Q & A: Your Experience Modification Factor
Q. “My company's Experience Modification is .94. Since it is below 1.00, is this considered a “good “ Mod?
A. It's a common misconception that a Mod of 1.00 is good. While the details of the formula that calculates the Mod are quite complex, the rating system is designed to measure whether your company's Workers' Compensation losses are better or worse than expected. If your experience is worse than expected, your Mod will be greater than 1.0. Conversely, if your experience is better than expected your Mod will be lower than 1.0. Therefore, a mod of 1.0 is average – much like getting a “C” on a report card.
In assessing whether or not you have a “good” Mod, the three most impact factors to look at are:
1. The gap between your current Mod and the lowest possible Mod
2. Actual vs. expected losses
3. The cost of each loss
Q. “If we have a really good year with few losses, will our Mod be reduced?”
A. It's important to understand that the Mod is computed using data for an experience rating period. Generally, this covers three years and the most recently completed year is excluded. For example, the mod for 1/1/2007 would contain experience from policies that were effective 1/1/2003, 1/1/2004 and 1/1/2005. If your “really good year” was in 2006, it will not come into play until 1/1/2008 and will be included along with years 2004 & 2005.
Q. “What happens if our company has one very large loss? Will our Experience Mod go through the roof?”
A. The experience rating system has checks in place to limit the impact of one very large loss. The losses for a company are divided into two categories: primary losses and excess losses. For most states, the first $5000 of each loss is called primary and the balance is excess. The experience rating formula uses all of the actual primary losses in the calculation of the Mod. However, only a percentage of the excess losses is used. In addition, single loss limits are set by states.
Q. “Our Mod is higher than I'd expect. We have had no large claims, but several smaller claims, all of which were less than a few thousand dollars.”
A. Actually, loss frequency is a great concern of underwriters. A company with 10 small losses is considered more risky than a company with one large loss, because frequency can reflect a negative pattern. Each time a loss occurs, it is possible that the severity could be significant. If you reduce the frequency of losses, you reduce the possibility of having a severe loss.
As noted in the question above, losses are divided into primary and excess. All things being equal, if you have 20 losses, totaling $50,000 and another company has one claim of $50,000, you will have a higher Mod.
Q. “How are ‘expected' and ‘actual incurred' losses determined?”
A. Expected losses are based on actuarial models of how others in your industry are performing. Actual incurred losses include not only what the insurance company has paid out for the claim, but also the reserves that the insurance company has set aside to pay for the claim. If the claim is closed, it is the total amount paid.
If your losses are higher than expected loss, then you are at a competitive disadvantage because your costs will be higher than your competitors. The lower your losses, the more competitive you can be.
Q. “The classification system is baffling me. I don't understand why I can breakout some workers into their own classification, whereas others go into the governing classification.”
A. You are not alone; the classification systems used for Workers' Compensation are unique and confusing. It's important to remember that it is your business that is classified, not each and every job function. Almost all businesses will have more than one classification code used in their policy and the rate per hundred dollars of payroll varies by classification. Therefore, it is critical to work with your Advisor to be sure that all employees are properly classified. Mistakes often result in unnecessary increased premiums.