BASIC TECHNIQUES FOR WORKERS COMPENSATION

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BASIC TECHNIQUES FOR WORKERS COMPENSATION

• Presented by
• Richard B. Moncher, Bristol West
• Jeremy N. Scharnick, General Casualty
• 2002 CAS Seminar on Ratemaking
• Tampa, Florida
• March 8, 2002
• WCP - 15

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SESSION OUTLINE
RICH MONCHER

• Overview of WC
• NCCI Filing
• Overall Rate / LC Level Change
• Class Rate / LC Changes

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SESSION OUTLINE
JEREMY SCHARNICK

• Other Bureau Ratemaking
• Expenses
• Loss Cost Multipliers
• Company Pricing Programs
• Current WC Market

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WC RATING PROCEDURE

• Exposure x Manual Rate Manual Premium
• Manual Premium x Experience Mod
• Standard Premium
• - Premium Discount Net Premium

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Example Loss Cost 1.60 Expenses 0.40
Rate 1.60 0.40 2.00 2001 Payroll
1,500,000 Exposure Payroll / 100
15,000 2001 Manual Premium Rate x Exposure
2.00 x 15,000 30,000
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Example (contd) 2001 Payroll 1,500,000
2002 Payroll 1,800,000 20 increase in
payroll If same 2.00 Rate, then 2002 Manual
Premium 18,000 x 2.00 36,000 36,000 / 30,000
20 increase in premium
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ADVANTAGES OF PAYROLL

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

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WC DATA BASES

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

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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

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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

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VALUATION OF FINANCIAL DATA POLICY YEAR
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VALUATION OF FINANCIAL DATA ACCIDENT YEAR
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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

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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.

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Does current premium level provide adequate
funds for future benefits?
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PREMIUM ON-LEVEL FACTORS

• Adjust historical premium to current rate / loss
  cost level based on subsequent rate / loss cost
  changes
• PY 2000 Premium 100M
• 1/1/2002 Loss Cost Change - 5.0
• PY 2000 Premium at Current Loss Cost Level
  95M

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LOSS ON-LEVEL FACTORS

• Adjust historical losses to current benefit
  level based on subsequent benefit (law) changes
• PY 2000 Medical Losses 100M
• 1/1/2002 Medical Fee Schedule Change 10
  savings
• PY 2000 Medical Losses at Current Benefit Level
  90M

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• Trend Factors
• - Compares movements in indemnity and
  medical benefits to movements in payroll
• - Applied to loss ratio
• (Adjusted losses) / (Adjusted premium)

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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 2003).

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LOSS EXPERIENCE INDICATION

• If loss ratio gt 1.0, then more premium is needed.
  So, loss costs need to be increased for PY
  2003.
• If loss ratio lt 1.0, then less premium is needed.
  So, loss costs need to be decreased for PY 2003.

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WC STATISTICAL PLAN

• Purposes
• - Classification Relativities
• - Industry Group Differentials
• - Experience Rating
• - Retrospective Rating
• - Research

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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.)

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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

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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
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VALUATION OF WC STATISTICAL PLAN DATA
3rd Report Valuation
4th Report Valuation
1st Report Valuation
2nd Report Valuation
5th Report Valuation
Policy Effective 1/1/97
7/1/00
7/1/01
7/1/02
7/1/98
7/1/99
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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

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BASIC TECHNIQUES FOR WORKERS COMPENSATION

• Company Perspective

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INDEPENDENT BUREAU VS. NCCI FILING ACTIVITIES

• Independent States
• California
• Delaware
• Massachusetts
• Michigan
• Minnesota
• New Jersey
• New York
• Pennsylvania
• Wisconsin

• Independent, but NCCI prepares rates/loss costs
• Indiana
• North Carolina

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LOSS COSTS - WHY?

• Antitrust Concerns
• Need for Large Database for Class Analyses
• Ease of Developing Final Rates

• Note Twenty years ago, all states were rate
  states. Now, almost all NCCI states use loss
  costs.

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COMPONENTS OF A RATE

• Losses
• Loss Adjustment Expenses
• Expenses and Profit
• Loss Based Assessments

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EXPENSE COMPONENTS

• Production - commissions, premium collection,
  underwriting
• Taxes, Licenses, and Fees - various premium
  taxes, bureau and filing fees
• General - policy processing, overhead, premium
  audits, actuarial
• Profit and contingencies - combined with
  investment income

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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

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COSTS AS A PERCENTAGE OF STANDARD PREMIUM
Sometimes in the Loss Cost
Sometimes in the Loss Cost
Almost Always in the Loss Cost
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HOW TO ACCOUNT FOR ITEMS OUTSIDE THE LOSS COST

• The Loss Cost Multiplier (LCM)
• Also known as a Pure Premium Multiplier
• Loss Cost x LCM Rate
• Factor to load loss costs for insurers expense
  and profit
• Must also consider other items not included in
  the Loss Cost
• Insurance companies must file LCMs for approval
  in loss cost states

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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 Only
• In all three cases, loss includes full trend and
  loss development

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DERIVATION OF A LOSS COST MULTIPLIER

• 
  Portion of Standard Premium
• 
  State
• 
  A B
  C

Expenses
.275 Profit
.025
.275 .275 .025 .025
Loss Assessments ( Prem)
.020 .020 Loss Adj. Expense (
Prem)
.080

Total of Items to Load on Loss Cost .300
Indicated Loss Cost Multiplier
1.429 1/(1 - Load Needed)


.320 .400 1.471 1.667
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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)

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DERIVATION OF THE LCM ALTERNATIVE APPROACH

• For State C in the Prior Example
• Loss related expenses total 10 of premium
• Loss equals 60 of premium
• Premium related expenses total 30 of premium
• 1 (10 / 60)
• LCM
  1.667
• 1 - (30)

The two methods are mathematically equivalent,
but this approach may produce more stable results
over time.
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ADDITIONAL CONSIDERATIONS FOR THE LCM

• Bureau Rates vs. Loss Costs
• 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 companys experience
  How does your experience compare? Are
  there changes in your companys
  operations to consider?
  When will you implement the change?

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MANUAL RATES ARE JUST THE BEGINNING

• Additional Pricing Elements
• Deviations
• Premium Discount
• Expense Constant
• Schedule Rating
• Experience Rating
• Dividend Plans
• Retrospective Rating
• Deductibles (Small and Large)

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ADDITIONAL PRICING ELEMENTS

• Deviations - filed by companies to reflect
  anticipated experience differences (rate or LCM)
• Premium Discount - by policy size reflects that
  relative expense is less for larger insureds
• Expense Constant - reflects that relative expense
  is greater for smaller insureds
• Schedule Rating - recognizes characteristics not
  reflected in experience rating

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PROGRAMS THAT ADJUST PREMIUM TO REFLECT ACTUAL
LOSS EXPERIENCE

• Experience Rating - Mandatory tool that compares
  actual and expected losses
• Dividend Plans - Meant to reflect favorable
  experience
• Retrospective Rating - Premium is adjusted based
  on insureds experience during the time the
  policy is in force
• Large Deductibles - similar to retrospective
  rating, but can offer cash flow benefits and
  premium tax savings to the insured

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WORKERS COMPENSATION CLIMATE AND THE ROLE OF THE
ACTUARY

• Industry results deteriorating on calendar and
  accident year bases
• Rates / Loss Cost changes vary by jurisdiction,
  from decreases to increases
• Current economic conditions may impact workers
  compensation 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