CHAPTER XVI MERIT RATING The Principles of Merit Rating. The manual of classifications, rules and rates provides a method of classifying and rating risks by grouping them according to certain general characteristics such as process, product, or occupation. Rates are provided for each group so that the saw mill owner, for example, will pay one rate, the department store owner another, the contractor a third, and so on down the list. These various rates are designed to differentiate one industry from another and to distribute the premium income in accordance with the hazard. In this way equitable rates are produced as between industries. When this process is completed there still remain risks within groups which, upon analysis, are found to present widely different hazard conditions. As an instance, it may be found that two machine shops, though they both fall in the classification "Machine Shops," present quite different conditions. One may be housed in a one-story concrete building with excellent lighting and adequate ventilation, every normally dangerous point may be well guarded, the plant may be maintained in an orderly and efficient manner, a skilled and intelligent class of workmen may be employed as well as a sensible and efficient group of foremen, and all other conditions of employment may be carefully regulated in order to conserve the lives, limbs and health of the workers. The second machine shop may be housed on the third floor of a dangerously constructed building, it may have poorly arranged lighting and ventilating equipment, the machines may be antiquated and unguarded, there may be no order in the arrangement of the premises so that there is crowding and confusion, material may be piled in a haphazard manner, the workers may be unskilled and unintelligent with the result that inefficiency prevails, and in every other respect the shop may typify all of the practices that are known to be hazardous. These two shops, though differing widely, fall in the same classification and take the same manual rate. This illustration is not an extreme one nor does it represent a condition which is to be found only in this one industry. This wide divergence between individual risks which belong to the same manual classification is found in a great number of other classifications. It is found in bakeries, laundries, saw mills, department stores, hotels, quarries and building construction. The manual does not carry the rating procedure far enough in any case. It provides a starting point but fails to recognize important differences in hazard which should be taken into consideration in fixing the rate. The task of merit rating is to raise or lower the manual rate in accordance with the hazard of the individual risk by applying plans which will reflect in the rate the conditions peculiar to the risk. It is the function of merit rating to distinguish between risks within a manual classification, to measure the deviation from average conditions found in individual risks, and to fit the average rate contained in the manual to the requirements of each risk just as a suit of ready-made clothes, built according to general measurements, is altered to fit the individual purchaser. It is a plan for the reclassification of risks within the manual classification. The manual classification groups all of the risks of a certain general type and merit rating sorts these into a number of smaller groups which are more homogeneous in hazard, with the result that more equitable rates are developed for individual risks. Competition. Merit rating is, primarily, a method of producing correct rates but it also has solved two phases of the competitive problem. It provides a means of combating the tendency toward self-insurance. The larger risks usually keep a record of their experience and, therefore, know when they are paying greater premiums than their claim records warrant. If their experience is good and they are held to the average rate (which is manifestly too high for the best risks just as it is too low for the worst risks), they will adopt the system of self-insurance. Therefore, the best large risks will tend to leave the companies and carry the workmen's compensation obligation for them selves. A plan which lowers the average rate for the good risks and increases it for the bad risks relieves the situation, for it enables the companies, by keeping the premium in line with the actual cost in all cases, to combat the trend toward adverse selection which would otherwise ensue. Merit rating does not entirely prevent self-insurance but makes it less attractive in comparison with other insurance. Merit rating also provides a fair basis of competition between companies operating on the "non-participating" plan and those which issue participating contracts. The former companies, as has been explained, use guaranteed rates and the developments of the insurance period do not change the premium rate. Participating companies, on the other hand, use initial rates which are subject to revision in accordance with the actual experience of the insurance period. If both classes were restricted to the use of manual rates, the non-participating companies would be at a distinct disadvantage. Competition would tend to drive from their books those risks which are better than the average, thus leaving them with an adverse selection of business on which the average rate would not produce an adequate premium. Merit rating, by placing the correct rate upon each risk, avoids this difficulty, just as it solves the competitive situation created by self-insurance, and gives the non-participating company an equal opportunity to compete for the good risks. Prevention. Perhaps the best argument in favor of merit rating is that it serves as a most effective weapon for prevention. By placing a penalty upon the risk which is worse than the average of its class, and by rewarding policyholders for their efforts in prevention in direct ratio to the results produced as measured by the improvement in the conditions of individual risks, merit rating commercializes safety. This valuation of the efforts of the policyholder in concrete terms, which enables him to reduce his safety work to a definite business basis, has produced results where all other plans have failed. This point will be clarified when the details of the plans of merit rating are described. At present there are two kinds of merit rating in use in the field of workmen's compensation insurance. They are "schedule rating" and "experience rating." SCHEDULE RATING Schedule rating is a method of measuring physical hazards. The schedule is a list of important physical conditions which produce injuries, with values measuring the relative importance of these conditions and a corresponding list of "safety standards." Standards. Safety standards define the schedule requirements necessary for the safeguarding of various physical conditions found in the industries subject to schedule rating. Compliance with these standards determines the application of the individual schedule items. For example, one item in the present schedule deals with the condition of the shaftway in which an elevator is operated. The standard which determines whether the condition of an individual risk is sub-standard and, therefore, entitled to a debit for this item, reads as follows: 1. Sides of elevator shaftway not used for entrance shall be substantially enclosed to a height of six (6) feet, and distance between members shall not exceed two (2) inches. At all places where moving car or door presents a hazard, space shall not exceed one-half (1⁄2) inch. 2. Where automatic hatch covers are used only a standard railing is required which shall be placed at least twelve (12) inches from the shaftway edge on all sides except at entrances. 3. Elevator counterweights shall be enclosed as follows: a. On the outside of shaftway by a solid enclosure or mesh not exceeding one-half (2) inch, and constructed of wire not smaller than No. 20 gauge U. S. Standard, to height of ceiling. b. On the inside of shaftway with No. 16 gauge U. S. Standard sheet metal, to a height of at least seven (7) feet from the lower permanent counterweight stop or bumper. The conditions which are listed and the value of each as a contributor to the total loss cost are determined from actual experience. On page 19 will be found a general summary of the latest compilation of data used for the preparation of a schedulerating plan. Data such as these serve to indicate the important hazard-producing conditions. The less important ones are eliminated so that the schedule will not be burdened with a great number of items of little consequence. Such data also serve to determine the relative value of each condition so that the hazard t represented by each cause may be subjected to actual measurement. The use of this and other statistical information for the development of the schedule-rating plan in present use will now be explained.1 Basic Data. The first step is an analysis of the total hazard by causes. This is obtained by listing the causes of injury and by assigning to each the losses which have resulted therefrom. When this exhibit is available, it is possible to compare the amount of losses assigned to an individual cause with the total losses thus obtaining a weight which measures the relative importance of the cause under consideration. It is then a simple matter to select those causes involving considerable amounts of loss, and to use these as a basis for the construction of the schedule. For example, in furniture manufacturing it has been discovered that there are five important items to be considered. These, with their respective weights determined from actual experience, are as follows: The balance of 34 per cent, known as the "residue," represents many causes of accidents; some physical, others mental or "moral," but all of such character as to make it impracticable to recognize them by specific items in the schedule. Since these causes are important in the aggregate they are treated under the "Safety Organization" section of the schedule-a section devoted to methods of education and medical treatment which affect the entire hazard and thus influence the large number of miscellaneous causes included in the residue. 1 The material used in explaining the schedule-rating plan is taken from a memorandum of the National Bureau of Casualty & Surety Underwriters prepared by L. L. Hall, formerly Assistant Secretary. |