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Title: CARe Reinsurance Boot Camp on Pricing Techniques


1
CARe Reinsurance Boot Camp on Pricing Techniques
  • Workers Compensation

Robert S. Yenke, ACAS August 9, 2007
2
  • The views and opinions expressed in this
    presentation are solely my own, and do not
    necessarily reflect the views or opinions of
    Odyssey America Reinsurance Corporation.

3
Outline
  • Workers Compensation Background
  • Quota Share Treaties
  • Excess of Loss Treaties
  • Catastrophe Treaties
  • Facultative

4
Workers Compensation Background
  • Started in U.S. in early 1900s, before Social
    Security, before Federal Income Tax Withholding
  • Benefits were low
  • Early 1970s National Commission of State Workers
    Compensation Laws
  • Frequency declines, severity increases

5
Workers Compensation Background
  • Independent Bureau states California, Delaware,
    Indiana, Massachusetts, Michigan, Minnesota, New
    Jersey, New York, North Carolina, Pennsylvania,
    Texas, Wisconsin
  • Monopolistic state Funds North Dakota, Ohio,
    Washington, West Virginia, Wyoming

6
Workers Compensation Background
  • Extremely long tail
  • Annuity-type benefits for Survivors and Permanent
    Total claims
  • Benefits defined by state law, not by courts
  • Indemnity and Medical benefits
  • Benefits, to some degree, vary by state
  • No policy limits
  • Essentially unlimited medical coverage
  • No-Fault system

7
Quota Share Treaties
  • Does the treaty cover losses up to a dollar
    amount, such as the first million, or the ceding
    companys Net?
  • If Net, what happens if the ceding company does
    not renew its Excess of Loss treaties? What if
    there is a loss above the top of the ceding
    companys reinsurance?

8
Quota Share Treaties
  • Quota Share up to a dollar limit - What is the
    cost of Excess of Loss reinsurance treaties?
  • Compare Premium Net of Reinsurance Cost to
    Expected Losses at dollar limit
  • Keep Actuaries Honest

9
Quota Share Treaties
  • Is the ceding company writing Retrospectively
    Rated policies? If so, how are premium
    adjustments accounted for.
  • Benefit level changes for states in analysis need
    to be included in estimate of projected loss
    ratio
  • Use state specific trends if ceding company is
    predominately in only one or a small number of
    states
  • In addition to filed rate changes, need to obtain
    impact of Schedule Rating, Group Discounts, etc.

10
Quota Share Treaties
  • Standard Quota Share Treaty issues including
    Ceding commission versus actual expenses, Impact
    of Sliding Scale Commission or Profit Commission
  • What is considered ALAE vs. ULAE?
  • What is included in definition of Subject
    Premium, e.g. Expense Constant?
  • For smaller companies and start-up operations you
    can obtain state specific loss and ALAE ratios
    from bureaus usually a little old

11
Quota Share Treaties
  • Quota Share of Excess WC Insurance
  • Who is handling the ground-up claims?
  • Reinsurer is relying on Excess Insurer to audit
    original claims adjustors. There could be many
    different entities handling the claims scary!

12
Excess of Loss Treaties
  • Typical layers of 4M xs 1M, 3M xs 2M
  • Working layers of 750K xs 250K, 500K xs 500K
    are less common than they used to be
  • Occasionally there are requests for lower layers,
    but in most cases the primary company decides to
    keep the layer Net
  • Some layers are unusual, such as 6M xs 1M, or
    8.75M xs 1.25M

13
Excess of Loss Treaties
  • Many treaties have free and unlimited
    reinstatements
  • Some treaties have a limited number of free
    reinstatements, often expressed as a maximum
    aggregate recoverable e.g. 4M xs 1M with four
    reinstatements 20M aggregate cap
  • Usually the aggregate cap is set high, so there
    is a low a probability that it will be exceeded,
    still nice to have
  • Some treaties have Annual Aggregate Deductibles

