Experience Modification Rate
The Experience Modification Rate has 2 important roles:
1) The EMR is a pricing tool that insurance companies use to price workers' compensation insurance policies.
If you and I are both Missouri plumbers, for example, our workers’ compensation claims experience (over a three-year period) will be compared with other plumbers in the state, and an experience modification rate will be derived.
A 1.00 rating is average. Above a 1.00 is worse than average and below 1.00 is better. This factor is multiplied by your "manual premiums" and you either pay additional premium to your insurance carrier or receive a discount.
So, if my experience modification rate is worse than average and calculated to be a 1.10, I’ll pay my insurance company an additional 10 percent. An Experience Modification Rate above a 1.00 is known as a "debit mod." If yours is better than average and calculated to be a .90, you’ll receive a 10 percent discount. An Experience Modification Rate below a 1.00 is known as a credit mod.
It's pretty easy to understand that a debit mod (above a 1.00) will increase your premiums; cost you more money. But, this premium increase could be just the beginning.
Look at your most recent work comp audit for something called "Schedule Modification," "Schedule Rating," or something similar. Like an Experience Modification Rate this will be a debit or credit. And, without going into the detail of schedule rating here, this figure normally moves in correlation with the Experience Modification Rate. So, if you have a debit mod, you can expect to have a schedule debit. If have a credit mod, you can expect to have a schedule credit.
There are plenty of other examples. Take the Illinois Contractor's Credit Premium Adjustment Program for example. Illinois has a special rule that requires an experience modification rate below 1.00 to qualify for these lucrative credits which can be as high as 30 or 40%! If your Experience Modification Rate is above a 1.00, you don't qualify and your competitors (with credit mods) are getting 2 credits that you won't.
Underwriters have various guidelines for writing business; experience mod, lines of business, class code, premium size, credit history, etc. They all come into play. But, rest assured, Experience Modification Rate level IS one of those guidelines.
Insurance companies have to file their rates annually, so, theoretically, they have to offer the same rates to anyone in a certain class of business. However, they establish multiple "underwriting companies" which are different legal entities with different levels of filed rates. This allows them to have tiers of rates to offer a diversity of risks. A higher Experience Modification Rate will result in a quote from one of a carrier's "higher tier" underwriting companies. As your claims experience improves and you EMR falls, your business becomes more profitable to the insurance carrier and they'll typically move you to an underwriting company with lower rates to help retain your business. Of course, lower rates means lower premiums.
Some of the underwriters and insurance carriers with whom your broker does business could have easily declined to quote your business based on your Experience Modification Rate. You will probably never know about it. A lower experience modification rate will open up "more" markets from which your broker can obtain, possibly, better quotes.
2) The EMR is a crucial safety metric for many businesses operating in industries where the EMR must be submitted along with new business proposals and contract renewals.
There are many industries in which the submission of an Experience Modification Rate is required for new business proposals and contract renewals. Construction is one of those industries. If your company is one of the trades like, electrical, concrete, etc and you are bidding on a project for a general contractor, that GC will have a requirement that your Experience Modification Rate must be below a certain threshold. Normally, a 1.00 is that threshold although thresholds as low as a .80 are not unheard of in the industry.
You can imagine how critical this number is to those for whom the Experience Modification Rate impacts both premiums (expenses) and their ability to win jobs (revenues)!
The Experience Modification Rate is a critical "metric" to track and manage.
Both of the roles that an Experience Modification Rate serves, mentioned above, make it too critical to ignore. Especially so because it is a slow moving, difficult-to-change metric. The EMR is a 3 year moving average of policy data beginning 5 policies ago. Every year the oldest of 3 policy years falls out of the calculation and a new one enters the calculation.
For example, let's say that your current policy is your 1/1/20-21 work comp policy. The policies that are included in your Experience Modification Rating are your 1/1/18-19, 1/1/17-18 and 1/1/16-17 policies.
Current Experience Modification Rate Effective: 1/1/20
Current Policy: 1/1/20-21
Last Year's Policy: 1/1/19-20 (not included)
Policy 1/1/18-19 (included)
Policy 1/1/17-18 (included)
Policy 1/1/16-17 (included)
Next year, on 1/1/2021, 2 of the 3 policies from last year will still be included in your Experience Modification Rate.
Current Experience Modification Rate Effective: 1/1/21
Current Policy: 1/1/21-22
Last Year's Policy: 1/1/20-21 (not included)
Policy 1/1/19-20 (included)
Policy 1/1/18-19 (included)
Policy 1/1/17-18 (included)
You see that a bad year of claims data will take 3 years before expiring from your Experience Modification Rate calculation. And, let's say your EMR is not good and you decide right now on actions you can take to improve the situation. It will take be 2 more policy renewals before the claim reducing measures undertaken will enter into your Experience Modification Rate; 2 more beyond that before you enjoy the full effects of your efforts.
The Weight Factor is an important element in determining your Experience Modification Rate. It is found in the upper left corner of the first page of your Experience Modification Rating Worksheet; Box A.
