If your **workers compensation** costs are a significant factor in your labor costs, you know how important your "experience modification factor" (your "mod") is.

The workers comp experience mod is a multiplier in the calculation for how much you pay for workers compensation insurance, where 1.00 is the mean (the average). Over 1.00 will charge you more, and under 1.00 will be less. For example, if a 1.00 factor generates a $5,000 workers compensation cost, then a 1.10 will take you to $5,500. Conversely a .90 factor gets you to $4,500, much better. This has a direct effect on your labor costs relative to your peers.

**How is the mod calculated?**

The workers comp experience mod calculation takes your loss experience and historical cost (premium) into consideration to calculate how much above or below the median your experience places your company. High losses, you'll pay more; fewer, smaller losses, you'll pay less.

The experience used for the calculation is ancient history for some, from four, three and two years ago. Why so long back? Because we don't know the final premium and loss experience - needed for the experience calculation - until after a policy year is over. See the chart below for a 2018 renewal as an example:

The 2017 policy year experience does NOT count for 2018, since the year is not yet over when the renewal cost is calculated. There is a one year gap for the most recent year, to allow the audit to occur and for any claims to close out (or not), then a three year look-back. One conclusion we can immediately make from this chart is that the large claim ($79,110) that occurred in 2014 will not be on next year's calculation. Meaning we can expect the factor to drop significantly next year as this big loss ages off.

What is the difference between **Actual Incurred** and **Actual Primary** losses?

"Actual Incurred" includes the losses paid, plus expected future payments (known as reserves), plus insurance company expenses. "Actual Primary" losses are limited to the first $5,000* of each claim. In the example above, we know that in 2014 there was one big claim, limited to $5,000 'primary', plus two other small claims for a combined total of $5,653.

(* Primary losses are capped at $5,000 in Massachusetts. Most states follow a national model – NCCI – which include primary losses up to $16,500.)

What are **Expected Losses?**

"Expected losses" are the average losses in a given class code. If a company had losses that were the same as expected losses, they would end up with a 1.00 factor. These expected numbers derive from published tables at the Workers Compensation Bureau. These are important because they make up part of the denominator – the bottom half of a fraction – in calculating the experience modification factor.

**How does the fraction unfold?**

For those who jump into the math behind an experience worksheet, the printed section below will look familiar. This is how the math works. It may look intimidating with all the letters and numbers, but can be boiled down to a few simple components.

Each of the components is broken down further in the color coded image below. To simplify, bear in mind that the second and fourth formulas are numbers over themselves, or mathematically, 1. Because the formula adds these, rather than multiplies them, they still matter. But they matter less and are not numbers that we control. Focus instead on the first and third calculations, **B/D** and **(E x G) / (F x G)**.

Insurance pricing has two fundamental elements: **frequency and severity**. The first formula measures frequency, by adding up all the "primary losses"; the third measures severity, aggregating "excess losses", duly discounted (in this case by 93%). The other components to the fraction only moderate the effects of these two (which matter).

The first formula includes your "Actual Primary Losses," all those under $5,000, relative to your industry's average (the "Expected Primary"). If your actual losses are higher than your peers, your factor will trend higher. If you're lower, your factor will follow. Lower is better, because lower relative costs improve your position against competitors. This is the 'frequency' part of the insurance calculus: three $2,000 claims have a greater impact on this ratio than one $12,000 claim, which will be capped at $5,000 (primary).

The second portion is ballast (H/H): just as ballast rights a ship buffeted by strong winds, ballast in this calculation is intended to steady the fraction from one-off severe claims. Ballast is a published number related to your "Expected Losses" - a measure of your size - for you and your peers in an industry.

The third piece, the other important element, "Actual Excess Losses" over "Expected Excess" measures the Excess losses relative to the industry average, discounted by a statistical weighting moderator, in this case, to 7% (weighting is also a published number, and also derived from Expected Losses). Losses over the $5,000 primary limit are discounted 93% (1 - .07 = .93). That's the good news. The bad news is that large claims, even when heavily discounted, can still have a major effect. In the example above, Excess losses ( E ) were $73,457 from one huge claim. 7% of $73,457 is still $5,142, more than another "primary" maximum loss. Remember too that each of these count for three years.

Of note, these large paid claims often include "lost time", aka "indemnity," in addition to medical care, meaning continued wages paid by workers compensation insurance to an injured employee. This is why "**return to work**" policies can be so important to businesses that __can__ re-deploy injured workers into light duty work. Minimizing the impact of infrequent severe losses through formal "return to work" programs eases its (3 year) impact on your future labor costs.

The final element in the fraction is another number over itself: Expected Excess over Expected Excess, both of which are industry averages, independent of a company's experience. This has a stabilizing effect and cannot be influenced by our or your company's efforts.

The experience worksheet may seem unimportant where losses are infrequent and below peers. Everyone likes a lower factor, and attention to this calculation lacks urgency when all is well. Ultimately, effective worker safety programs will help to keep losses low and the calculation will reflect those efforts over time.

For a closer look at your experience and how you can improve it, how the All Risk Adjustment Program (the ARAP Factor) is an accelerant on these calculations, or to discuss any other aspect of your **workers compensation** program, contact the risk and insurance professionals at **Gordon Atlantic Insurance** by calling toll free (800) 649-3252. Prefer to type instead of talk? Click below!