Experience rating modification (ERM) as used in workers compensation is intended to objectively adjust premium promulgation according to an individual employer’s claim history. ERM’s can have a significant affect on final premium calculations and are used in some industries as eligibility thresholds for vendors and contractors.
In August 2011, National Council on Compensation Insurance (NCCI) announced it had filed with the various insurance departments a substantive change in the ERM calculation methodology. Since NCCI acts as the rating bureau for all but eleven of the non-monopolistic workers compensation states, acceptance of the new methodology will be widely felt.
The ERM calculation splits each claim in a particular policy-year between the amounts above and below $5,000. The amounts below are known as the primary losses; the amounts above as excess losses and the $5,000 amount itself is referred to as the primary/excess split point.
The purpose of splitting each claim for the ERM is to tabulate primary losses and excess losses separately as measures of frequency and severity, respectively. Under the split approach to ERM calculation, primary losses receive full weighting in the formula, while excess losses receive only partial weight.
Since the last split point revision occurred two decades ago, the average claim cost has tripled. Therefore the number of claims that remain in the primary layer at full value is much smaller than twenty years ago. This has resulted in treating claims average in size more like an excess than primary losses.
To address this “bracket creep” NCCI has proposed to adjust over three years, the primary/excess split point. The proposed transition plan is as follows:
- Year 1: The split point will initially be increased to $10,000 to become effective with each state’s approved rate/loss cost filing on or after January 1, 2013.
- Year 2: The split point will be increased to $13,500 with the state’s next year filing.
- Year 3: Effective with a state’s third year filing the split point will be raised to $15,000 plus two year’s inflation adjustment rounded to the nearest $500.
NCCI intends the aggregate affect of the split point adjustment to be neutral across all employers. However, the impact to individual employers will vary greatly according to their loss history of claims that exceed $5,000. If none of their claims exceed $5,000 they will generally see a decrease in their ERM. An increase will generally depend upon whether an employer has an above average amount of claims over $5,000.
An analysis by an independent consulting firms indicate that 18% of employers will see changes in their ERM from +2 to +11 or more points. Some employers with significantly above average claims above $5,000 will see the ERM increase from 6 points to as much as 15. On the bright-side, nearly half of all employers will see a ERM decrease of 2 or more points.