Understand how your experience modifier can impact your construction insurance premium.
Editor's Note: See Steven Davis's other articles in this insurance series that covers every type of insurance coverage a contractor needs.
When insurance companies assign premiums, they compare an individual contractor’s loss experience to those performing similar types of work. While a construction insurance company underwriter will employ several tools in accomplishing this, one common process is known as the Experience Rating Modifier (ERM), declared by the National Council on Compensation Insurance (NCCI).
Insurance companies calculate the ERM as a factor of the insured’s loss experience, and that factor modifies the standard workers’ compensation premium. Therefore, contractors with higher than average losses will pay more for their insurance than those with average or lower than average losses.
High ERMs lead underwriters to be more cautious with program design and cost factors. Additionally, project owners will examine a contractor’s ERM as part of the qualification process. Those with an ERM greater than 1.00 may be subject to closer scrutiny for safety management processes and may be excluded from consideration.
The most effective method to manage the ERM is understanding how it is calculated. For instance, ERMs are more sensitive to loss frequency than loss severity. The modifier will more likely fluctuate with continuous, repetitive claims than with a few large losses. With that in mind, reducing loss frequency will greatly enhance a contractor’s ability to lower the ERM and reduce the probability of larger claims. But it goes much further than that.
Seven-step action plan to manage your ERM
1. Create a Construction Safety Program
By developing and implementing an effective safety program, the severity and frequency of workers’ compensation losses can be greatly reduced. The ERM formula recognizes it is more difficult to control loss severity than loss frequency. With that in mind, a contractor experiencing numerous small losses will more than likely have a higher modifier than a contractor experiencing a few large losses, even if the dollar amounts total the same. Currently, the ERM is calculated using a primary and excess loss split, which is set at $5,000 per claim. A claim at that level or under that level will be fully ratable at 100 percent, while losses exceeding $5,000 will be discounted by a percentage within the ERM formula.
2. Ensure Proper Rating Classification
Misclassification can greatly affect the ERM and the resulting insurance premium. Classification into a lower rated class may initially result in lower premiums, but loss experience will place increasing pressure on the ERM, resulting in an increased modifier and associated premiums.It is critical to know your classification matrix. Misclassification may inaccurately compare your loss history to those in your field. Work with your insurance broker/agent to ensure proper classification. Over a long period of time, a lower class rate could negatively affect the ERM.
3. Review Open Claims Annually with Your Construction Insurance Adjuster
Your ERM calculation incorporates reserves for open claims and paid claims. Insurers generally set up an initial reserve when a claim is first filed and will adjust this reserve as the claims process continues, with the final claim often settling for less than the initial reserve. Work with your claims adjuster on the remaining reserve levels, and negotiate a reduction or elimination of certain amounts. Insurance companies will report the upcoming modifier data to NCCI four to six months prior to the next mod effective date. The claims review should be completed early enough to incorporate reserve changes into the loss information.
4. Audit for Mistakes
Your ERM is calculated based on three years of loss information, audited payroll, applicable states of operation and WC classification. Work with your insurance provider to review the accuracy of this information. Be sure this data has been properly reported to the rating bureau and that it includes any Owner or Contractor Controlled Insurance Program (OCIP or CCIP) payroll/losses. Be aware that mistakes happen. Typical ones include payroll allocated to incorrect states, wrap-up (OCIP) payroll missing, incorrect claim values included in data, subrogation recoverables and misclassification of operations.
5. Prepare a Test Modifier, and Compare Year-end Calculations
Have your insurance provider prepare a test modifier at least 60 days in advance of the actual rate date to gauge the potential modifier level. Use this as a benchmark for future ERM levels and accuracy. Once the test modifier is calculated, this information can be used to audit the actual modifier developed by NCCI.
6. Pay Small Medical Claims
Since the ERM is more directly related to loss frequency than loss severity, medical-only claims of $5,000 or less can greatly affect the modifier. To offset this, contractors can pay these small medical-only claims through an agreement with their insurance provider. This will help alleviate the frequency-driven upward pressures of the experience modifier. Set up a plan with your insurance provider that dictates all small, medical-only claims will be paid out of pocket.
7. Review Premium Fluctuations
Insurance companies will differ on their workers’ compensation rates by state to some degree. For instance, one insurance company may charge $5.75 for WC 5606, whereas another insurer may charge $3.89 for the same class and state. This lower rate will also mean a lower expected loss rate. The ERM compares expected losses to actual losses. If lower rates are used to calculate expected losses within the formula, the result puts pressure on the ERM over the long term. A similar challenge exists today with contractors having to move around the country to secure work. Rates vary by state. The ERM can be impacted negatively if rates are adequate in one state but inadequate in another and payroll moves from one to the other.
Future Changes from NCCI
The NCCI recently completed an Experience Rating Plan methodology review. Recent bulletins from this review suggest upcoming changes that could have negative implications for contractors and their ERMs. While these changes must be approved by individual states, they will be implemented over the next three years. Two key changes include the following:
- An increase of the current split for primary and excess losses is due given a 250 percent increase in the average WC claim since 1993. As noted earlier, the current split is set at $5,000. NCCI is suggesting a three-year transition for this split and indexing the split point for claim inflation. Beginning on or after January 2013, the split will begin to rise in increments over the transition period. The ultimate split level is set at $15,000 plus applicable adjustments for inflation. While the proposed split level is deemed by NCCI to be premium-neutral across all employers, the impact of the split will be risk-specific and will vary depending on each company’s risk experience. The key here will be whether an employer has below-average or above-average claims above $5,000. Both credits and debits will increase.
- Debit modifiers that exceed a specified amount are subject to a cap, which is determined by a formula. This cap will vary by state and by the size of the risk. For instance, a smaller employer will have a lower cap.