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Empirical Evidence ofFactors Affecting ExperienceModification Rate Used by theU.S. Insurance IndustryTantatape Brahmasrene a & Sarah Sanders Smith ba Business at the College of Business , PurdueUniversity North Central , Westville, Indianab Organizational Leadership & Supervision at theCollege of Business , Purdue University NorthCentral , Westville, IndianaPublished online: 11 Oct 2008.

To cite this article: Tantatape Brahmasrene & Sarah Sanders Smith (2008) EmpiricalEvidence of Factors Affecting Experience Modification Rate Used by the U.S.Insurance Industry, Journal of Transnational Management, 13:3, 244-258, DOI:10.1080/15475770802400400

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Empirical Evidence of FactorsAffecting Experience ModificationRate Used by the U.S. Insurance

Industry

Tantatape BrahmasreneSarah Sanders Smith

ABSTRACT. The improvement of safety programs is of significantimportance to the economy of countries that move toward a globalperspective. The objective of Experience Modification Ratings(EMR) is to encourage employers, through management incentives,to reduce the frequency and severity of work-related injuries. Theinsurance industry uses EMR to assess premiums. A U.S. nationalsurvey was conducted to investigate EMR determinants. EMR andits average (AEMR) are hypothesized to vary inversely with the

Tantatape Brahmasrene is Professor of Business and Sarah SandersSmith is Assistant Professor of Organizational Leadership & Supervisionat the College of Business, Purdue University North Central, Westville,Indiana.

The authors wish to thank William Bannister, Operator Qualification(OQ) Coordinator of BP Pipelines (North America), Inc. for his assistancein conducting a survey for this project. The authors also thank all of therespondents for their interest in and support of this research.

Address correspondence to Tantatape Brahmasrene, College of Business,Purdue University North Central, Westville, 46391-9528 IN. E-mail:tapeb@pnc.edu

Journal of Transnational Management, Vol. 13(3) 2008Available online at http://www.haworthpress.com# 2008 by The Haworth Press. All rights reserved.

doi: 10.1080/15475770802400400244

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number of training hours, number of safety audits, the company’sannual revenue, and the annual cost of safety training per employee.The empirical findings indicated the number of training hours was sig-nificant while revenue was highly significant. This paper offers practi-cal and policy implications with respect to these findings.

KEYWORDS. Experience modification ratings, insurance industry,management, safety management

Although global occupational safety initiatives vary by culture andcountry policy, risk assessments based on world-class standards helpensure not only the well-being of the workforce, but also the profit-ability of the company (Vance & Paik, 2006). Workers’ compensationexpenditures represent a substantial input of the cost of goods sold.According to the Insurance Information Institute, the average costfor workers’ compensation insurance has risen 50 percent in the pastthree years (Hurns, 2004). More than $40 billion are paid each yearby employers and their insurers in workers’ compensation benefits(American Society of Safety Engineers or ASSE, 2002). This is nearly$500 per covered employee. Outright savings on worker’s compen-sation benefit claims and having a solid safety management programwith senior management commitment will improve productivity andemployee morale. This can also make the difference between winningand losing bids, obtaining government contracts, and remainingcompetitive in the global market.

The initial motivation behind this research was to assess theimpact of crucial factors affecting experience modification ratings(EMR). The objective of EMR is to encourage employers, througheconomic incentive, to reduce the frequency and severity of work-related injuries (Hinze, Bren, & Piepho, 1995). The insurance indus-try argument is based on clients’ actual claims histories versusinsurance industry predictions. The EMR reflects total recordableincidents, but it weighs a higher frequency of lower dollar claimsto be more detrimental than less frequent, more costly claims.The ‘‘primary’’ dollar carries more weight than the ‘‘excess’’ dollar.Primary are dollars paid out that are $5,000 or less per claim. Thus,there is a frequency and a severity factor in calculating the EMR.For example, 20 primary losses at $5,000 or $100,000 in primarydollar losses are more costly than two excess losses at $50,000 or

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$10,000 in excess. This is how the insurance industry usually utilizesthe EMR when determining the next year’s workers’ compensationinsurance premium. Often, organizations and associations thatrecognize sound safety performance through awards request mea-sures of safety performance, including the EMR (OccupationalSafety and Health Administration or OSHA, 2004). A three-yearEMR history or AEMR in this study is generally the benchmark.The EMR is innately computed as a three-year average as itexcludes the last year and nine months, but considers data throughfour years and nine months for computation (State CompensationInsurance Fund, 2007). Thus, when a three-year history of EMRis requested (AEMR), this provides, in essence, a five-year summaryof the EMR performance of an organization.

