Understanding some basic information about how a Workers Compensation Experience Modifier
is calculated can go a long way in understanding how to keep workers comp premiums in line. It is a complex formula, but this article is an attempt to bring just a few basic points.
Many people believe the experience modifier is driven by two items-workers comp premium and the cost sustained by work related injuries. If you think this, you would be wrong. The true basis for the experience modifier calculation is payroll assigned to a particular workers comp class code and expected losses.
Each employee's payroll is assigned to a workers comp class code. Each class code has a rate per $100 of payroll which is driven statistically by losses coming from that particular job responsibility. The more prone a particular class is to either frequency of injury or severity of injury, the greater the rate. Usually the insurance agent and the employer together project the payroll for the upcoming policy year by workers comp class code. For example, if clerical payroll for a business (class code 8810) was projected to be $400,000 for a policy year and the rate was .85, then the pure workers comp premium would be $4000 X .85 or $3,400. This is where many people will make their mistake by thinking the $3,400 in premium drives the experience modifier, while in fact it is the $400,000 of clerical (8810) payroll.
Each workers comp class code that is used in premium calculations will carry with it a statistically driven amount of loss that is expected. Interestingly enough this amount is called "expected losses" in the experience modifier calculation formula. Every code that is used to develop a workers comp premium carries with it an expected loss ratio. This ratio drives the expected loss amount that will go with each workers comp class code. If a business happens to have a claim or claims that exactly equaled the expected loss then the modifier would be 1.00. If claims were less than the expected loss, then the workers compensation policy would have a credit modifier. Likewise with claims exceeding the expected loss amount, there would be a debit modifier. Expected losses are statistically developed by NCCI and are applied to all workers comp class codes.
As you can see a workers comp experience modifiers are not promulgated using premium but rather (1) payroll by workers comp class code and (2) expected losses associated with that class code. Actual premium paid has no part in the formula.
One needs to understand also that there are other factors that enter into the development of a workers comp experience modifier. It is a complex calculation but understanding the relationship between the workers comp class code and expected losses should help in determining ways to reduce a workers comp experience modifier. The more a business owner knows about its calculation, the greater chance there is to positively influence loss experience that drives the workers comp experience modifier.