BASIC TECHNIQUES FOR BASIC TECHNIQUES FOR WORKERS COMPENSATIONWORKERS COMPENSATION

Presented by Presented by

Richard B. Moncher, Protegrity ServicesRichard B. Moncher, Protegrity Services

Andrew J. Doll, General CasualtyAndrew J. Doll, General Casualty

2001 CAS Seminar on Ratemaking2001 CAS Seminar on Ratemaking

Las Vegas, NevadaLas Vegas, Nevada

March 13, 2001March 13, 2001

WCP - 16WCP - 16

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SESSION OUTLINESESSION OUTLINE

RICH MONCHER:RICH MONCHER:

• Overview of WCOverview of WC• NCCI FilingNCCI Filing• Overall Rate / LC Level ChangeOverall Rate / LC Level Change• Class Rate / LC ChangesClass Rate / LC Changes

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SESSION OUTLINESESSION OUTLINE

ANDY DOLL:ANDY DOLL:

• Other Bureau RatemakingOther Bureau Ratemaking• ExpensesExpenses• Loss Cost MultipliersLoss Cost Multipliers• Company Pricing ProgramsCompany Pricing Programs• Current WC MarketCurrent WC Market

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Exposure x Manual Rate = Manual PremiumExposure x Manual Rate = Manual Premium

Manual Premium x Experience Mod Manual Premium x Experience Mod

= Standard Premium= Standard Premium

- Premium Discount = Net Premium- Premium Discount = Net Premium

WC RATING PROCEDUREWC RATING PROCEDURE

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Example:Example:

Loss Cost = 1.60Loss Cost = 1.60 Expenses = 0.40Expenses = 0.40 Rate = 1.60 + 0.40 = 2.00Rate = 1.60 + 0.40 = 2.00 2000 Payroll = 1,500,0002000 Payroll = 1,500,000 Exposure = Payroll / 100 = 15,000Exposure = Payroll / 100 = 15,000

2000 Manual Premium = Rate x Exposure2000 Manual Premium = Rate x Exposure = 2.00 x 15,000 = 30,000= 2.00 x 15,000 = 30,000

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Example (cont’d)Example (cont’d)

2000 Payroll = 1,500,0002000 Payroll = 1,500,000 2001 Payroll = 1,800,0002001 Payroll = 1,800,000

20% increase in payroll20% increase in payroll

If same $2.00 Rate, thenIf same $2.00 Rate, then2001 Manual Premium = 18,000 x 2.00 = 36,0002001 Manual Premium = 18,000 x 2.00 = 36,000

36,000 / 30,000 = 20% increase in premium36,000 / 30,000 = 20% increase in premium

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ADVANTAGES OF PAYROLLADVANTAGES OF PAYROLL

• Inflation SensitiveInflation Sensitive- Payroll up Premium up- Payroll up Premium up

• Tracks with Indemnity BenefitsTracks with Indemnity Benefits

• Verifiable / AuditableVerifiable / Auditable- Less potential for fraud- Less potential for fraud

• Readily AvailableReadily Available

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WC DATA BASESWC DATA BASES

• Financial Aggregate CallsFinancial Aggregate Calls- Annual Data at Year End- Annual Data at Year End- Statewide & Assigned Risk- Statewide & Assigned Risk

• WC Statistical Plan WC Statistical Plan - Detail By Class - Detail By Class - Payroll & Losses- Payroll & Losses- Five Evaluations- Five Evaluations

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FINANCIAL AGGREGATE CALLSFINANCIAL AGGREGATE CALLS

• PurposesPurposes

- Overall Rate/Loss Cost Level Change- Overall Rate/Loss Cost Level Change- where overall means statewide,- where overall means statewide,

voluntary or assigned riskvoluntary or assigned risk

- Trend Analyses- Trend Analyses- changes in historical loss ratios- changes in historical loss ratios

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FINANCIAL AGGREGATE CALLSFINANCIAL AGGREGATE CALLS

• ExperienceExperience- By Policy Year- By Policy Year- By Calendar-Accident Year- By Calendar-Accident Year

• Data ElementsData Elements- Std Earned Premium at DSR Level- Std Earned Premium at DSR Level- Std Earned Premium at Company Level- Std Earned Premium at Company Level- Net Earned Premium- Net Earned Premium- Benefit Costs: Indemnity/Medical/Total- Benefit Costs: Indemnity/Medical/Total

- Payments (Paid Losses)- Payments (Paid Losses)- Case Reserves- Case Reserves- Bulk & IBNR Reserves- Bulk & IBNR Reserves