14
Excess of Loss Treaties
  • Most treaties are flat rated
  • Some treaties have adjustable features such as
    Swing Rating, Profit Commissions or Reinstatement
    Premiums
  • The long loss reporting patterns make the number
    of potential premium or commission adjustments
    very large

15
Excess of Loss Treaties Claims
  • WC Injury Types
  • Death
  • Permanent Total
  • Major Permanent Partial
  • Minor Permanent Partial
  • Temporary Total
  • Medical Only
  • Only the first three impact most Excess of Loss
    Treaties

16
Excess of Loss TreatiesClaims
  • Some claims are recognized quickly as high cost,
    e.g. multiple person catastrophes
  • Many claims are take years and years to develop
    into excess layer
  • Injured Worker Mortality how different from
    standard population mortality?

17
Excess of Loss TreatiesClaims
  • Workers have lower Mortality than general
    population
  • Injured Workers identified as Permanently
    Disabled have similar Mortality as population
  • Sometimes severely injured workers die before
    being classified as Permanently Disabled
  • Medical care for WC injury may help early
    diagnoses of other issues
  • Claims can develop adversely years later
  • Family stops taking care of claimant
  • Back injuries creep into the layer

18
Excess of Loss Treaties Loss Development
  • Discounting of case reserves is standard
  • Explicit indemnity reserves on lifetime pension
    cases discounted 3.5 interest rate common
  • Implicit medical by not inflating projected
    future payments
  • Mortality assumptions used in setting reserves
    Bureau tables are used for Statistical Reporting,
    some companies have mortality tables that vary
    with injury severity.
  • Effect of unwinding of discount can be much
    larger on an excess layer than the retained layer

19
Excess of Loss Treaties Loss Development
  • Long payment pattern, explicit discounting of
    indemnity reserves, implicit discounting of
    medical reserves produces large Excess LDFs
  • Account specific LDFs often have few claims,
    therefore LDFs are volatile for higher layers
  • RAA gathers data from reinsures every other year
    and publishes LDFs by line of business
  • In the 2005 study, WC Treaty data included
    Accident Years from 2004 back to 1958, 46 years!

20
Excess of Loss Treaties Loss Development
  • My analysis produced a Treaty WC Incurred LDF
    from 12 months to ultimate of 11. Therefore,
    less than 10 reported after one year
  • Gross Incurred LDF from 12 months to ultimate is
    1.9
  • Treaty WC LDF from 156 months to ultimate LDF is
    2. Therefore, after 13 years, only 50 of
    ultimate losses have been reported, the same as
    Gross LDF at 1 year!
  • The Incurred LDF from 45 to 46 is 1.01, there is
    still IBNR at 45 years!

21
Excess of Loss Treaties Loss Development
  • 2005 RAA Study included Paid Loss Development
    data
  • My analysis of Treaty WC Paid LDFs produced a 12
    month to ultimate of 190 approximately 0.5 is
    paid at 12 months. The Gross LDF is 4.5
  • The Paid LDF to Ultimate reaches 2 at 22 years,
    i.e. 50 paid at 22 years, the Gross LDF is 2 at
    2 years
  • The Paid to Case Incurred Ratio at 46 years is
    96 - there are still open cases

22
Excess of Loss TreatiesImpact on Reinsurer
  • An injured worker is expected to live 10 years.
  • Weekly indemnity benefits are 500/wk 26,000/yr
  • Expected indemnity benefit 260,000
  • Discounted value at 3.5 interest 220,000
  • Initial stabilizing medical expenses are 150,000
  • Annual medical expenses are 50,000/yr
  • Expected medical benefit 650,000
  • Undiscounted case reserve 260K 650K 910K
  • Discounted case reserve 220K 650K 870K
  • Expected loss to the 1M xs 1M reinsurer is zero.

