Editor’s note: Don’t miss our newer articles on this topic :

• Experience Rating Split Point Change FAQs 6/12/2012
• News Regarding the 2013 Split Point Change (from NCCI and Independent Bureau States) 2/8/2012
• New Report Estimates Mod Change Due to 2013 Split Point Value 11/16/2011
• NCCI Publishes FAQ on Split Point and Maximum Debit Mod Changes 8/8/2011
• How Will Mods Change Under New NCCI Plan Recommendations? 8/2/2011

A few weeks ago, colleague Michelle Jackson and I attended NCCI’s 2011 Annual Issues Symposium. We got lots of great data and ideas to share with insurance and risk management professionals, and their clients, in coming blogs on a wide range of work comp topics. But the piece of news that captured my attention the most will also interest many of you, I’m sure. On one slide near the end of the sixty-slide State of the Line address, NCCI chief actuary Dennis Mealy shared this news about the experience rating calculation: The primary-excess split point is increasing.

The Few Facts We Know

NCCI has recently conducted an “extensive review” of the experience rating plan. Overall, Mealy stated, they are very pleased with plan results. While several adjustments, such as changing the number of years in the experience period, were apparently considered, the only change will be to the split point:

• The split point will be increased from $5,000 to $15,000 over a 3-year transition period.
• After the transition, the split point will be indexed for claim inflation in subsequent updates.
• Filing for these changes will likely be made in 3rd quarter this year; an NCCI staff member told me that the effective date of the change will roll out, state by state, in the late 2012 – early 2013 time frame.

Revisiting the Purpose of the Split Point

Every loss is divided into a primary and excess portion. Until now (and for as long as I can remember), the split point has been $5,000. This means that the first $5,000 of a loss is allocated to primary losses, and any amount over $5,000 is allocated to excess. (California readers, remember that your split point is calculated differently and this change won’t apply to you.)

Since small losses – those less than the split point – have NO excess value, primary losses work as an indicator of loss frequency. For example, three $4,000 losses yields $12,000 in primary and $0 in excess.

Since large losses – those over the split point – always generate some excess value, they work as an indicator of loss severity. For example, one $12,000 loss yields $5,000 in primary and $7,000 in excess.

Primary losses are used at their full value in the mod calculation, while excess losses are reduced by the weighting factor.  This follows the simple – but proven – concept in insurance that “severity follows frequency.” So in the sample above, a company with several small losses will have a higher mod than a company with only one large loss (all other things being equal). And, in the sample above, after the split point has moved to $15,000, both examples would have all primary and no excess losses!

What Does This Mean to Brokers and Their Clients?

First of all, I think it’s important not to assume too much about this change, because NCCI will certainly be changing rates to coincide with the change in split point. Remember, their goal is for the average mod to be 1.00. That said, I think it’s reasonable to expect that companies with certain payroll and loss profiles may be slightly more vulnerable to an impact from this change than others. This is the phenomena that we saw when California changed some of their experience rating plan rules effective 1/1/2010. Unfortunately, we don’t know yet what those profiles may be, since we don’t know how NCCI will be adjusting the ELR and D ratios and the weighting and ballast values.

Just to see the impact of the split point change alone, I changed it from $5,000 to $15,000 in ModMaster (sorry, this isn’t something you can do on your version!). On a handful of test cases – all actual mods that we’ve assisted clients with – primary losses increased by 35 to 50%. But again, we can’t know the significance of this, since we don’t know how expected primary losses will be changing, and therefore it’s impossible to know what this will ultimately do to the mod. However, I do think this means there will need to be a mind shift about the significance of losses, since in a few years losses up to $15,000 will be contributing entirely to frequency.  Here’s what I recommend brokers, risk management consultants, and their clients start considering:

• What is the company’s current ratio of actual to expected primary losses, and actual to expected excess losses? (ModMaster users can run the Ratio Analysis report to get this data.) If the company currently has – or is on the brink of – a primary loss (frequency) problem now, then this seems like an especially good time to be talking about safety measures and hiring practices to reduce the incidence of losses, and the importance of keeping losses medical-only, in states where the medical-only reduction applies.
• What is the company’s current mod? If it’s at or only slightly under 1.00, and the company is one that must have a 1.00 or other value to bid on certain jobs, then you especially want to help them take a look at the current mix of their losses and what they can do to assure losses are under control in the next couple of years.

Hopefully, as we had in California, we’ll have indications from NCCI about what to expect before the change actually occurs. If so, we’ll certainly be updating you on this topic again. In the meantime, what thoughts and questions come to your mind about this change? I’ve been experimenting with some ideas for a ModMaster report to help assess the losses that might be most vulnerable to this change – do you have ideas for a new report that could be helpful?

As always, feel free to comment here or to email me at [email protected].

– Kory Wells, WorkCompEdge Blog Editor

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