BASIC TECHNIQUES FOR WORKERS COMPENSATION

1. BASIC TECHNIQUES FOR WORKERS COMPENSATION Presented by Richard B. Moncher, Protegrity Services Andrew J. Doll, General Casualty 2001 CAS Seminar on Ratemaking Las Vegas, Nevada March 13, 2001 WCP - 16

2. SESSION OUTLINE • Overview of WC • NCCI Filing • Overall Rate / LC Level Change • Class Rate / LC Changes RICH MONCHER:

3. SESSION OUTLINE • Other Bureau Ratemaking • Expenses • Loss Cost Multipliers • Company Pricing Programs • Current WC Market ANDY DOLL:

4. WC RATING PROCEDURE Exposure x Manual Rate = Manual Premium Manual Premium x Experience Mod = Standard Premium - Premium Discount = Net Premium

5. Example: Loss Cost = 1.60 Expenses = 0.40 Rate = 1.60 + 0.40 = 2.00 2000 Payroll = 1,500,000 Exposure = Payroll / 100 = 15,000 2000 Manual Premium = Rate x Exposure = 2.00 x 15,000 = 30,000

6. Example (cont’d) 2000 Payroll = 1,500,000 2001 Payroll = 1,800,000 20% increase in payroll If same $2.00 Rate, then 2001 Manual Premium = 18,000 x 2.00 = 36,000 36,000 / 30,000 = 20% increase in premium

7. ADVANTAGES OF PAYROLL • Inflation Sensitive • - Payroll up Premium up • Tracks with Indemnity Benefits • Verifiable / Auditable • - Less potential for fraud • Readily Available

8. WC DATA BASES • Financial Aggregate Calls • - Annual Data at Year End • - Statewide & Assigned Risk • WC Statistical Plan - Detail By Class • - Payroll & Losses • - Five Evaluations

9. FINANCIAL AGGREGATE CALLS • Purposes • - Overall Rate/Loss Cost Level Change - where overall means statewide, voluntary or assigned risk • - Trend Analyses - changes in historical loss ratios

10. FINANCIAL AGGREGATE CALLS • Experience • - By Policy Year • - By Calendar-Accident Year • Data Elements • - Std Earned Premium at DSR Level • - Std Earned Premium at Company Level • - Net Earned Premium • - Benefit Costs: Indemnity/Medical/Total • - Payments (Paid Losses) • - Case Reserves • - Bulk & IBNR Reserves

11. Expiration Date Policy Year 1999 Effective Date 1/1/99 12/31/99 12/31/00 (1st report) 12/31/01 (2nd report) VALUATION OF FINANCIAL DATA POLICY YEAR

12. Expiration Date Accident Year 2000 Effective Date 1/1/99 1/1/00 12/31/00 (1st report) 12/31/01 (2nd report) VALUATION OF FINANCIAL DATA ACCIDENT YEAR

13. RATEMAKING: THE BIG PICTURE • Start with historical (premium and loss) data usually one to two years old • Use analysis and judgment to estimate the ultimate losses by adjusting historical losses • Adjust the premium (excluding expenses for loss cost states) from historical data to simulate the (pure) premium currently in place

14. RATEMAKING: THE BIG PICTURE • Divide ultimate losses by simulated premium to obtain loss ratio. • Trend loss ratio to effective period. • Check if current rates / loss costs are adequate. If trended loss ratio is close to 1.0, then no rate / lost cost change may be needed. Otherwise, revised rates / loss costs are needed.

15. Does current premium level provide adequate funds for future benefits?

16. PREMIUM ON-LEVEL FACTORS Adjust historical premium to current rate / loss cost level based on subsequent rate / loss cost changes PY 1999 Premium = $100M 1/1/2001 Loss Cost Change = - 5.0% PY 1999 Premium at Current Loss Cost Level = $95M

17. LOSS ON-LEVEL FACTORS Adjust historical losses to current benefit level based on subsequent benefit (law) changes PY 1999 Medical Losses = $100M 1/1/2001 Medical Fee Schedule Change = 10% savings PY 1999 Medical Losses at Current Benefit Level = $90M

18. } Benefit Costs Trend Payroll Filing Data in Filing Time Eff Date • Trend Factors - Compares movements in indemnity and medical benefits to movements in payroll - Applied to loss ratio = (Adjusted losses) / (Adjusted premium)

19. LOSS EXPERIENCE INDICATION • Estimate ultimate losses at current benefit level. • Estimate premium at current loss cost level. • Divide these losses by these premiums to obtain loss ratio. • Trend loss ratio to average accident date of effective period (PY 2002).

20. LOSS EXPERIENCE INDICATION • If loss ratio > 1.0, then more premium is needed. So, loss costs need to be increased for PY 2002. • If loss ratio < 1.0, then less premium is needed. So, loss costs need to be decreased for PY 2002.

21. WC STATISTICAL PLAN • Purposes - Classification Relativities - Industry Group Differentials - Experience Rating - Retrospective Rating - Research

22. WC STATISTICAL PLAN • Experience by Policy • Classification Details - Exposure / Premium / Experience Mod - Individual Claim Records Indemnity / Medical Case Incurred Values By Injury Type (Fatal, PT, etc.)

