Consolidating separate legal entities’ loss experience to develop a common experience modification factor has the potential to cause confusion for the client and sometimes the agent. Clients may view such mixing of loss experience due simply to common majority ownership as less than reasonable – especially if the commonly-owned entities substantially differ in regards to the relative hazard presented (i.e. the owners of a heavy equipment contracting company purchase a marina).
Further, combinability rules not only marry the experience of entities that are currently in operation and related via common majority ownership, they also assure that owners do not avoid their historically poor loss records simply by closing down one entity and reopening and operating under another corporate name. Few agents would argue that such a stunt is unethical at best and may actually be considered fraud. Changing the name of the operation does not change the operational methods of the owner(s).
Understanding combinability rules necessitate a basic understanding of the theory and practice behind the calculation of experience modification factors. Following is a brief synopsis of experience modification calculations.
Calculating Experience Modification Factors
Workers’ compensation loss costs are calculated and charged based on the average expected losses for that particular business classification. All insureds in the same hazard class (based on the assigned code) are charged the same basic loss cost (individual carriers apply conversion factors to these loss costs to develop their individual rates). However, not all insureds within a particular hazard class operate in the same manner, nor does each experience the same losses. To adjust for these differences in operation and loss histories, a method had to be created allowing for premium/rate differentiation between the above average, average and below average insureds within any particular hazard class code.
Experience modification factors (experience mods) allow such “customizing” and individualization of the workers’ compensation premium. Basing the standard premium on the insured’s unique loss history allows the class’ average rates to remain relatively constant and the subject insured to be rewarded or punished based on its own experience (rather than be subject solely to the experience of the group).
“Stop loss” limits used as part of the experience mod calculation makes loss frequency weightier than loss severity. One large claim will not damage an experience mod factor as drastically as three small claims in a single experience period (the “experience period” is usually the three years ending 12 months prior to the policy effective date – a 6/1/08 mod would apply the experience for the three years ending 6/1/07).
Calculating experience modification factors is far more complicated than presented in three short paragraphs. Mod calculations are a function of expected losses, actual losses, payrolls, class averages, loss limits (medical only vs. medical plus indemnity) and formulary factors applied by NCCI (or the applicable rating bureau) to all such collected data. Detailing this calculation is outside the scope of this commentary and is not an intended focus of this article.
Knowing and understanding that experience modification factor calculations allow for the reward or punishment of individual employers allows one to more clearly view the need for loss experience combinability. Employers should not be freed of their premium responsibility simply due to legal structure. And rarely are majority- owned entities not interrelated such that employees work for multiple entities even though they appear to be operating for just one employer in the course and scope of their daily duties (combinability avoids some of the problems created by the borrowed servant doctrine).
A Case For Combinability Rules
Owners theoretically run each and every operation (past and present) in essentially the same manner with the same attitudes. An employer that is concerned with safety and strives to provide the best equipment and training will likely always act the same way with each entity. Likewise, employers looking for the easiest and cheapest way out will likely continue down the same path in the future. Combinability rules are, to some extent, based around these theories:
• Employers that operate in the supposed best interest of their employees should have all their entities (current and future) rewarded due to such attitude. Commonly-owned operations will likely be managed in the same manner and the same care and concern is expected to be showed for all employees (regardless of the hazard of the operation).
• If an employer allows unsafe operations in one entity, it is reasonable to postulate that such attitude will carry over to the new entity and all commonly-owned entities (current and future). Employers not operating (or not appearing to operate) in the best interest of their employees should be subject to their past (or current) experience.
Past actions are not a guarantee of future actions, but they stand as a very good indicator. To not reward or punish allows employers/owners to act with impunity, knowing that as long as no law is broken, all that is necessary to escape a poor loss history is the killing off of an old and birthing a new corporation.
Without the ability to combine loss histories, workers’ compensation carriers would potentially be victims of inadequate premiums. In like manner, average and above average risks would be victimized by higher premiums than necessary. The “average loss cost” balance would be tilted and all employers would likely see an increase in their rates rather than just the ones that “earned” the increase. Rate predictability and possibly rate adequacy may be compromised without combinability rules.
Granted, there are exceptions to every rule such as is demonstrated by the employer that had a hiccup in their loss history not indicative of their past. Not every injury can be avoided, even with top-notch safety and training, bad “things” sometimes just happen. This is why there is underwriting discretion and the availability of rate credits and debits. A historically above-average employer with a bad year or two in their experience modification calculation can have the debit mod negated by a rate credit.
Conversely, an average or below average employer that has been fortunate can be debited to account for the increased hazard presented to the insured. Employers that do not practice or refuse to comply with recommended safety practices, as reported by the loss control department, can see their rates increased by a debit factor in anticipation of the increased potential for employee injury.
How combinability is determined along with the “rules” of premium audit and payroll inclusions and exclusions will be featured in the next several articles.