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VALUATION OF FINANCIAL DATA VALUATION OF FINANCIAL DATA POLICY YEARPOLICY YEAR

ExpirationExpirationDateDate

EffectiveEffectiveDateDate

PolicyPolicyYearYear19991999

1/1/991/1/99 12/31/9912/31/99 12/31/0012/31/00(1st report)(1st report)

12/31/0112/31/01(2nd report)(2nd report)

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VALUATION OF FINANCIAL DATA VALUATION OF FINANCIAL DATA ACCIDENT YEARACCIDENT YEAR

1/1/991/1/99 1/1/001/1/00 12/31/0012/31/00(1st report)(1st report)

12/31/0112/31/01(2nd report)(2nd report)

AccidentAccidentYearYear20002000

ExpirationExpirationDateDate

EffectiveEffectiveDateDate

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RATEMAKING: THE BIG PICTURERATEMAKING: THE BIG PICTURE

• Start with historical (premium and loss) data Start with historical (premium and loss) data usually one to two years oldusually one to two years old

• Use analysis and judgment to estimate the Use analysis and judgment to estimate the ultimate losses by adjusting historical lossesultimate losses by adjusting historical losses

• Adjust the premium (excluding expenses for loss Adjust the premium (excluding expenses for loss cost states) from historical data to simulate the cost states) from historical data to simulate the (pure) premium currently in place(pure) premium currently in place

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RATEMAKING: THE BIG PICTURERATEMAKING: THE BIG PICTURE

• Divide ultimate losses by simulated premium to Divide ultimate losses by simulated premium to obtain loss ratio. obtain loss ratio.

• Trend loss ratio to effective period.Trend loss ratio to effective period.

• Check if current rates / loss costs are adequate. If Check if current rates / loss costs are adequate. If trended loss ratio is close to 1.0, then no rate / lost trended loss ratio is close to 1.0, then no rate / lost cost change may be needed. Otherwise, revised cost change may be needed. Otherwise, revised rates / loss costs are needed.rates / loss costs are needed.

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

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PREMIUM ON-LEVEL FACTORSPREMIUM ON-LEVEL FACTORS

Adjust historical premium to current rate / loss Adjust historical premium to current rate / loss cost level based on subsequent rate / loss cost cost level based on subsequent rate / loss cost changeschanges

PY 1999 Premium = $100MPY 1999 Premium = $100M

1/1/2001 Loss Cost Change = - 5.0%1/1/2001 Loss Cost Change = - 5.0%

PY 1999 Premium at Current Loss Cost Level = PY 1999 Premium at Current Loss Cost Level =

$95M $95M

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LOSS ON-LEVEL FACTORSLOSS ON-LEVEL FACTORS

Adjust historical losses to current benefit level Adjust historical losses to current benefit level based on subsequent benefit (law) changesbased on subsequent benefit (law) changes

PY 1999 Medical Losses = $100MPY 1999 Medical Losses = $100M

1/1/2001 Medical Fee Schedule Change = 10% 1/1/2001 Medical Fee Schedule Change = 10% savingssavings

PY 1999 Medical Losses at Current Benefit Level PY 1999 Medical Losses at Current Benefit Level = $90M= $90M

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• Trend FactorsTrend Factors

- Compares movements in indemnity and - Compares movements in indemnity and medical benefits to medical benefits to movements in payrollmovements in payroll

- Applied to loss ratio =- Applied to loss ratio =

(Adjusted losses) / (Adjusted premium)(Adjusted losses) / (Adjusted premium)

Data inData inFilingFiling

TimeTime

} FilingFilingEff DateEff Date

TrendTrend

PayrollPayroll

Benefit CostsBenefit Costs

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LOSS EXPERIENCE INDICATIONLOSS EXPERIENCE INDICATION

• Estimate ultimate losses at current benefit level.Estimate ultimate losses at current benefit level.

• Estimate premium at current loss cost level.Estimate premium at current loss cost level.

• Divide these losses by these premiums to obtain loss Divide these losses by these premiums to obtain loss ratio.ratio.

• Trend loss ratio to average accident date of effective Trend loss ratio to average accident date of effective period (PY 2002).period (PY 2002).

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LOSS EXPERIENCE INDICATIONLOSS EXPERIENCE INDICATION

• If loss ratio > 1.0, then If loss ratio > 1.0, then more premium is needed. more premium is needed. SSo, loss costs need to be increased for PY 2002.o, loss costs need to be increased for PY 2002.

