James B. Kahn, FCAS, MAAA CLRS Session #8 September 24, 2002 Arlington, Virginia

1. Reserving For Runoff Operations – A Real Life Claims Specific Methodologyfor Reserving a Workers Compensation Runoff Entity James B. Kahn, FCAS, MAAA CLRS Session #8 September 24, 2002 Arlington, Virginia

2. Why a claim specific WC model? Needs to be tailor-made to each company because of many different factors internal or external – big differences between actual and expected (reinsurance leveraging, SDTF, settlements) • Medical benefits vs. Indemnity benefits • Injury type classifications such as PT, PP, etc. • States or Jurisdictions • Handling of Claims/Settlements and Loss Adjustment Expense • Reinsurance Agreements, Retention Limits, Outside Recoveries (2nd Injury Funds, etc.) • Implicit or Explicit Discounting Procedures

3. Particulars of WC Line of Business • Generally few IBNR claims if no latent disease • Payments over many years allows time to make adjustments • Benefits set by Statute - changes to statutes of limitation or tort law can have profound impact • Re-openings possible, though restricted by settlement language • Lifetime reserves can be estimated relatively easily with mortality table assumptions

4. Particulars of WC Runoff Entity • Will have dwindling number of claims – over time becomes more manageable to look at individually • May be in timeline beyond initial costs of hospitalizations and surgeries • Shift in open claimants may eventually go more towards those who have suffered PT injuries and/or will not agree to settlements • Do claimants pursue runoff less aggressively? • Our runoff entity shown is referred to as “ABC Insurance Company” – latest AY is 1997

5. WC Claims Handling Particulars • Definitions of Closed Claims • Discounting • Reserving to Ultimate or otherwise • Accounting issues • Differences up to or beyond retentions (subrogation, etc.)

6. “Settlement Value” Case Reserves • A unique ABC practice? • Has there been a distinction between those who will accept settlement vs. those that will not? • Will there be changes in philosophy going forward?

7. Our Example – “ABC Insurance Company” • Mostly Florida WC Funds; construction and auto dealers risks • Indemnity needs adjustment for PTS • SDTF Recoveries need consideration • Establishes Case Reserves for ALAE • Initially a “settlement” value reserve for many claimants who will ultimately not accept a settlement • Relatively low retention limits (~$0.5-1.0M)

8. ABC’s Categories of Claimants • Closed Claims • Resolved Claims • Coverage B/Coverage Issues • Special Disability Accepted Claims • Maximum Reinsurer Reserve Claims • PT • Not at MMI • Medical Maintenance • PT Pending • Other All but Closed, Resolved, and Coverage B further segmented into ‘Likely to Settle’ or ‘Unlikely to Settle’

9. External Influences to Consider • Florida Tort Reforms of 1994 • Recent Medicare activity • Social Security Offsets

10. Claims Specific Model Development of IBNR • Indemnity • ALAE • Medical • Miscellaneous adjustments/outside model adjustments • Likely to settle claims – ultimate reserve estimated to be a percentage of current case reserves (at settlement value). • Unlikely to settle (maximum exposure) - essentially applies a selected monthly amount by the number of remaining months from a mortality table (plus ‘adjustments’); no pdf(x) distribution around life expectancy. • Reinsurance and Other Recoveries - easier to track all recoveries including SDTF by looking at individual claims. ALAE cession for each claimant – pro rata, same as loss, or not at all. Commuted or insolvent carriers?

11. Indemnity Reserve • In its simplest form, should be remaining months of lifetime times an amount determined by statute • Permanent Total Supplemental (PTS) in Florida to reflect cost of living adjustments • ~20 % Social Security Disability offsets in some cases – adjustments made to ‘Not at MMI’, ‘PT Pending’ classifications

12. ALAE Reserve • Will need to know how ALAE treated in cessions • Unlike other LOBs, older WC claims may not have as high a % of ALAE to loss as less mature claims • ABC has seen favorable incurred ALAE development the last several quarters, although Industry shows development including a 5% tail beyond 19 years of age

