The National Council on Compensation Insurance (NCCI) recently announced its plan to increase the primary-excess split point over a three-year transition period. The first stage of the transition will take effect with each state’s approved rate and loss cost filing on or after January 1, 2013.
Understanding the Primary-Excess Split
In the experience rating process, each loss is divided into a primary and excess portion. Currently, the first $5,000 of every loss is allocated as a primary loss with everything over and above considered an excess loss. For example, a $3,000 loss has no excess value. On the other hand, a loss of $15,000 would have $5,000 in primary losses, as well as $10,000 in excess losses. Primary losses are used as an indicator of frequency and are counted in full as part of the mod calculation. Conversely, excess losses receive partial weight in the mod calculation. This means that primary losses affect the mod more than excess losses do.
The rationale behind assessing primary and excess loss amounts is that “severity follows frequency,” or in other words, an organization that displays a continual pattern of loss has an increased chance of a severe loss in the future. Thus, a company with a large number of primary losses will have a higher mod than a company with the same amount of losses split between primary and excess.
NCCI has announced a proposal to raise the split point from $5,000 to $15,000 over a three year period to better correlate with claim inflation, which has almost tripled since the last split point change nearly two decades ago. Because of this, the portion of each claim that flows into the experience rating formula at full value (primary loss amount) is much smaller than 20 years ago giving less weight to each employer’s actual experience. Consequently, the Plan formula has become less responsive and individual risk experience rating modifications have gravitated toward the all-risk average over time.
The split point will also be indexed for claim inflation in the third and subsequent years of this transition. These changes will directly affect the 34 states and the District of Columbia currently using the NCCI’s rating system, and may cause the independent rating bureaus of Indiana, Massachusetts, Michigan, Minnesota, New York, Texas and Wisconsin to re-evaluate their split points as well. North Carolina, which has an independent rating bureau, will be enacting the changes. The rating methods used by California, Delaware, New Jersey and Pennsylvania differ widely from NCCI’s approach, so similar changes in those states may not occur.
- Year 1: The split point will initially be increased to $10,000 to become effective with each state’s approved rate/loss cost filing on or after January 1, 2013
- Year 2: A state’s next effective year filing will further increase the split point to $13,500
- Year 3: A state’s third effective filing year will further increase the split point to $15,000 plus two years of inflation adjustment (rounded to the nearest $500)
Affect on Organizations
The potential for a mod increase or decrease will depend on whether you have an above or below average number of losses under the split point. If most of your losses are under $5,000, you are likely to see a decrease in your mod. If many of your losses exceed $5,000, you should prepare for an increase.
If you’re not prepared, an NCCI increase of the primary-excess split point could raise your primary losses and negatively influence your mod.