• If loss ratio < 1.0, then less premium is needed. If loss ratio < 1.0, then less premium is needed. So, loss costs need to be decreased for PY 2002.So, loss costs need to be decreased for PY 2002.

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WC STATISTICAL PLANWC STATISTICAL PLAN

• PurposesPurposes

- Classification Relativities- Classification Relativities

- Industry Group Differentials- Industry Group Differentials

- Experience Rating- Experience Rating

- Retrospective Rating- Retrospective Rating

- Research- Research

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WC STATISTICAL PLANWC STATISTICAL PLAN

• Experience by PolicyExperience by Policy

• Classification DetailsClassification Details

- Exposure / Premium / Experience Mod- Exposure / Premium / Experience Mod

- Individual Claim Records- Individual Claim Records

Indemnity / MedicalIndemnity / Medical

Case Incurred ValuesCase Incurred Values

By Injury Type (Fatal, PT, etc.)By Injury Type (Fatal, PT, etc.)

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OVERALL CHANGE TO INDUSTRY OVERALL CHANGE TO INDUSTRY GROUPSGROUPS

• Overall change is distributed to industry groups Overall change is distributed to industry groups and then to individual classesand then to individual classes

• ManufacturingManufacturing TextilesTextiles CabinetsCabinets AutomobilesAutomobiles

• Office & Office & ClericalClerical

Clerical Clerical office office employeesemployees

Outside Outside salessales

• ContractingContracting PlumbingPlumbing RoadsRoads HousesHouses

• Goods & Goods & ServicesServices

RestaurantsRestaurants Retail salesRetail sales Nursing Nursing

HomesHomes

• MiscellaneousMiscellaneous TruckingTrucking LoggingLogging Surface coal Surface coal

miningmining

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MANUFACTURING INDUSTRY GROUP MANUFACTURING INDUSTRY GROUP CHANGECHANGE

Analysis shows that:Analysis shows that:• Overall (statewide) change is +10%Overall (statewide) change is +10%• Manufacturing industry group experience is 10% Manufacturing industry group experience is 10%

worse than statewide. So,...worse than statewide. So,...

Mfg IndustryMfg IndustryGroup ChgGroup Chg

== StatewideStatewideChangeChange

x x Industry GroupIndustry Group DifferentialDifferential

== (1.10) (1.10) - 1(1.10) (1.10) - 1== 1.21 - 11.21 - 1== 21%21%

-- 11

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VALUATION OF WC STATISTICAL VALUATION OF WC STATISTICAL PLAN DATAPLAN DATA

7/1/997/1/99PolicyPolicy

EffectiveEffective1/1/961/1/96

7/1/977/1/97 7/1/987/1/98 7/1/007/1/00 7/1/017/1/01

1st1stReportReport

ValuationValuation

2nd2ndReportReport

ValuationValuation

3rd3rdReportReport

ValuationValuation

4th4thReportReport

ValuationValuation

5th5thReportReport

ValuationValuation

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DISTRIBUTION OF INDUSTRY GROUP DISTRIBUTION OF INDUSTRY GROUP CHANGE TO CLASSCHANGE TO CLASS

• Unit ReportsUnit Reports

• Relativities (between classes)Relativities (between classes)

- Five years of WCSP data- Five years of WCSP data

- Current loss cost / rate (adjusted)- Current loss cost / rate (adjusted)

- Adjusted national experience for - Adjusted national experience for classclass

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BASIC TECHNIQUES FOR BASIC TECHNIQUES FOR WORKERS WORKERS

COMPENSATIONCOMPENSATION

Company PerspectiveCompany Perspective

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INDEPENDENT BUREAU INDEPENDENT BUREAU VS. NCCI FILING VS. NCCI FILING

ACTIVITIESACTIVITIES CaliforniaCalifornia MassachusettsMassachusetts MinnesotaMinnesota New JerseyNew Jersey New YorkNew York Pennsylvania/DelawarePennsylvania/Delaware TexasTexas

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LOSS COSTS - WHY?LOSS COSTS - WHY?

McCarran-Ferguson DebateMcCarran-Ferguson Debate Antitrust ConcernsAntitrust Concerns Ease of Developing Final RatesEase of Developing Final Rates

Note: Twenty years ago, all states Note: Twenty years ago, all states were rate states. Now, almost all were rate states. Now, almost all NCCI states are loss costs.NCCI states are loss costs.

