected losses. 4. Calculate the Expected es (Item 19 & Column 5 on Exhibit C) for each class code and payroll amount [Expected es = Payroll/100 x ELR (Item 18)] 5. Calculate the Expected Primary es (Item 22 & Column 6) for each Expected Amount [Expected Primary es = Expected es x D-Ratio (Item 21)] 6. Total the Expected es (Item 20 & Box D) and Expected Primary es (Item 23 & Box E) 7. Calculate the Expected Excess es (Item 24 & Box C) 22. Calculating The Experience Rating We then need to include two other important factors in calculating the experience rating. 8. The Weighting Value (Item 27 & Box A) is the factor that determines how much of the excess losses are used in the experience rating. This factor changes based on the size of the employer. Remember that the larger employer is more credible in predicting their own future losses. 9. The Ballast Value (Item 29 & Box G) is a stabilizer that lessens the effect of any one claim on the experience rating. 23. Calculating The Experience Rating Now we can calculate the experience rating by comparing the actual information (how the employer fared) versus the expected information (the average). To make this comparison between actual and expected, we total the following amounts for each: 10. The primary losses (Items 25 & 26) 11. The stabilizing value [a calculated value that applies equally to actual and expected losses and is based on the ballast value] (Item 28) 12. The weighted excess losses [Excess X Weighting Value] (Items 30 & 31) Compare the actual totals (Item 32 & Box J) to the expected totals (Item 33 & Box K). Your result is the experience rating, expressed as a decimal (Item 34).