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Apr 12, 2010

Information On California's New Mod Formula



On November 9, 2009, the Insurance Commissioner approved a number of changes to the California Workers' Compensation Experience Rating Plan - 1995 (ERP) intended to simplify the experience rating system, improve its predictive accuracy and enhance its ability to provide a financial incentive for workplace safety. (See related story.) The changes are based on recommendations made by the Experience Rating Task Force, which was created by the WCIRB at the request of the Insurance Commissioner in 2007. Some of the approved changes will become effective on January 1, 2010 and some on January 1, 2011.

Experience Rating Formula Changes - Primary and Excess Losses

Whether or not a claim occurs tends to be more statistically predictive of an employer's future claims experience than the ultimate value of that claim which can be driven by factors outside the employer's control. For this reason, the incurred loss amount reported for each individual claim is, for experience rating purposes, split into "primary" and "excess" components.

The primary component of an employer's actual historical losses is more closely related to claim frequency and is more predictive of future claim experience. Primary losses are fully reflected in the experience rating calculation. The excess component of each claim is more closely related to claim severity and is less predictive of future losses. For this reason, the extent to which the excess component of an employer's actual historical losses is reflected in experience rating depends upon the size of the employer. For the smallest experience rated employers, none of the actual excess loss experience is reflected. For very large employers, most of their actual excess loss experience is reflected.

Until now, each historical loss amount was split into its primary and excess components using a complex algebraic formula. To simplify this portion of the experience rating formula, the WCIRB proposed a "single split" approach whereby the first $7,000 of a claim's value is considered primary and any remainder is considered excess (up to the $175,000 individual claim limitation). This single split simplifies the experience rating formula without impacting its predictive value. The Insurance Commissioner approved this change and it will become effective for all experience rated risks with an anniversary rating date on or after January 1, 2010.

Revised Credibility Values ("B" and "W")

The weight applied to the actual loss experience of an individual employer depends upon the predictive value of that experience in projecting future experience. In general, the claim experience of a large employer is more predictive of future claim experience (more credible), whereas the claim experience of a small employer is less predictive (less credible).

The credibility values in the experience rating formula, referred to as "B" and "W" values, reflect the statistical reliability of the employer's past experience as a predictor of future experience. These credibility values vary based on the size of the employer as measured by the total average losses expected to arise during the experience period for an employer of that size and industry classification. Based on a review of the recent loss experience of experience rated employers, the WCIRB recommended, and the Insurance Commissioner approved, updated credibility values for 2010.

Impact of the Changes in the Split Formula and Credibility Values

On average, the change in total credibility will be relatively small for most employers and the average experience modification over all employers will be essentially unaffected by the approved changes to the experience rating split formula and credibility values. However, the changes will affect the experience modifications of some employers depending on their payroll and loss history. The magnitude of these changes is typical of the change that occurs from year-to-year as a result of increases or decreases in payroll or losses incurred during the experience period. The combined impact of the change to the $7,000 single split formula and the indicated adjustments to the credibility values would be to improve the predictive accuracy of experience rating by approximately 12%.

Enhanced Expected Loss Rate Methodology

The Expected Loss Rate for each classification reflects the anticipated average cost of benefits estimated to arise during the experience rating period per $100 of payroll. Each classification has an expected loss rate and this rate is the basis to which an employer's actual losses are compared for experience rating.

At the recommendation of the Experience Rating Task Force, the WCIRB enhanced the methodology used to compute each classification's expected loss rate in order to improve their accuracy. Specifically, instead of developing expected loss rates based on a number of actuarial adjustments using statewide data, the WCIRB will use adjustment factors based on the experience of classifications grouped in accordance with the North American Industrial Classification System (NAICS). This enhanced methodology is anticipated to significantly improve the accuracy of the classification expected loss rates without impacting the overall average experience modification. The Insurance Commissioner approved this change effective January 1, 2010.

Impact of Expected Loss Rate Methodology Changes

The impact of these methodology enhancements on an employer's experience will depend on the mix of NAICS Sectors to which each employer's classifications are assigned and the employer's size. The impact of the expected loss rate methodology change should be relatively minor for the overwhelming majority of experience rated employers.

Experience Rating Worksheet Changes for 2011

The Insurance Commissioner also approved changes to the experience rating worksheet. Experience rating worksheets with an effective date on or after January 1, 2011 will include the employer's "Loss-Free Mod" showing the experience modification the employer would have received if no losses were incurred. In addition, each experience rating worksheet will include a page explaining the experience rating process and a brief definition of many of the terms shown on the worksheet.

More Information

The Insurance Commissioner's decision, the WCIRB's filing and related files are available in the Regulatory Filings section of the website. More information about the experience rating system, as well as other helpful information about workers' compensation insurance can be found in the Helpful Information section. See the Employer's Guide to Workers' Compensation.