Table 1 describes EMR values and related grades. For example, anEMR of 1 is equivalent to a ‘‘C’’ grade,which means no gain or noloss; an EMR of 0.9 to 0.8 is a ‘‘B’’. This means the company per-formed better than the insurance industry had anticipated. Thus,the next year’s workers compensation rates will be decreased. AnEMR below 0.8 is an ‘‘A’’. The company’s reduction in workers’compensation premium will be even greater. When an EMR is above1, e.g., 1 to 1.5¼D and above 1.5¼F, the insurance company willadd a penalty and surcharge to what would have been the normalinsurance premium.

LITERATURE REVIEW

The first national study of total costs associated with occupationalinjuries and illnesses was conducted by Leigh, Markowitz, Fahs, andLandrigan (2000) utilizing 1992 data. They stated that associatedcosts are spread to consumers in the form of higher prices. Some costsare incurred by workers through lower wages and by taxpayers.Despite the fact that the costs are sizable and that so many peoplepay them, expenditures associated with occupational injuries and ill-nesses do not receive the attention they deserve. In the United States,by law, employers must arrange for workers’ compensation coveragefor their employees. The experience modification rate (EMR) wasdesigned to establish a financial incentive for firms to invest in safety.Companies that have worse records of injuries and claims pay morefor workers’ compensation insurance than their comparative others

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(Walsh, 2007). This section reviews literature related to the inde-pendent variables included in the models.

Safety Training

An organization should become a safer workplace with implemen-tation of safety training. Experience modification ratings (EMR) andassociated premiums would decrease. According to the AmericanSociety of Training and Development, business justification isthe first step in designing a training program (McCardle, 1999).

TABLE 1. Description of Variables

Dependent Variables

EMR Experience Modification Rate and grade

A¼ below 0.8

B¼ 0.9–0.8

C¼1 (No gain or lost)

D¼1.1–1.5

F¼above 1.5

AEMR Three-Year Average Experience Modification Rate

Independent Variables

TRNGHRS Number of training hours provided by the company

SAFEAUDIT Number of safety audits conducting in a year

1¼ 0

2¼ 1–5

3¼ 6–10

4¼ 11–15

5¼ 16–20

6¼ 21 or more

REVENUE Annual revenue provided by the company

SAFECOST Annual cost of safety training per employee ($)

1¼ 0–100

2¼ 101–500

3¼ 501–1,000

4¼ 1,001–1,500

5¼ 1,501–2,000

6¼ 2,001–2,500

7¼ 2,501–3,000

8¼ 3,001–3,500

9¼ 3,501–4,000

10¼Over 4,000

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The justification behind the training request and the implications ofconducting or not conducting the training is analyzed. Managersuse the business justification to decide whether to provide training,allocate resources, and prioritize training programs for schedulingpurposes (see details in the implications for management section).Nevertheless, the amount of mandated training required for anorganization can be a contributing factor to lower the EMR.

Safety Audit

Initiatives for safety audits usually begin as reactive activity in theorganization. As the supervisors, safety personnel, and workers gainexperience and knowledge, proactive audit procedures ensue. Accordingto Barrett, Cooper, and Jamal (2005), two key issues were identified asthey relate to safety audits: the increased risk of litigation and the com-mercialization of the audit industry. Morgan (2005) discussed theimportance of auditor training and checklists. He also noted that less-experienced auditors tended to audit against standards for complianceversus auditing for overall design and its affect on peoples’ safety.

Revenue

According to the insurance industry, a company’s revenue affectsEMR because it is thought that larger companies can afford to takeon more risk. Thus, they will choose to ‘‘self–fund’’ their smallerclaims. Every state in the United States requires all but the smallestcompanies to have some form of coverage for occupational injuriesand illnesses that occur. When permissible by state law, rather afflu-ent companies self-insure and self-administer part of their workers’compensation claims to contain the costs submitted to their workers’compensation insurance administrators. Others elect to have theinsurance carrier manage their system (American Industrial HygieneAssociation, 2008). For example, at XYZ Corporation, all claims upto $1,000 are paid out of its own checkbook. These claims never reachthe insurance company unless the nature of the injury becomes pro-gressively worse and subsequently exceeds the $1,000 level. This issimilar to an individual choosing a higher deductible on health orcar insurance to in turn realize a lower monthly premium. In the caseof workers’ compensation insurance, the insured organization has theability to assume some of the initial costs and protect their EMR.Thus, companies with higher revenue should be able to self-pay some

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or all of their claims or choose worker’s compensation plans withmore risk. A larger firm has the ability to achieve a substantiallylower EMR than an equally safe smaller firm without the largerpremium entering into the EMR calculation (Blair, 2006).

