Masonry Magazine June 1986 Page. 29
In those cases where errors have been found, NCCI sees no trend toward pricing the risk too low or too high. This suggests that most erroneous classification assignments are simply mistaken judgments, and not attempts to lure business by deliberately underpricing, or to produce higher premiums by overcharging.
NCCI's classification system and the other, similar systems in use in states under independent jurisdictions are based upon sound insurance theory and offer both buyer and seller a cost-efficient, non-discriminatory method for pricing the workers compensation exposure.
An Introduction to Experience Rating
"Experience," said Oscar Wilde, "is the name everyone gives to their mistakes." While this may be true of life in general, in workers compensation it is only partially true, for while experience can be a measure of error, it can contribute to a firm's profitability as well.
The pricing of workers compensation insurance begins with the "manual" rate (so named because you can find it in an insurance manual). There are about 600 industrial classifications used in workers compensation. Each insured business (or organization-not everyone who is an employer, and thus subject to the workers compensation system, is a business) is assigned one or more of these classifications. Each classification has its own rate, based on its experience in the state (plus national experience when there is little state experience).
The manual rates use the record of the past to estimate the results of the future. Actuarial science has its limits, however. While you can be quite confident of results in the aggregate, the smaller the portion of the aggregate you consider, the less certain you can be of the outcome. The National Safety Council can predict that 500 people will be killed in auto accidents over a given Memorial Day weekend with some confidence; it cannot, however, name them.
Experience rating allows you to use this divergence between what you can predict in the aggregate and what will occur in the particular to reward employers with good safety records and penalize those with poor ones. This must always occur within limits, of course. The whole principle of insurance requires that the risk be shared, and because some risks are better than others some employers will always pay something, even though they have few losses, while others, with many losses, will still pay less than their share.
Experience rating makes each insured bear a greater measure of its own share of the total losses than would be the case if the rates based on the aggregate of their group were the sole determinant of their premium.
The manual rate, with which we begin, represents the average losses expected for the classification. It makes no discrimination between good and bad safety records, nor should it. But if there were only the manual rate, underwriters would bend their efforts toward finding the best risks in the group: less desirable than average risks would find it difficult to obtain coverage. Without some means to identify the quality of the individual insured, access to the marketplace itself would be restricted.
With experience rating, you measure the employer's actual record over a period of time with the norm for the classification (or classifications) to which it has been assigned. Good experience lower than expected losses-will earn a credit for the insured; poor experience-higher than expected losses-receives a debit. The credit or debit is then applied to the manual premium.
Experience rating is not based solely on the cost of the accidents that have taken place. The plan recognizes that the actual cost of an accident can vary and can be predicted less easily than the likelihood that such an accident
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MASONRY-MAY/JUNE, 1986 29