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Workers’ Compensation Experience Modifications: What Happens When a Loss Reserve Changes?

For many businesses, workers’ compensation insurance is one of the largest expenses. A firm’s experience modification, which is a numeric factor that applies to the workers’ compensation premium, is a major influence on that cost. It is designed to reward firms that have below average loss activity and penalize those with above average activity. Firms with losses below average will have a mod of less than 1.0, while others with above average losses would have mods greater than 1.0. The insurance company multiplies this number by the calculated premium, producing either a reduced or increased premium. Firms with frequent, small losses fare worse under experience rating than those with infrequent, large losses. However, large losses and changes to the amounts reserved for them can still have a great impact.

In each state, a bureau independent of the insurance company calculates an eligible firm’s experience mod. The bureau uses a formula that considers the type of operation, the payroll over the previous three policy periods (not including the current one), the losses with values of less than $5,000 each, and the losses valued at more than $5,000. Through the application of mathematical factors, the formula determines the firm’s actual losses for the three-year period. The bureau divides this number by the expected losses for a firm in that classification with that amount of payroll. If actual losses exceed expected losses, the mod is greater than 1.0; the mod is less than 1.0 if the converse is true.

The formula values losses of less than $5,000 at full value. For example, a firm that had five losses totaling $10,400 would be charged that amount in the experience rating formula. However, a firm with one $10,400 loss would not be charged the full amount. The formula breaks this loss into two amounts — $5,000 plus some fraction of the amount in excess of that. The experience rating manual contains the factors that apply to the amount over $5,000, and they will vary by the firm’s expected losses. Factors are greater for firms with greater expected losses. Each state has a maximum amount for which any one loss can be valued, no matter what its actual size. For example, if a firm suffers a loss reserved at $900,000 and the state’s maximum single loss is $200,000, the formula will apply the factor only to $195,000 (the amount between $5,000 and $200,000).

A significant change in the amount reserved for a loss can have a dramatic effect on a firm’s experience mod. In the example above, if the reserve dropped from $900,000 to $100,000, the factor would now apply to $95,000 instead of $195,000. This would produce a major decrease in the formula’s calculation of actual losses, resulting in a big drop in the experience mod. Conversely, a loss reserve that jumped from $50,000 to $250,000 would produce a sizable increase in the calculated actual losses, as the factor is now applied to $195,000 rather than $45,000. This shows the importance of proper claims management. Lingering problems such as back injuries can result in large reserve increases if the injured worker does not receive effective medical treatment early on.

A good insurance agent will work with the firm to analyze the experience modification worksheet and verify its accuracy. The firm and its agent should inform the insurance company of any errors in reported losses or payroll. Also, the firm should question an usually large decrease in a reserve and appeal to have its mod reduced. A properly calculated experience mod should neither over-reward nor under-penalize a firm for its loss experience.