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COMPONENTS OF A RATECOMPONENTS OF A RATE

LossesLosses Loss Adjustment ExpensesLoss Adjustment Expenses Expenses and ProfitExpenses and Profit Loss AssessmentsLoss Assessments

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EXPENSE COMPONENTSEXPENSE COMPONENTS

ProductionProduction - commissions, premium - commissions, premium collection, underwritingcollection, underwriting

Taxes, Licenses, and FeesTaxes, Licenses, and Fees - various - various premium taxes, bureau and filing feespremium taxes, bureau and filing fees

General General - overhead, audits, general - overhead, audits, general administrationadministration

Profit and contingenciesProfit and contingencies - combined - combined with investment incomewith investment income

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COSTS AS A PERCENTAGE OF COSTS AS A PERCENTAGE OF FIRST $5,000 OF STANDARD FIRST $5,000 OF STANDARD

PREMIUMPREMIUMProfit

Taxes

General

Production

Loss & Loss Adjustment

Loss Assessments

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EVALUATION OF THE NEEDS EVALUATION OF THE NEEDS OUTSIDE OF THE LOSS COSTOUTSIDE OF THE LOSS COST

Items always Outside the Loss CostItems always Outside the Loss Cost ProductionProduction Taxes, Licenses, and FeesTaxes, Licenses, and Fees GeneralGeneral Profit and ContingenciesProfit and Contingencies

Items sometimes Outside the Loss CostItems sometimes Outside the Loss Cost Loss Adjustment ExpensesLoss Adjustment Expenses Loss Based AssessmentsLoss Based Assessments

Items rarely Outside the Loss Cost (MN)Items rarely Outside the Loss Cost (MN) TrendTrend Loss Development beyond 8th reportLoss Development beyond 8th report

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COMPONENTS OF A RATE IN OR COMPONENTS OF A RATE IN OR OUT OF THE LOSS COSTOUT OF THE LOSS COST

Losses

Loss Adjustment Expense

Expense and Profit

Loss Assessments

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HOW TO ACCOUNT FOR ITEMS HOW TO ACCOUNT FOR ITEMS OUTSIDE THE LOSS COSTOUTSIDE THE LOSS COST

The Loss Cost Multiplier (LCM)The Loss Cost Multiplier (LCM)

Factor to multiply loss costs by in order to Factor to multiply loss costs by in order to load in insurer’s expense and profitload in insurer’s expense and profit

Must also consider other items not included Must also consider other items not included in the Loss Costin the Loss Cost

Loss Cost x LCM = RateLoss Cost x LCM = Rate Insurance companies must file LCMs for Insurance companies must file LCMs for

approval in loss cost statesapproval in loss cost states Also known as a Pure Premium MultiplierAlso known as a Pure Premium Multiplier

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DERIVATION OF A LOSS DERIVATION OF A LOSS COST MULTIPLIERCOST MULTIPLIER

State A:State A: Loss Cost includes Loss, Loss Loss Cost includes Loss, Loss Adjustment expense, and AssessmentsAdjustment expense, and Assessments

State B:State B: Loss Cost includes Loss and Loss Cost includes Loss and Loss Adjustment expenseLoss Adjustment expense

State C: State C: Loss Cost includes Loss Loss Cost includes Loss

In all three cases, loss includes full trend In all three cases, loss includes full trend and loss developmentand loss development

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DERIVATION OF A LOSS DERIVATION OF A LOSS COST MULTIPLIERCOST MULTIPLIER

Portion of Standard PremiumPortion of Standard Premium

StateState

A B CA B C

Expenses .275Expenses .275

Profit .025Profit .025

Total of Items to Load on Loss Cost .300Total of Items to Load on Loss Cost .300

Indicated Loss Cost Multiplier 1.429Indicated Loss Cost Multiplier 1.429

= 1/(1 - Load Needed)= 1/(1 - Load Needed)

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DERIVATION OF A LOSS DERIVATION OF A LOSS COST MULTIPLIERCOST MULTIPLIER

Portion of Standard PremiumPortion of Standard Premium

StateState

A B CA B C

Expenses .275 .275 .275Expenses .275 .275 .275

Profit .025 .025 .025Profit .025 .025 .025

Loss Assessments (% Prem) .020 .020Loss Assessments (% Prem) .020 .020

Loss Adj. Expense (% Prem) .080Loss Adj. Expense (% Prem) .080

Total of Items to Load on Loss Cost .300 .320 .400Total of Items to Load on Loss Cost .300 .320 .400

Indicated Loss Cost Multiplier 1.429 1.471 1.667Indicated Loss Cost Multiplier 1.429 1.471 1.667