23. OVERALL CHANGE TO INDUSTRY GROUPS • Overall change is distributed to industry groups and then to individual classes • Manufacturing • Textiles • Cabinets • Automobiles • Miscellaneous • Trucking • Logging • Surface coal mining • Contracting • Plumbing • Roads • Houses • Office & Clerical • Clerical office employees • Outside sales • Goods & Services • Restaurants • Retail sales • Nursing Homes

24. MANUFACTURING INDUSTRY GROUP CHANGE Analysis shows that: • Overall (statewide) change is +10% • Manufacturing industry group experience is 10% worse than statewide. So,... Mfg Industry Group Chg Statewide Change Industry Group Differential - = x 1 = (1.10) (1.10) - 1 = 1.21 - 1 = 21%

25. VALUATION OF WC STATISTICAL PLAN DATA 3rd Report Valuation 4th Report Valuation 1st Report Valuation 2nd Report Valuation 5th Report Valuation Policy Effective 1/1/96 7/1/99 7/1/00 7/1/01 7/1/97 7/1/98

26. DISTRIBUTION OF INDUSTRY GROUP CHANGE TO CLASS • Unit Reports • Relativities (between classes) - Five years of WCSP data - Current loss cost / rate (adjusted) - Adjusted national experience for class

27. BASIC TECHNIQUES FOR WORKERS COMPENSATION Company Perspective

28. INDEPENDENT BUREAU VS. NCCI FILING ACTIVITIES California Massachusetts Minnesota New Jersey New York Pennsylvania/Delaware Texas

29. LOSS COSTS - WHY? McCarran-Ferguson Debate Antitrust Concerns Ease of Developing Final Rates Note: Twenty years ago, all states were rate states. Now, almost all NCCI states are loss costs.

30. COMPONENTS OF A RATE Losses Loss Adjustment Expenses Expenses and Profit Loss Assessments

31. EXPENSE COMPONENTS Production - commissions, premium collection, underwriting Taxes, Licenses, and Fees - various premium taxes, bureau and filing fees General - overhead, audits, general administration Profit and contingencies - combined with investment income

32. COSTS AS A PERCENTAGE OF FIRST $5,000 OF STANDARD PREMIUM

33. EVALUATION OF THE NEEDS OUTSIDE OF THE LOSS COST Items always Outside the Loss Cost Production Taxes, Licenses, and Fees General Profit and Contingencies Items sometimes Outside the Loss Cost Loss Adjustment Expenses Loss Based Assessments Items rarely Outside the Loss Cost (MN) Trend Loss Development beyond 8th report

34. COMPONENTS OF A RATE IN OR OUT OF THE LOSS COST

35. HOW TO ACCOUNT FOR ITEMS OUTSIDE THE LOSS COST The Loss Cost Multiplier (LCM) Factor to multiply loss costs by in order to load in insurer’s expense and profit Must also consider other items not included in the Loss Cost Loss Cost x LCM = Rate Insurance companies must file LCMs for approval in loss cost states Also known as a Pure Premium Multiplier

36. DERIVATION OF A LOSS COST MULTIPLIER State A: Loss Cost includes Loss, Loss Adjustment expense, and Assessments State B: Loss Cost includes Loss and Loss Adjustment expense State C: Loss Cost includes Loss In all three cases, loss includes full trend and loss development

37. DERIVATION OF A LOSS COST MULTIPLIER Portion of Standard Premium State A B C Expenses .275 Profit .025 Total of Items to Load on Loss Cost .300 Indicated Loss Cost Multiplier 1.429 = 1/(1 - Load Needed)

38. DERIVATION OF A LOSS COST MULTIPLIER Portion of Standard Premium State A B C Expenses .275 .275 .275 Profit .025 .025 .025 Loss Assessments (% Prem) .020 .020 Loss Adj. Expense (% Prem) .080 Total of Items to Load on Loss Cost .300 .320 .400 Indicated Loss Cost Multiplier 1.429 1.471 1.667 = 1/(1 - Load Needed)

39. DERIVATION OF THE LCM ALTERNATIVE APPROACH Prior methodology assumes that all items included in the LCM are related to Premium Loss Adjustment Expenses and Assessments may not have a stable relationship to Premium An alternative approach for states that require a loading for “loss related” items is: 1 + Loss Related Items (% Loss) LCM = 1 - Premium Related Items (% Premium)

40. ADDITIONAL CONSIDERATIONS FOR THE LCM Administered Pricing vs. Competitive Rating When to use a LCM? Evaluation of the Bureau Loss Cost Filing Do you agree with the various assumptions? How does your book compare? Is there additional, more current info? Consideration of the Company’s experience How does your experience compare? Are there changes to consider? When will you be implementing a change?

41. MANUAL RATE IS STARTING POINT FOR DETERMINING COST OF WORKERS COMPENSATION INSURANCE Additional Factors Prospective Experience Rating Premium Discounts Deviations Schedule Rating Retrospective Rating Dividend Plans Deductibles (Small and Large)

42. PROGRAMS THAT CAN BE USED TO BETTER REFLECT INDIVIDUAL RISK CHARACTERISTICS Experience Rating - mandatory tool that compares actual and expected losses Premium Discounts - by policy size; reflects that relative expense is less for larger insureds Expense Constant - reflects expense gradation for smaller insureds Deviations - filed by companies (LCM or rate) to reflect anticipated experience differences Schedule Rating - reflects characteristics not reflected by experience rating Dividend Plans - means to reflect favorable experience; similar to schedule or retro rating

43. PROGRAMS THAT CAN BE USED TO REFLECT ACTUAL LOSS EXPERIENCE Retrospective Rating - premium depends on the experience generated by the insured during the time the policy is in force Large Deductibles - similar to retrospective rating, but can often allow for cash flow benefits to the insured

44. WORKERS COMPENSATION CLIMATE AND THE ROLE OF THE ACTUARY Industry results deteriorating on calendar and accident year bases Rates / Loss Costs changes vary by jurisdiction, from decreases to increases Changes are not reflective of deterioration in results Actuaries must be aware of changing environments, how pricing tools are used, and how that will impact results Actuaries must communicate findings with management