an insurance agent determining the loss cost multiplier of a business

What is a Loss Cost Multiplier?

May 27, 2024
Mordechai Kamenetsky

A loss cost multiplier (LCM) modifies base loss costs, which are an estimate of expected claims losses for every industry. LCM is used by insurance companies to calculate the final premium rate for policyholders.

Sounds confusing? Keep reading and we’ll explain.

Workers’ comp insurance is categorized according to the NCCI list of job roles. Each industry is assigned a 4 digit reference code, called a class code, and a rate. The rate represents the average medical cost of a claim per $100 of payroll for that industry.

These rates do not include the administrative costs of the insurance company. Each insurance company has a number that is multiplied with the NCCI rates to cover their costs. That number is called a Loss Cost Multiplier.

The  LCM adjusts these base costs from the NCCI based on the insurance company’s specific financial and operational needs to calculate the premium for the insurance policy.

What factors contribute to the Loss Cost Multiplier?

There are many parts to running an insurance company and the LCM needs to include all of them in the calculations.

The most common ones are:

  • Administrative Costs - This is used to cover the insurance company’s overhead. This includes office maintenance, staff salaries, and other operational expenses related to daily functions. 
  • Claims Handling Expenses - These are costs are related to processing, investigating, and settling claims. Efficient claim handling can cut these expenses while complicated claims may increase them.
  • Regulatory Compliance Costs - Insurance companies must deal with several federal and state regulations. These costs cover maintaining compliance with these laws.
  • Reinsurance Costs - In some cases, part of the insurance risk is transferred to a reinsurance company. The costs to purchase reinsurance are included in the LCM.
  • Taxes, Licenses, and Fees - These are necessary payments that insurance companies have to pay to stay in business. They will vary based on location as well as type of insurance.

How to apply the Loss Cost Multiplier

After the insurance company finalizes the LCM, they need to file it with a state agency and get it approved. The next step is to apply it to the base loss costs. This is used to set the final premium rates for different policies. 

How do Loss Cost Multipliers impact Insurance Premiums?

Using the loss cost multiplier has an impact on the insurance premiums for each policy. If a company has a higher LCM, that means premiums will also be higher. This indicates that there are lots of expenses or the insurance company has larger profit targets. 

On the other hand, an efficient insurance company who has fewer operational costs might have a lower LCM. This lets them provide more competitive rates.

Kickstand Note
Kickstand Note

The LCM is going to vary between different insurance companies based on factors like expense management, efficiency, and strategic objectives. This is how you will get differently priced quotes for the same insurance policy. 

Do Regional and Sector conditions impact the LCM?

The LCM not only varies between insurance companies but also across different locations and sectors. This is due to diverse risks and costs. 

Insurance companies in a location prone to natural disasters tend to have higher LCM since there is a higher chance a lot of claims will come in. If an area has more regulatory hurdles or higher litigation risks, this can also lead to higher multipliers and more expensive premiums. 

Competition also affects the LCM

Competition and market conditions can also majorly influence the loss cost multiplier. If an area is highly competitive, insurance companies might choose a lower LCM to bring in more customers even if that results in a lower profit margin. 

However, in specialized or competitive markets, insurance companies might choose a higher LCM to get the best profits.

Challenges and Considerations

Choosing the best possible loss cost multiplier can be a huge challenge for many insurance companies. They need to forecast their costs while also being aware of any potential risks to choose a premium that is profitable and competitive at the same time. Making a bad estimate could create financial losses or less competitiveness. 

Mordechai Kamenetsky

Mordechai Kamenetsky, co-founder and lead agent of Kickstand, is recognized as an expert in workers' compensation. He is passionate about helping small businesses manage risks and lower their workers' comp costs. In his articles, he educates readers and clients on the intricacies of workers' comp insurance.

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