= 1/(1 - Load Needed)= 1/(1 - Load Needed)

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DERIVATION OF THE LCM DERIVATION OF THE LCM ALTERNATIVE APPROACHALTERNATIVE APPROACH

Prior methodology assumes that all items included in the LCM Prior methodology assumes that all items included in the LCM are related to Premiumare related to Premium

Loss Adjustment Expenses and Assessments may not have a Loss Adjustment Expenses and Assessments may not have a stable relationship to Premiumstable relationship to Premium

An alternative approach for states that require a loading for An alternative approach for states that require a loading for “loss related” items is:“loss related” items is:

1 + Loss Related Items (% Loss)1 + Loss Related Items (% Loss)

LCM = LCM =

1 - Premium Related Items (% Premium)1 - Premium Related Items (% Premium)

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ADDITIONAL CONSIDERATIONS ADDITIONAL CONSIDERATIONS FOR THE LCMFOR THE LCM

Administered Pricing vs. Competitive RatingAdministered Pricing vs. Competitive Rating When to use a LCM? When to use a LCM?

Evaluation of the Bureau Loss Cost FilingEvaluation of the Bureau Loss Cost Filing Do you agree with the various assumptions? Do you agree with the various assumptions? How does your book compare? How does your book compare? Is there additional, more current info? Is there additional, more current info?

Consideration of the Company’s experienceConsideration of the Company’s experience How does your experience compare? How does your experience compare? Are there changes to consider? Are there changes to consider? When will you be implementing a change? When will you be implementing a change?

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MANUAL RATE IS STARTING POINT FOR MANUAL RATE IS STARTING POINT FOR DETERMINING COST OF WORKERS DETERMINING COST OF WORKERS

COMPENSATION INSURANCECOMPENSATION INSURANCE

Additional FactorsAdditional Factors

Prospective Experience RatingProspective Experience Rating Premium DiscountsPremium Discounts DeviationsDeviations Schedule RatingSchedule Rating Retrospective RatingRetrospective Rating Dividend PlansDividend Plans Deductibles (Small and Large)Deductibles (Small and Large)

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PROGRAMS THAT CAN BE USED TO PROGRAMS THAT CAN BE USED TO BETTER REFLECT INDIVIDUAL RISK BETTER REFLECT INDIVIDUAL RISK

CHARACTERISTICSCHARACTERISTICS Experience RatingExperience Rating - mandatory tool that compares - mandatory tool that compares

actual and expected lossesactual and expected losses Premium DiscountsPremium Discounts - by policy size; reflects that - by policy size; reflects that

relative expense is less for larger insuredsrelative expense is less for larger insureds Expense ConstantExpense Constant - reflects expense gradation for - reflects expense gradation for

smaller insuredssmaller insureds DeviationsDeviations - filed by companies (LCM or rate) to - filed by companies (LCM or rate) to

reflect anticipated experience differencesreflect anticipated experience differences Schedule RatingSchedule Rating - reflects characteristics not - reflects characteristics not

reflected by experience ratingreflected by experience rating Dividend PlansDividend Plans - means to reflect favorable - means to reflect favorable

experience; similar to schedule or retro ratingexperience; similar to schedule or retro rating

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PROGRAMS THAT CAN BE USED TO PROGRAMS THAT CAN BE USED TO REFLECT ACTUAL LOSS EXPERIENCEREFLECT ACTUAL LOSS EXPERIENCE

Retrospective RatingRetrospective Rating - premium depends on the - premium depends on the experience generated by the insured during the experience generated by the insured during the time the policy is in forcetime the policy is in force

Large DeductiblesLarge Deductibles - similar to retrospective rating, - similar to retrospective rating, but can often allow for cash flow benefits to the but can often allow for cash flow benefits to the insuredinsured

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WORKERS COMPENSATION CLIMATE WORKERS COMPENSATION CLIMATE AND THE ROLE OF THE ACTUARYAND THE ROLE OF THE ACTUARY

Industry results deteriorating on calendar and Industry results deteriorating on calendar and accident year bases accident year bases

Rates / Loss Costs changes vary by Rates / Loss Costs changes vary by jurisdiction, from decreases to increasesjurisdiction, from decreases to increases

Changes are not reflective of deterioration in Changes are not reflective of deterioration in resultsresults

Actuaries must be aware of changing Actuaries must be aware of changing environments, how pricing tools are used, and environments, how pricing tools are used, and how that will impact resultshow that will impact results

Actuaries must communicate findings with Actuaries must communicate findings with managementmanagement