23
Excess of Loss TreatiesImplicit Discount Effect
  • Assume medical expenses are inflating at 6 per
    year
  • Primary company books the ongoing medical loss at
    500K, implicitly discounting them at 6/yr.
  • Total undiscounted ongoing medical expenses are
    really 680K instead of the booked 500K
  • The total undiscounted loss is 260K 150K 680K
    1,090K and the 1M xs 1M reinsurer will see 90K of
    loss development
  • If the injured workers life expectancy is 20,
    30, 40 or more years, the impact is much larger

24
Excess of Loss Treaties Mortality Assumption
Effect
  • Instead of a certain 10 year survival, there was
    a 50 probability of this worker living only 5
    years and 50 of living 15 years.
  • Losses paid if the claimant lives 5 years 530K
    150K (26K50K) 5
  • Losses paid if the claimant lives 15 years
    1,290K 150K(26K50K) 15
  • There is a 50 probability, the 1M xs 1M
    reinsurer will see no loss development and 50
    probability the reinsurers will see 290K of loss
    development

25
Excess of Loss Treaties Trend
  • The long tail and unlimited medical benefits add
    to the difficulty in estimating trends for
    Workers Compensation.
  • In addition, states can and do change the WC
    benefits, adding to the uncertainty.

26
Excess of Loss TreatiesImpact of Non-uniform
Frequency Trend on Excess of Loss Pricing
  • Exposure Rating
  • Shape of the distribution changes, with more of
    the losses coming from larger claims
  • Experience Rating
  • Measured ground-up severity trend will increase
    from the reduced frequency of the smaller claims
  • Assuming uniform trend by size of loss, the
    measured large loss trend will be lower than the
    measured ground-up trend
  • This impact is mitigated by the less-negative
    frequency trend

27
Excess of Loss TreatiesTrend Example
  • Two types of claims, small and large.
  • In year 1, small claims have average severity of
    100K, while large claims have average severity of
    500K.
  • In year 1, there are an equal number of small and
    large claims, say 50 of each claim
  • Total Losses are 30,000,000
  • Average Severity in year 1 is 300K
  • (50100k 50500k)/(5050)

28
Excess of Loss Treaties Trend Example, continued
  • In year 2, there are now 40 small claims
    (frequency trend -20), while there are still
    50 large claims (0 frequency trend). Total
    frequency trend -10
  • The average severity for each claim type
    increases 10
  • Small claim severity 110K
  • Large Claim Severity 550K
  • Total losses are not 31,900,000 an increase of
    6
  • But, the measured overall severity is now 354K
  • (40110K 50550K)/(4050)
  • This is an 18 increase!

29
Excess of Loss Treaties Benefit Changes
  • Most benefit changes are small, increase in
    maximum weekly benefit, change in burial
    allowance, etc.
  • Large changes occur rarely, but sometimes in
    quick succession impact by injury type can be
    vary
  • California AB 749 January 1, 2003 PT Benefit
    Impact 54, Overall Impact 5
  • California AB 227, SB 228 January 1, 2004,
    Overall Impact -9
  • California SB 899 April 19, 2004 Overall Impact
    -20, January 1, 2005 Overall Impact -14
  • California January 1, 2006 Fatal Benefit Impact
    50, Overall Impact 3

30
Excess of Loss Treaties Experience Rating
  • Paid losses projections are not usable
  • Size of incurred LDFs gives projections low
    credibility
  • Presence or absence of large loss in a recent
    period produces large impact on projected losses
    to layer if LDF method is used
  • B-F method, using Cape Cod method to estimate
    initial loss cost

31
Excess of Loss Treaties Experience Rating
  • Higher layers may have no reported losses to
    develop.
  • I do not want to compare a zero from experience
    rating to the loss cost obtained from exposure
    rating.
  • Use ratio of exposure rating loss cost of higher
    layer to credible layer to apply to experience
    rating loss cost of credible layer

32
Excess of Loss TreatiesExposure Rating
  • Workers Compensation is similar to other lines
  • Compute overall expected losses
  • Allocate these losses to the layer being priced
    by an industry size-of-loss curve