Below are examples from two different clients. One's weight is a .21 while the other is a .68.
There are a number of ways to describe this factor. One is related to the Law Of Large Numbers and the greater predictive value of a sample the larger that sample grows. In insurance The Law Of Large Numbers states that as the number of policyholders increases, the more confident the insurance company is of the accuracy of it's predicted losses.
This principle is behind the determination of your Weight Factor. It is a measure of the credibility of losses and rises as the size of the employer rises. Another way to look at it is that it rises as the amount of an employer's expected losses rise.
Notice in the examples above that the client with a .21 Weight Factor had only $300,215 in Actual Incurred Losses (Box H). And, the client with a .68 Weight Factor had $10,407,969 in Actual Incurred Losses.
So, how does this impact your Experience Modification Rate? The Weight Factor determines what percentage of Excess Losses are factored into your Experience Modification Rate.
The client with the .21 Weight Factor had a .87 Experience Modification Rate. You can see all of the actual inputs on the Experience Modification Rate Worksheet below. And, beneath that, you can see what happens to this clients Experience Modification Rate when we change that Weight Factor to a .68.
Using the same loss data in our spreadsheet while only changing the Weight Factor to .68 from a .21 decreases the Experience Modification Rate to a .75.
Another important characteristic of the Weight Factor is that it controls how low your "minimum experience modification rate" can go. Click on the page What Is A Good EMR to see how to calculate your "minimum mod" (what your experience modification rate would be without any claims). The minimum Experience Modification Rate for this client with a .21 Weight Factor is a .69. However, when you change the Weight Factor to a .68 the minimum Experience Modification Rate for this client becomes a .37. So, the higher the Weight Factor the lower your minimum Experience Modification Rate can drop.
Click on the above image to read the article; Liberty Mutual Accused Of Inflating Comp Premiums
Experience Modification Rate errors described in the above article are not unique to any one workers' compensation insurance carrier. They happen all the time. That is why it's a good idea to have some due diligence performed from time to time by an independent auditor to confirm your Experience Modification Rate is accurate and your work comp premiums are properly calcualted.
EMR, Mod, EMod, XMOD
18 months after the inception date of your policy (normally 6 months after expiration if you don't terminate a policy early) is your valuation date. Your insurance company/companies send payroll, classification, and loss data to NCCI for promulgation of your next Experience Modification Factor.
The "Rating Bureau" that calculates Experience Modification Rate in 39 states.
Scopes - Classification Codes
"Scopes" gets it's name from NCCI's Scopes Manual; a guide of classification codes used to properly classify employees. Each code defines jobs (like Carpentry) and describes employees who would be covered under that code. How your employees are classified is important for many reasons, but, from an Experience Modification Rate perspective, one of the most important is the determination of Expected Losses.
Expected Loss Rate
The amount your carrier can expect to pay in losses for every $100 of payroll per Classification Code. An Expected Loss Rate is calculated by NCCI for every classification code in every one of the 39 states where they have jurisdiction. The other states have bureaus that calculate their own ELRs.
The Split Point is currently (2019) $17,000.
The amount of an individual claim below the Split Point.
The amount of an individual claim above the Split Point.
The "D" in D-Ratio on your experience modification rating worksheet stands for Discount. The D-ratio is the estimated ratio in your experience modification rate of expected primary losses to expected total losses. This is calculated individually for each classification in every state . The D-ratio is used to determine the expected primary losses to be used in the experience modification rate calculation.
An Experience Modification Rating has an effective date normally corresponding to the effective date of your policy. It contains historical policy data used to calculate your EMR. The Experience Period governs which historical policies are to be included. NCCI's Experience Period is any policy whose effective date is not more than 57 months prior to your EMR's effective date and not less than 21 months.
The NCCI Experience Rating Plan gives more weight to frequency that it does severity. High frequency indicates a higher likelihood of future losses. The amount of a claim below the Split Point (above) reflects frequency.
Severity in your NCCI Experience Modification Factor is accounted for by the amount of each claim above the Split Point, Excess Loss.
Frequency vs Severity
Take 2 plumbing contractors with the same number of employees:
Business 1 has one claim for $20,000
Business 2 has 20 claims for $1,000 each
Both have $20,000 in total claims. Business 2 will have a higher Experience Modification Rate due to frequency.
Experience Rating Adjustment - ERA
The Experience Rating Adjustment has been adopted in nearly all NCCI states and independent bureau states. Medical Only Claims are reduced by 70% in your Experience Modification Rate. So, if you have a $300 Medical Only Claim on your Experience Modification Rate worksheet, only $90 dollars of that claim (30%) will be factored into your Experience Modification Rate.
Ownership - ERM-14
Entities under common ownership are supposed to be combined for Experience Modification Rating. So what happens when companies or divisions of a company are sold, acquired, merged, etc? Portions of ownership interests are sold? A new entity is formed? Determining the combinability of experience to produce a new, combined Experience Modification Rate is one of the functions of NCCI. An ERM-14 form must be completed and is the first step in the process.