NCCI Increases Split Point in Experience Rating Methodology - Our Agent Base Will Have the Advantage Over the Chaos to Come.

August 2011

At the Annual Issues Symposium 2011 in Orlando, FL, The National Council on Compensation Insurance (NCCI) Chief Actuary Dennis Mealy delivered his State of the Line report. This year's report outlines the continuing difficult trends facing the workers compensation industry and includes a "deteriorating" market forecast. Mealy shared the news that the primary-excess split point is increasing.

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NCCI Rating Plan Methodology Review

NCCI has recently conducted an “extensive review” of the experience rating plan. The experience rating shows “excellent results overall in performance testing for prior years”. While several adjustments, such as changing the number of years in the experience period, were apparently considered, the only change will be to the split point:

• The split point will be increased from $5,000 to $15,000 (trended) over a 3-year transition

• The split point will be indexed for claim inflation

• Filing for these changes will likely be made in 3rd quarter this year

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Primary/Excess Split Point

Every loss is divided into a primary and excess portion. In the promulgation of an experience rating modification, a split rating approach is used to reflect both the frequency and severity of losses. Currently, the split of actual incurred losses used in the experience rating calculation is applied as follows:

• The amount of the loss up to $5,000 is known as the primary loss, which reflects frequency

• The amount of the loss in excess of $5,000 is known as the excess loss, which reflects severity

This means that the first $5,000 of a loss is allocated to primary losses, and any amount over $5,000 is allocated to excess. (California - this change won’t apply to you.)

Small losses – those less than the split point – have NO excess value, primary losses work as an indicator of loss frequency. Large losses – those over the split point – always generate some excess value, they work as an indicator of loss severity. Primary losses are used at their full value in the mod calculation, while excess losses are reduced by the weighting factor. This follows the concept “severity follows frequency.” A company with several small losses will have a higher mod than a company with only one large loss (all other things being equal).

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Our Mod Department Calculations - Results Shocking

Our Mod Department has calculated the impact on the mods for several of our actual insureds with their current claim exposures, with only the change in primary split points from $5,000 to $15,000. A

t this point there is no telling what other weighting factors may be changed as this is instituted- but the results are predictably shocking.

1.) a 1.45 changed to a 1.83
2.) a 1.36 changed to a 1.72
3.) a .89 changed to a .96
4.) and a .96 changed to a 1.15

Every mod calculation is different- but both credit and debit mods saw dramatic increases. We strongly believe our agent base will have a unique advantage to capitalize on the chaos to come.

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Why Change the Split Point

Why change? The average cost of a claim has tripled since the last split point update two decades ago. Because of this, the portion of each claim that flows into the experience rating formula at full value (primary loss amount) is much smaller than what it was 20 years ago. The result is that the Experience Rating Plan is giving less weight to each employer’s actual experience.

The Plan formula has become less responsive and individual risk experience rating modifications have gravitated toward the all-risk average over time. To address this issue, a transition plan to increase the split point amount over time is proposed.

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What Should Brokers and Their Clients Do?

1. What is the company’s current ratio of actual to expected primary losses, and actual to expected excess losses? If the company currently has a primary loss (frequency) problem now, then start talking about safety measures and hiring practices to reduce the incidence of losses, and realize the importance of keeping losses medical-only, in states where the medical-only reduction applies.

2. What is the company’s current mod? If it’s at or only slightly under 1.00, and the company is one that must have a 1.00 or other value to bid on certain jobs, then take a look at the current mix of their losses and what they can do to assure losses are under control in the next couple of years.

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NCCI Suggested Second Change: Maximum Mod Formula

NCCI is also suggesting a change to the maximum mod formula. The purpose of this formula is to cap, or limit, any debit mod (a mod over 1.0) that exceeds a specific amount. The capped mod typically applies when expected losses are quite low in comparison to actual losses. Because the cap is determined by a formula related to expected losses and average claim cost (a number adjusted each year by NCCI), it is risk-specific.

NCCI is recommending a change because the current formula can produce a very low cap for small risks (generally 1,000 to 10,000 in expected losses, according to the NCCI graphs). This means:

• employers who are small risks and currently have a limited mod may see their mod increase

• other employers who are relatively larger risks and currently have a limited mod may see their mod decrease

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How These Changes Will Affect the Mod

Below is a summation and graph the impact on risks that NCCI projects:

Your client demographics may differ from this risk profile, but on average this graph suggests that:

• Nearly half of your clients will see a mod decrease of 2 points or more.

• Over a third of your clients will experience a small mod change of -2 to +2 points.

• If your clients are average, 1 in 7 will experience a mod increase of 5 points or more.

All of these changes are a great opportunity to be conversing with your clients and prospects about the minimum mod, the controllable mod, the maximum mod (when it applies to them) and the possibility of a mod change. The NCCI presentation also mentions some other possible forthcoming changes, but it appears that only the split point and maximum mod formula changes will be filed for approval by the states this year, in anticipation of a roll-out in 2013.

Future changes, which NCCI indicates they may further discuss late in 2011, include:

• an increase to the eligibility threshold

• replacing weighting and ballast factors with primary and excess credibility factors (Zp and Ze)

• other minor changes to make the language of experience rating more accessible