33
Excess of Loss TreatiesExposure Rating
  • For lines with policy limits, like GL, the rating
    bureaus publish ILFs, which are based on
    size-of-loss curves
  • But, WC doesnt have policy limits.
  • Reinsurers use Retrospective Ratings Excess Loss
    Factors (ELFs), even though they were not
    designed for reinsurance

34
Excess of Loss TreatiesExposure Rating
  • Excess Loss Factors tables are published by
    state, typically for loss limits up to 10M, by
    Hazard Group
  • Variations by state are due to differences in
    benefit levels
  • Variations by Hazard Group are due to differences
    in the distribution of injury types by Hazard
    Group

35
Excess of Loss TreatiesExposure Rating
  • 2004 ELF changes
  • More reliance on state data
  • Use empirical data for small claims, fit
    distribution for tail
  • Distributions fit for Fatal, Permanent Total,
    Permanent Partial, Temporary Total and Medical
    Only
  • Comparison to Prior ELFs
  • Percent of total losses in low layers, less than
    1M similar to prior factors, some states
    increased, some decreased
  • Percent of total losses in layers above 1M
    dropped significantly in almost every state

36
Excess of Loss TreatiesExposure Rating
  • Comparison to Prior ELFs
  • Refitting current data using prior procedure
    produced ELFs much closer to new procedure
  • Conclusion data, not procedural change, drove
    most of the reduction in percent of losses in
    high layers
  • Decline in claim frequency in 1990s changed
    theshape of the loss distributions

37
Excess of Loss Treaties Exposure Rating How
Many Hazard Groups?
  • NCCI and the other bureaus used four Hazard
    Groups, however, 95 of the premium was in Hazard
    Group II or III. Mining, explosive
    manufacturing, longshore, in HG IV. Much HG IV
    was in Assigned Risk Pools, so business written
    Voluntarily included very little HG IV business
    excluded from many treaties except for
    incidental.
  • WCIRB adopted nine Hazard Groups A-I, which were
    subsequently updated to J-R. A four Hazard Group
    set of LERs was produced but class assignments
    did not match NCCI groupings.
  • NCCI did there own study and selected seven.

38
Excess of Loss Treaties Exposure Rating
  • Seven Hazard Groups are A through G, collapsible
    into four (1, 2, 3 and 4) AB into 1, CD into 2,
    EF into 3, G into 4
  • Premium by Hazard Group is much more evenly split
    Hazard Groups have really increased from 2 to
    7
  • Improves estimates of losses by layer for
    reinsurers and for primary companies, for example
    Loss Rated Accounts

39
Excess of Loss Treaties Exposure Rating
  • Suppose were pricing the 1M xs 1M layer
  • Expected Loss Ratio 70
  • ELF(1M) 0.10 ELF(2M) 0.06
  • Losses in the layer ELF(1M) ELF(2M) 4.0
  • 4.0 of the total losses are in this 1M xs 1M
    layer
  • Exposure Loss Cost 70 4.0 2.8

40
Excess of Loss Treaties
  • Combine experience and exposure loss cost
  • Discount?
  • Load for internal and external expenses
  • When do you know true result?

41
Catastrophe Treaties
  • Treaties requiring at least two injured workers,
    usually above 5M
  • Maximum Any One Life (MAOL)
  • Example 5M xs 5M, 5M MAOL requires the total
    loss from one occurrence to exceed 5M, with no
    single injured worker contributing more than 5M
  • Similarities to Property Cat Treaties

42
Catastrophe Treaties
  • Reinstatement terms frequently one
    reinstatement of limit with a premium expressed
    as a percent of original reinsurance premium.
  • Reinstatement premiums are typically paid when
    losses are paid which can be many years from
    inception, unlike Property Cat treaties.

