Is Your Experience Mod About to Become a Headache?

If you are a contractor, odds are that you are familiar with the Experience Modification Rating Factor (Mod or EMR for short) component of your Workers’ Compensation Insurance. Many owners and general contractors have requirements limiting a subcontractor’s Mod to a specific level, usually no higher than 1.00. In addition, since the Mod is a significant component in determining Workers’ Compensation pricing, it makes sense to be on top of it.

Given the way it is promulgated, it is debatable that the Mod is a good indicator of a contractor’s overall safety program or safety record. At best it is an imperfect tool for predicting the frequency and cost of workplace injuries for a specific class of business by examining past losses incurred by that class of business. What is not debatable is that the National Council on Compensation Insurance (NCCI), the organization that is responsible for determining the formula used to promulgate the Mod, is changing that formula. And it could create a headache you were not expecting.

Most states are already on board with this modification. NCCI has filed for a change in Illinois to become effective on January 1, 2013. Missouri was one of the few remaining holdouts, but has adopted the new formula as well. In its Illinois filing, NCCI noted that the impetus for the change was that loss costs have been increasing and that some alterations to the calculation were necessary to take these increases into account.

The purpose of the Mod is to compare an insured’s Actual losses to losses Expected for all insureds in a class of business in a given state or states. Expected losses are calculated using audited payroll amounts, by state, for the past three policy years not including the most recent year (these losses are considered “too new”). So, for example, an insured’s 2012 EMR is calculated using 2008, 2009, and 2010 losses. The formula uses three different amounts, added together, to determine both Actual and Expected losses for the rolling three year period. These amounts are Primary Losses, Excess Losses and a Ballast Factor.

Currently loss amounts up to $5,000 are counted in the EMR as Primary Losses on a dollar-for-dollar basis. Loss amounts in excess of the $5,000 are considered Excess Losses, but are discounted significantly (roughly 95%). The Ballast Factor is a calculated amount that is much larger than Primary or Excess Losses and is added to Actual and Expected Losses to moderate the affect losses have on the Mod. Without the Ballast Factor relatively small losses could create large swings in the Mod from one year to another. The dollar amount that separates Primary and Excess Losses (currently $5,000) is called the Split Point.

For states adopting the new formula NCCI is changing the Split Point. Over a three-year period beginning in 2013 the Split Point will increase from the current $5,000 to a number indexed upward annually. In Illinois the splits will be implemented differently ($10,000 in 2013, $13,500 in 2014, and $15,000 in 2015) than in Missouri ($7,500 in 2013, $10,000 in 2014, and $13,500 in 2015).

The index is based on a national average dollar amount per claim. NCCI is increasing Expected Losses as well, but is not disclosing how that component of the formula will be changed. Most experts believe that the increase will not be commensurate with the increase in the Primary Loss factor on a 1:1 basis.

So what does all this mean to a construction business owner? Most likely it means that Primary Losses will comprise a larger percentage within your EMR. In Missouri under the current formula, a $7,500 loss reflected in your EMR calculation would have had $5,000 allocated towards Primary Losses and roughly $125 towards Excess Losses (5% of the remaining $2,500 Excess) for a total loss amount of about $5,125. In 2013, if that loss is still a part of your Mod calculation, that same $7,500 loss will all be allocated towards Primary Losses, for a total loss amount of $7,500. In this example, you would see a 32% increase in the Actual loss amount and a 50% increase in Primary Losses in 2013 for the year reflecting that same loss in the Mod calculation. So, contractors that have losses that fall between the old and new Split Points in their 2013 EMR calculation could see an increase in their Mod without any significant increase in loss activity. Contractors with only smaller losses that fall below the old Split Point could see their EMR go down.

This can affect your ability to get work and what you pay for workers’ compensation insurance. The jury is still out on how owners and general contractors will react to the change and how NCCI will modify the Expected Losses component of the EMR calculation. Stay tuned!