Safety Cost

Employers experience direct and indirect costs as a result of injur-ies and illnesses in the workplace. An investment in safety trainingrepresents a direct cost. The total costs associated with injuries andillnesses in the United States are roughly five times the costs forAIDS, three times the costs for Alzheimer’s disease, more than thecosts of arthritis, and nearly as great as the costs for cancer (Leigh,Markowitz, Fahs, & Landrigan, 2000). As a direct cost component,the dollars a business expends per employee must be evaluated.

HYPOTHESIS

The previous literature review leads to the hypothesis that ExperienceModification Ratings (EMR) and its average (AEMR) are affected bythe number of training hours (TRNGHRS), number of safety auditsconducted in a year (SAFEAUDI), the company’s annual revenue(REVENUE), and the annual cost of safety training per employee(SAFECOST). The EMR and AEMR are inversely related to the num-ber of training hours, number of safety audits conducted in a year, thecompany’s annual revenue, and the annual cost of safety training peremployee. All four independent variables (TRNGHRS, SAFEAUDI,REVENUE, and SAFECOST) are expected to have a negative impacton both dependent variables, EMR and AEMR. This means anincrease in the number of training hours, safety audits, revenue, andsafety cost reduces the experience modification ratings, and vice versa.For empirical analysis, the model has been constructed as shown below:

I: EMR ¼ CONSTANTþ b1 TRNGHRSþ b2 SAFEAUDI

þ b3 REVENUEþ b4 SAFECOSTþ ui

II: AEMR ¼ CONSTANTþ b1 TRNGHRSþ b2 SAFEAUDI

þ b3 REVENUEþ b4 SAFECOSTþ ui

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Description of variables is summarized in Table 1. ui is a stochasticerror term or disturbance term.

DATA AND METHODOLOGY

An original survey conducted in 2007 was dispersed among safetyprofessionals across the United States through national and regionalWeb sites of the ASSE, and ISNetworld’s national database. Morethan ten thousand contractors store safety program information inISNetworld. From data and anecdotal information, ASSE knowsthat investment in safety, health, and environmental programs is asound business strategy that leads to a positive impact on the firm’sfinancial bottom line (American Society of Safety Engineers, 2002).The dispersed target group helps eliminate geographical bias. Threehundred nine forms were completed out of 814 visits, representinga 38% completion rate. Table 2 provides descriptive statistics of theexperience modification ratings, the number of training hours, safetyaudits, revenue, and safety cost. The experience modification ratings,training hours, and revenue are scale variables in which differencesbetween values are comparable. EMR and AEMR vary from 0 to7.2 and 7.0, with a mean of about 0.8. The maximum annual traininghours were 670, with an overall average of about 50 hours. Annualrevenue shows the range of $100,000 to $41.5 billion with an averageof about $469 million. The number of safety audits and safety costsare ordinal variables with natural order where differences betweenvalues are not meaningful. Their description in Table 2 just providesan overview. Their frequencies are reported in Table 3. When asked

TABLE 2. Descriptive Statistics

N Minimum Maximum Mean Std. Deviation

EMR 286 .00 7.20 .8026 .48512

AEMR 271 .00 7.00 .8021 .48860

TRNGHRS 276 0 670 49.83 71.125

SAFEAUDIT 294 1 6 3.81 1.877

REVENUE 188 100,000 41.5 billion 468,665,323 3,222,287,643

SAFECOST 273 1 10 3.48 2.216

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how many safety audits were conducted in a year, 37.08% or 109 outof 294 valid cases indicated 21 or more. About 52% or 141 out of 273spent $101 to $1,000 on safety training per employee. This surveysample draws major industry groups such as construction, energy,manufacturing, scientific professional, and petroleum refining fromnearly all states in the United States.