13. ALAE Reserve (Continued) • ABC Model initially takes responsive approach of multiplying latest four year monthly paid average by the remaining number of months • Possible ALAE payment data distortions • 1994 Florida Tort Reforms allowed entire settlement of claims for first time – resulted in more ALAE fees • Push for reclassification of Injury Type beginning in Calendar Year 1996 as TT benefits expired at 1/1/1996 – resulted in more ALAE fees • A runoff company should have fewer claims willing to accept settlements over time– should result in less ALAE fees • Effective 10/1/2001, no longer need a judge’s approval for settlement (if claimant’s legally represented) – should result in less ALAE fees • Model uses the 4 year monthly average with a per claim reserve cap of two times incurred • As loss begins to exceed retention, more ALAE ceded under Pro Rata policies

14. Medical Reserve • Looked at historical CY payment by AY of remaining body of claims not already at maximum reinsurance retention • After first 4 years following an accident, medical claims appear to follow a “U-Shaped” payment pattern over time as forces of inflation and utilization interact – similar patterns seen for virtually all Accident Years • In model’s escalation scenarios, kept flat payment pattern for years 5-16 following the accident, and began to escalate at year 17

15. Medical Reserve (Continued) • Very little variation among average payments for Accident Years 1979-1991 – model uses a total weighted average of payments for this group of Accident Years • Average payment for AY 1992 and AY 1993 calculated in model; immature years 1994-1997 calculated by using 1993 average payment adjusted for trend • Escalation scenarios (beginning at year 17) at inflation rates of 0%, 6%, 10%, and “10% years 17-21, 6% years 22 onward” calculated

16. Medical Reserve (Model Calculation) • Years 1-8 - for each open claim, the average monthly payment through the first 8 years is calculated and applied to remaining months through year 8 • Years 9-16 - takes lesser of 1-8 year monthly average and the all claim monthly average (for the appropriate Accident Year) and applies to remaining months through year 16 • Year 17 onward - yearly escalation determined from the selected year 16 payment, and applied to all remaining months for the expected lifetime of the claim

17. Medical Payments-Claims Open With Exposure Excluding Maximum Retention

19. Backup to Workers Compensation Claims Development Model

20. Settled/Closed Claim Percentages of Reserved Amounts by Calendar Year of Closing

21. Medical Payments-Claims Open With Exposure Excluding Maximum Retention - Medical Escalation at 10% Years 17-21, 6% thereafter

22. Medical Payments-Claims Open With Exposure Excluding Maximum Retention - Medical Escalation at 6% Beginning with Year 17

23. Medical Payments-Claims Open With Exposure Excluding Maximum Retention - Medical Escalation at 10% Beginning with Year 17

24. Claim Examples

25. Loss Reserve Model at December 31, 2000

26. Loss Reserve Model at December 31, 2000

27. Loss Reserve Model at December 31, 2000

28. Scenario Summaries

29. Claim Specific Loss Reserve Model with Losses Evaluated as of December 31, 2000

30. Claim Specific Loss Reserve Model with Losses Evaluated as of December 31, 2000

31. Claim Specific Loss Reserve Model with Losses Evaluated as of December 31, 2000

32. Other Adjustments (Outside the Claims Specific Model)

33. Calculation of IBNR for New and Reopened Claims

34. Calculation of IBNR Amounts Exceeding Reinsurance Limits

35. Calculation of Final IBNR Amount

36. Final ABC IBNR calculation including Adjustments not covered by Claims Specific Workers Compensation ModelScenario: (Likely to Settle at 100% of Current Reserves with 10% medical escalation years 17-21, 6% escalation thereafter)

37. Possible Enhancements • Using Accident Year Aggregation as A Priori in BF test • Restatement of Triangles to show history of open claims only • Indemnity averages by accident year or further segmentation into lost wages only, etc. • By all type splits for medical (see how “u” looks by category) • Hospital vs. Home Health Care patterns and history • Actual vs. Expected payment calculations

38. Other Items • ULAE Reserves • Differing philosophies as to whether ULAE costs should increase or decrease following runoff (decreasing staff vs. providing stay bonuses or considering ‘all costs’ as ULAE) • Adjustments to accepted methodologies may be necessary to consider particulars of runoff or Company philosophy • Different company philosophies of handling claims based on size may warrant different ULAE calculations based upon size of claim • All ULAE methods using Industry statistics could have distortions based on inconsistencies of ULAE definitions among entities

39. Other Items (Continued) • Duration for Economic Value of Company • “Rule of thumb” that duration should decrease over time may not hold up in the short term for WC because of change in payment patterns after year 4 • Claims specific calendar year payment projections can be applied to duration calculations for economic schedules (with adjustments for ‘unlikely to settle’ claims, reopens, etc.)