An Experience Mod lesson

Why small, frequent claims can be more costly than one severe claim

The formula for Experience Modification Factors is so complex it intimidates many. A ratio of the company’s actual losses compared to the losses that are expected for their company based on their payroll and industry classification, the Experience Mod is key to controlling Workers’ Compensation costs.

Included in the formula are actual primary losses – the first $5,000 of each loss. This is how the formula takes frequency or number of claims into account. Also included in the formula are actual excess losses – loss amounts more than $5,000. This is how the formula takes into account severity. These excess losses are then multiplied by a value set by the NCCI or state rating bureau that increases as the expected losses increase, but at a slower rate. This limits the effect of excess losses and the effect of any single loss on the Experience Mod.

As an example, multiple claims, each under $5,000, that total $10,000 are counted as primary losses. A single loss of $10,000 will be treated as a $5,000 primary loss and $5,000 excess loss. Thus, frequency or number of claims has a greater impact on the Experience Mod and the overall costs of Workers’ Compensation than severity.

It’s important to note that actual losses include not only what the insurance company has paid out for the claim, but also the reserves, or what the insurance company expects to pay for the claim in the future. Employers often do not realize this and it can have a significant impact on the cost of Workers’ Compensation insurance. For this reason, it’s critical that reserves be set correctly and carefully monitored regularly.