After 20 Years of Inflation, NCCI Updates Experience Mod Formula

A recent Business Insurance article “New NCCI Methodology Will Change Premium Calculations” discusses the potential impacts to individual risks of a long overdue update to the calculation of an employer’s experience modification factor.  But don’t be misled by the gloomy picture that is painted by the headline.  In actuality, the proposed changes to the “split point” in the experience modification formula represent neither a change in methodology nor a change in the way premiums are calculated. 

The function of the split point is to split a loss into primary and excess portions.  For an individual risk, losses that are considered primary (below the split point) are given full weight in the experience rating formula, while losses above the split point are considered excess losses and given only partial weight.

It is true that, under the proposed split point, employers with poor loss experience will pay more for their workers’ compensation coverage than under the current formula.  That’s because the current split point of $5,000 has been in effect, unchanged, for about 20 years.  Over this time, however, the average claim severity has approximately tripled.  Significant claim cost inflation has eroded the effectiveness of the current split point, resulting in an experience modification formula that is non-responsive to an individual employer’s loss experience.

In most states, the NCCI is proposing to update the split point over a transition period of 3 years.  Beyond the transition period, the split point will be updated annually in order to keep pace with inflation and to prevent another such disparity.

What should be emphasized is that the average statewide impact of this change will be revenue neutral.  That means that every additional dollar that is charged to an employer with poor loss experience will approximately represent a dollar of savings for an employer with effective loss control practices.

The primary objective of the experience rating plan is to distinguish an individual risk from those that are similarly classified by looking at that risk’s loss experience and charging premiums that are commensurate with that experience.  The erosion of the $5,000 split point over the past 20 years has resulted in an experience rating formula that does not effectively distinguish one risk from another.  The NCCI’s proposed changes to bring the split point up to current cost levels represent an improvement to the plan by giving more weight to an employers’ actual experience in the calculation of their experience rating modification factor.

What are your thoughts on the proposed change?  Do you think this update will encourage employers to implement loss control strategies?  Let us know.

Ashley Pistole, FCAS, MAAA, is a consulting actuary at Merlinos & Associates.


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