43
Catastrophe Treaties
  • WC Catastrophe Layers extend up to 100M and
    frequently higher, far beyond the ELFs.
  • Pricing is frequently expressed as Rate on Line
    Premium / Limit
  • Rates on Line vary by layer and exposure
  • Higher layers have lower Rates on Line

44
Catastrophe Treaties
  • Exposure is not necessarily correlated to Workers
    Compensation Premium the Catastrophe risk is
    also related to Payroll
  • Example two employers with the same WC Premium
    but the first has a WC rate 10 times as high as
    the second. The second employer has a Payroll 10
    times the first. The Catastrophe risk is not
    equal.

45
Catastrophe Treaties
  • Earthquake exposed areas have higher Rates on
    Line
  • Hurricanes are not considered a significant
    exposure for Workers Compensation except for
    First Responders, most workers are not at work
    when the storm arrives
  • Areas considered at higher risk for Terrorism
    have higher Rates on Line

46
Catastrophe Treaties
  • Similar to Property Cat after Hurricane Andrew,
    information has increased
  • Some submissions include information on
    Payroll/Premium/Employee counts by insured, or
    zip code, and time of day/shift or maximum
    exposed employee counts
  • Similar to Property Cat, a number of reinsurers
    are needed to provide layers requested. Some
    participate on lower layers, others on higher
    layers.

47
Catastrophe Treaties
  • As with Property Catastrophe, modeling firms are
    analyzing the exposures
  • As with Property Catastrophe, reinsurers monitor
    their aggregate exposure to WC Catastrophe
    losses
  • Potential exists for a Property Catastrophe loss
    and a Workers Compensation Catastrophe loss

48
Catastrophe Treaties
  • Much of the business was written in the London
    market or by Life Insurers
  • Terrorism was not recognized as a risk
  • After 9/11, many participants suffered losses and
    left the market
  • Rates on Line increased dramatically, attracting
    traditional reinsurers
  • Coverage was restricted i.e. limits on Terrorism

49
Catastrophe Treaties
  • Rates on Line have been declining
  • Coverage has been expanding more Terrorism
    coverage, requests for including NBCR
  • Fortunately, there have been no significant
    losses to this book of business since 9/11
  • Unfortunately, a significant Workers Compensation
    Catastrophe will eventually happen, whether a
    natural Catastrophe or a man-made Catastrophe
  • As with Property Cat pricing after a large event,
    pricing will increase and coverage will be
    restricted.

50
Facultative
  • Individual account pricing.
  • By its very nature facultative reinsurance
    operates based on adverse selections. Through
    careful underwriting and pricing the reinsurers
    can establish the proper pricing and terms which
    would be profitable to the reinsurer.
  • The ceding companies will place facultative
    reinsurance due to class, exposures, to protect
    the treaty, a treaty exclusion or cat exposures.

51
Facultative
  • Ceding companies are often looking for
    reinsurance in Buffer layers such as 750K xs
    250K, 500K xs 500K
  • Underwriters use a combination of loss rating and
    manual rating
  • Loss rating up to a loss limit, usually well
    below reinsurance attachment point, then use
    ELFs to estimate layer loss cost

52
Facultative
  • Credibility weight loss rating with manual rating
  • Load expected loss cost for internal and external
    expenses
  • In the current market ceding companies want the
    WC facultative market to either match their
    pricing for the layer or be less than what they
    price it for. In the event that this can't be
    met then the ceding company would retained the
    risk Net.

53
Workers Compensation Suggested Reading
  • Commentary on the New Hazard Groups by Jose
    Couret. Presentation at Spring 2007 CAS Meeting
  • The 2004 NCCI Excess Loss Factors by Dan Corro
    and Greg Engl. CAS Forum 2006
  • An Actuarial Note on Workers Compensation Loss
    Reserves 25 Years Later by Lee Steeneck. CAS
    Forum 1996
  • Ratemaking for Excess Workers Compensation
    Insurance, by Owen Gleeson. CAS Forum 2001
  • Levels of Determinism in Workers Compensation
    Reinsurance Commutations by Gary Blumsohn.
    Proceedings 1999
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