The ordinary least square method was employed to test the abovehypotheses. One of the tasks in performing regression analysis withseveral independent variables was to calculate a correlation matrixfor all variables. Table 4 reports the Pearson Correlations for all vari-ables. There were no particularly large intercorrelations among inde-pendent variables. However, a measure of multicollinearity amongindependent variables was performed.

EMPIRICAL RESULTS

The EMR and AEMR variables were transformed into naturallogarithms for better results. The assumption of linear multipleregression and the fitness of the model were tested. According tothe computed values of a multiple regression model, the null

TABLE 3. Frequency

SAFECOST SAFEAUDIT

Valid 1 33 17

2 81 105

3 60 24

4 37 29

5 21 10

6 12 109

7 10

8 4

9 3

10 12

Total 273 294

Missing System 36 15

Total 309 309

Notes: Variables in this frequency table are ordinal variables with natural order. See

description in Table 1.

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hypothesis was rejected at a significant level of less than 0.05 (F test)in both models, as shown in Table 5. This means that among theseestimated equations, a relationship existed between experience modi-fication ratings and the explanatory variables: the number of train-ing hours (TRNGHRS), number of safety audits conducted in ayear (SAFEAUDI), the company’s annual revenue (REVENUE)and the annual cost of safety training per employee (SAFECOST).The coefficients of multiple determination (R Square) were rela-tively low. Note that R Square is a measure of goodness of fit. RSquare of zero does not mean that no association exists amongthe variables. The variance inflation factor (VIF) is also presentedto detect multicollinearity among independent variables. A VIFvalue of less than 10 generally indicates no presence of multicolli-nearity. It appears that the observed dependencies did not affecttheir coefficients.

Furthermore, significant test (t-test) for models 1 and 2 (EMRand AEMR) in Table 5 indicated that the coefficient of the numberof training hours had a significant t-value (a< 0.05) with expectedsigns. The company’s annual revenue had a highly significant t-value (a< 0.01) on the natural log of EMR and AEMR, withexpected negative signs. Therefore, the null hypothesis of the num-ber of training hours and revenue were rejected. The number ofsafety audits and the annual cost of safety training per employeewere insignificant.

TABLE 5. EMR Model Coefficients

Model (1) Model (2)

Coefficients LNEMR VIF LNAEMR VIF

CONSTANT �.313��� (� 2.860) �.448��� (�3.516)

TRNGHRS �.001�� (�2.133) 1.029 �.001�� (�2.039) 1.029

SAFEAUDIT .016 (.727) 1.065 .038 (1.464) 1.063

REVENUE �2.88E-011��� (�2.450) 1.054 �2.69E-011�� (�2.007) 1.056

SAFECOST .018 (1.035) 1.076 .022 (1.045) 1.078

R Square 0.1 0.1

F Statistics 2.769�� 2.471��

Notes: t statistics are in parentheses. Significant level: �0.10, ��0.05, ���0.01

VIF¼Variance inflation factor, a measure of collinearity.

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DISCUSSION

This paper makes two important contributions:

1. In this study, the variable training hours (TRNGHRS) proved sig-nificant. The evidence shows the benefits of safety training inlowering a company’s EMR. This finding supports OSHA’s initia-tives, thus, training assessment must be optimized in order to bestmeasure business impact. Each year, corporate America providesnearly 2 billion hours of training to approximately 60 millionemployees at a total cost of $55 to $60 billion (Industry Report,1997). Requirements for worker training to reduce risk factorsfor injury and illness are contained in more than 100 OSHA stan-dards. Other standards limit certain jobs to workers consideredcompetent by virtue of special training (Cohen & Colligan,1998). Although it may seem logical to assume that an educatedworkforce will be safer and more productive, researchers do notfully understand precisely how training influences the actions ofworkers. Educational research should be conducted to investigatethis relationship so that optimum training effectiveness can beachieved (National Institute of Occupational Safety and Health,1999). Documented outcomes of occupational safety and healthtraining are varied and inconclusive. OSHA’s proposal in 1998redirected compliance initiatives to training measurable inoutcomes or impacts (U.S. Department of Labor, 1998). In thepast, measurement was simply focused on the hours of trainingdelivered. Thus, a decade ago, although not legally adopted aslaw, the Department of Labor recognized a need to shift focusfrom merely tracking training hours to measures that would assessthe business impact of safety and health training. Safety profes-sionals who are able to evaluate and communicate the businessvalue of safety efforts will improve understanding and thus initiatebetter decision making by their organizations (Linhard, 2005).

