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"Ex-mods" don't just drive premiums up or down based on recent experience. They also are used by underwriters and sometimes prime contractors to mark how an employer is doing relative to its peers in managing work injury risk. The NCCI designed the new formula to be revenue neutral. That is, among employers the combined premium will not change, although the effect will fall differently on each one.

It's this differential effect that is the most interesting thing about the new rules. For the new formula distinctly incents employers to be more assiduous about managing work injury risk. Some employers won't be happy that their premiums may over time surge because of the formula change.

I asked Scott Priz of Advanced Insurance Management to follow the ex-mod formula. Depending on its injury profile, the employer may find at the end a lovely damsel or a raging minotaur. (For a technical explanation the NCCI has a summary of its "split point" changes.)

The key change is a big increase from 2013 through 2015 in the losses per claim that are classified as "primary losses," from $5,000 to $15,000. These losses greatly influence the ex- mod. Priz told me that how this would affect a company's experience modification factors depends on the specific cost of individual claims, which, in turn can depend both upon employer safety management, insurer competency in adjusting claims and dumb luck.

Let's take two companies that are each paying $100,000 in premiums per year. Company A has had an average of two large claims per year of about $25,000. This would give it six claims total (i.e. three years) on its ex-mod, for a total of $150,000 in actual losses. It will have $30,000 of primary losses under the current system, since primary losses are capped at $5,000.

Company B has had more effective loss control, and those same six claims have averaged only $5,000. It will have a total of $30,000 of actual losses and $30,000 in primary losses.

Under the current system, the first company would have a mod of about 1.22, the second would have a mod of 1.08.

For both companies, their expected primary losses will rise by about 60 percent. But for Company A, which has not had effective loss control, its modification factor will increase dramatically. Using this new calculation, their actual primary losses will triple to $90,000. Because primary losses have a huge impact on ex-mods, its new ex-mod would be a 1.62, a third higher than before. Company B, whose losses have been held to $5,000 each, will have its modification factor drop 7 percent to 1.00.

This is a bit of an extreme example. Most companies have a mix of claims. But the effect of this change will be that if a company lets claims creep up, and doesn't get their injured employees back to work in a timely fashion, the effect of this change in NCCI's formula will be dramatic.

PETER ROUSMANIERE is an expert on the workers' compensation industry. He can be reached at riskletters@lrp.com.

April 13, 2012

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