The purpose of experience rating in workers compensation is to charge employers a premium that accurately reflects their risks. Experience rating plans compare employers that are in the same industry group to each other. For example, roofers are compared to other roofers, and bakeries are compared with other bakeries. The loss experience of each group is averaged, and then each employer’s loss experience is compared to the group’s loss experience. Employers whose experience is better than the group average receive a credit. Those whose experience is worse than the average receive a debit.
Experience rating provides incentives for employers to reduce losses by implementing safety programs. It also encourages employers to get injured employees back to work as soon as possible. Moreover, it ensures that insurers collect enough premium to cover the risks they undertake.
In workers compensation insurance, experience rating is performed by a rating bureau. In NCCI states, experience rating is performed by the NCCI. In independent states, experience rating is performed by the individual state rating bureaus.
To understand experience rating, you must first comprehend how workers compensation premiums are calculated. Premiums are determined by multiplying a rate times each $100 of employee payroll. For instance, suppose your payroll is $500,000 and the rate is $1. Your premium will be (500,000/100) X 1.00 or $5000. This premium is called the manual premium, which means that no experience modifier has yet been applied. When an experience modifier is applied to the manual premium, the result is called the standard premium.
Before a workers compensation premium can be developed, your employees must be assigned a classification based on their job functions. For instance, workers that sit at a desk and perform clerical duties only may be designated Clerical Office Workers. Each classification is assigned a four-digit identifying number called a class code. For instance, the NCCI class code for the classification Clerical Office Workers is 8810. If your company employs both clerical workers and outside salespeople, the salespeople will be assigned a separate classification. Your employees’ payroll will be allocated between the two classifications, and a separate rate will apply to each.
Experience Rate Calculation
Experience rating is typically based on a three-year period called the experience period. This period usually consists of the three years prior to your most recent expired policy period. For instance, suppose that your last policy expired on August 31, 2013. Your current policy runs from August 31, 2013/2014. The experience modifier that will apply to your current policy will be calculated based on the time period from August 31, 2009 through August 31, 2012. The claims that occurred in the 2012 to 2013 policy year are not considered because some of them may still be open.
An experience modifier is calculated every year. It is usually (but not always) effective on the inception date of your policy. Your modifier may be less than, greater than, or equal to “1.” A modifier of “1” means that your loss experience is average for your industry group. That is, your loss history is no better or worse than other employers similar to you. Your manual premium will remain unchanged. If your modifier is greater than 1, your loss experience is worse than average for your industry group. A modifier that is great than 1 represents a debit as it will increase your premium. Likewise, a modifier of less than 1 signifies a loss history that is better than average. A modifier of less than 1 will achieve a premium reduction.
An experience modifier is applied to the manual workers compensation premium to calculate your standard premium. For each classification, the insurer determines your manual premium by multiplying the rate times the payroll, which is divided by 100. For example, suppose that your workers are divided into two classifications. The annual payroll for the first classification is $300,000 and the rate is $1.25. For the second classification, the payroll is $100,000 and the rate is $3. Your manual premium will be 300,000/100 X 1.25 plus 100,000/100 X 3.00 ($3750 plus $3,000) or $6750. If your experience modifier is .90, your standard premium is $6750 X .90 or $6075. Many states add a surcharge or assessment (for your state’s guarantee fund) to your standard premium to calculate your final premium.
Experience modifiers may be intrastate or interstate. If you have operations in two or more NCCI states, the NCCI will provide you an interstate modifier. IF you operate in a single NCCI state, the NCCI will issue an intrastate modifier. An intrastate modifier will also be provided by any independent state in which you operate.
You will be subject to experienced rating only if you meet eligibility requirements established by your state. Eligibility rules vary from state to state. Most states require you to have been in business for a minimum time period (new firms are not eligible). States also require a minimum amount of premium within a certain number of years. For example, your state might require either (1) $10,000 in combined premium for the two most recent years of the experience period; or (2) an average premium of $5,000 per year over the 3-year period. If your premiums were $4500, $5500 and $4800 during the experience period, you would qualify based the first criteria (but not the second). If you are eligible for experience rating, an experience modifier will be calculated.
When the NCCI or independent state bureau issues an experience modifier, it provides an experience rating worksheet. The worksheet shows how your modifier was calculated. It lists the relevant class codes and applicable payrolls, claim numbers and losses used in the calculations. Note that if you have incurred any large losses, only a portion of it is typically included in the calculation of your modifier. If you have incurred several small losses, all of those losses might be included in the calculation. Thus, your modifier is generally more adversely affected if you have incurred numerous small losses rather than one large loss.