2. There is a highly significant effect of revenue on EMR. The effi-cacy of this relationship should be considered. The objective ofEMR is to encourage companies, through management incentives,to reduce the frequency and severity of work-related injuries.Although most managers realize the consequences of catastrophicevents, many fail to realize the financial implication of smaller, lesssevere events. More frequent and less costly accidents have a

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greater weight than less frequent and more severe events. TheEMR that an insurance industry measures mathematically favorslarger firms with strong revenue streams over smaller, less affluentcompanies that may in reality be equally safe.

Implications for Management

Prior to establishing an annual training schedule for safety, anorganization must determine if the business justification exists to con-duct the training. The company that adopts a business justificationapproach to safety has an opportunity to greater impact the organi-zation, despite mandated training that must occur. Business justifi-cation for training consists of two activities:

. Conducting a performance analysis. This process determineswhether a training need or opportunity exists. Answers to the fol-lowing questions help determine the nature, scope, and timing oftraining:

1. What is the problem or need?2. Why is this request being made now?3. What performance enhancement or deficiency is the training

intended to address?4. Who is the target population?5. What are the alternative ways in which the problem or need

could be addressed?

. Conducting a business analysis. To improve organizationalperformance, this analysis considers alternate methods in whichtraining can be delivered. The cost of training is compared to theorganizational benefit to determine whether the training will occur.

An internal audit of the organization’s training practices mustcompare current practice to a sound business justification model.Analysis must help identify opportunities to implement trainingthat will correlate with a reduction in EMR. Training content,scope, and timing should be designed to enhance worker and orga-nizational performance. Employers must also recognize thatalthough training is clearly necessary and important, training alone

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cannot make an unsafe condition safe. Deliverables in safety train-ing are compromised by vicissitudes of employee behavior (Walsh,2007). Thus, a firm’s safety policies must focus on hazard elimin-ation and abatement.

With respect to revenue, a manager studying the financial pic-ture of a company needs to understand the impacts of revenueon EMR. Revenue varies per company, and certainly not all firmsare in the financial position to assume more risk in return foruncertain financial gain in the end. Smaller firms with more restric-ted revenue are less able to implement a partially or fully fundedclaims arrangement. To maximize the value of a firm, a large com-pany that generates substantial revenue may assume more risk andsubsequently reduce workers’ compensation expense. In addition toEMR, safety recognition and awards may consider other indicatorsof desirable safety performance such as total recordable incidentrates and lost time incident rates. These provide an equitable mea-sure of safety performance to the organization as they are calcu-lated on a per employee basis. Reports to organizationalstakeholders must also include these measures, and clarify the roleof EMR as an insurance indicator. Upper management mustunderstand the effect of worker’s compensation claims on the prof-itability of the firm.

CONCLUSIONS

The attempted shift in training priorities, as outlined in theDepartment of Labor’s Occupational Safety and Health ProgramRule merits careful consideration. This research affirms the initia-tives sought to be incorporated in order to assess safety trainingeffectiveness on outcomes and impacts. This document emphasizedmanagement actions and business justification to ensure effectivetraining results, as well as to realize other program goals. Thus,the Department of Labor’s initiative to identify strategies forimproving the measurable performance of mandated trainingprograms was supported.

As our global economy causes competition to intensify, flatten-ing or trimming budgets may be a necessary survival skill. Man-agement must understand the financial implications of loss to thefirm. Several indices should be considered when reviewing safety

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performance and the profitability of the firm. Through communi-cation and study, organizational leaders and safety professionalscan effectively navigate the company toward protecting andenhancing the value of the firm. In today’s contemporary businessclimate, measures such as these are necessary to retain global com-petitiveness.

REFERENCES

American Industrial Hygiene Association (2008). View of the Use of OccupationalSafety and Health Performance Criteria in Contracting and Procurement. Whitepaper. http://www.aiha.org/Content/AccessInfo/gov/wpprocurement.htmAccessed February 10, 2008.

American Society of Safety Engineers (2002). White Paper Addressing the Return ofInvestment for Safety, Health, and Environmental Management Programs. DesPlaines, IL: American Society of Safety Engineers.

Barrett, M., Cooper, D. & Jamal, K. (2005). Globalization and the coordinating ofwork in multinational audits. Accounting, Organizations and Society, 30(1), 1–24.

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Submitted: March 2008Revised: May 2008

Accepted: July 2008

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