A critical yet sometimes overlooked factor in determining a contractor’s insurance premium is his or her own loss experience. Particularly in the world of workers’ compensation insurance, premiums are greatly affected by the frequency and severity of losses. For the insurer to properly assign premiums versus potential risk, they look to compare the individual contractor’s loss experience to those performing similar types of work. Simply put, the Experience-Rating Modifier (ERM) is computed as a factor of the insured’s own loss experience that is used to modify the standard premium. Therefore, those with higher-than-average losses will pay more for their insurance than those with average or lower-than-average losses.
So, it begs the question, “What does Experience Rating do for me?” For starters, ERMs can greatly affect the amount of premium required to pay out for workers’ compensation insurance. As noted earlier, Experience-Rating Modifiers can either reward or punish individual contractors based on their accompanying loss experience. Generally, if you are able to better control the frequency and severity of your workers’ comp-related losses, you will be rewarded with lowered premiums. However, if you simply allow insurance to act as your risk manager, more than likely your loss experience will be greater than those competing against you, resulting in a higher-than-average premium requirement.
How can you control and manage your ERM? Initially, the most effective method is to manage and control losses. Calculated ERMs are more responsive to loss frequency than to loss severity. Your modifier is more likely to fluctuate with continuous, repetitive claims than it would with a few large losses. With that in mind, reducing loss frequency will greatly enhance the contractor’s ability to lower the ERM. But it goes much further than that. Here’s a quick seven-step action plan each contractor, both large and small, can undertake that will allow for greater management of their Experience Rating Modifiers:
- Safety, Safety, Safety By developing and implementing a well thought out safety program, the severity and frequency of workers’ comp losses can be greatly reduced. The ERM formula recognizes that it is more difficult to control loss severity than frequency. With that in mind, a contractor experiencing numerous small losses will more than likely have a higher modifier than the contractor experiencing a few large losses, even if the dollar amounts total up the same. Safety and training will help to reduce the frequency of losses.
- Ensure Proper Rating Classification Whether intentional or not, misclassification can greatly affect the ERM and the resulting insurance premium. Classification into a lower-rated class may initially result in lower premiums for the contractor; however, loss experience will soon place upward pressure on its ERM, resulting in an increased modifier and accompanying premiums. It is critical to know your classification. Misclassification can hide effective safety programs by not accurately comparing your loss history to those in your field. Work with your insurance broker/agent to ensure proper classification.
- Review Open Claims Annually With Your Insurance Adjuster Your ERM calculation incorporates reserves for open claims as well as paid claims. The insurers generally set up an initial reserve when the claim is first filed, and will adjust this reserve as the claims process continues, with the final claim often settling for less than the initial reserve. Work with your claims adjuster on the levels of remaining reserves and negotiate a reduction or elimination of certain amounts. This needs to be done promptly in order to have any effect on the ERM calculation.
- Audit for Mistakes Your ERM is calculated based on the year’s loss history and a combination of information from your company payroll and industry classification. As noted earlier, improper classification can greatly affect the ERM. Work with your insurance provider to review the accuracy of this information. Ensure that this data is not only properly classified, but that it is properly reported to the rating bureau. All losses, payroll levels and classifications must be turned in no later than six months prior to the rate date for the ERM to be affected.
- Prepare a Test Modifier and Compare Year-End Calculations Have your insurance provider prepare a test modifier at least 60 days in advance of the actual rate date to use as a gauge of the potential modifier level. Use this as a benchmark for future ERM levels. You should also carefully review the factors affecting the ERM: losses, payrolls, and subrogation recoverables. Carefully analyze these inputs to ensure accuracy. By some estimates, more than half of all modifier calculations contain errors.
- Pay the Small Medical Claims Once again, the ERM is most directly related to loss frequency than loss severity. That being said, medical-only claims of $5,000 or less can greatly affect the modifier. To offset this, contractors can pay these small medical-only claims through an agreement with their insurance provider. This will help to alleviate the frequency-driven upward pressures of the experience modifier. Set up a plan with your insurance provider whereby all small medical-only claims will be paid out of pocket.
- Review Premium Fluctuations When premium rates fluctuate up or down, levels of expected losses generally tend to correlate. It is safe to say that if you see your premium rate drop for workers’ compensation, a lowered expected-loss rate will generally follow. Therefore, should loss experience and payroll levels stay the same, the contractor will see a rise in their ERM. Keep a close eye on your premium levels to forecast any potential future fluctuations.