Pricing Excess Workers Compensation 2003 CAS Ratemaking Seminar Session REI-5 By Natalie J. Rekittke, FCAS, MAAA Midwest Employers Casualty Company

Pricing Excess Workers Compensation

2003 CAS Ratemaking Seminar

Session REI-5

By

Natalie J. Rekittke, FCAS, MAAA

Midwest Employers Casualty Company


Estimate ultimate ground-up losses Estimate excess portion of ultimate

losses Consider qualitative information Apply risk loadings including load for

terrorism


Estimating Ultimate Ground-up Losses• Loss Ratio (or Loss Cost) Method• Experience Modified Loss Cost Method


• Loss Ratio (or Loss Cost) Method– Estimate on-level premium (or payroll) for

historical years– Develop losses to ultimate– Adjust ultimate losses for trend in excess of

payroll trend to prospective pricing period– Calculate loss ratio (loss cost) by year and select– Apply selected loss ratio (loss cost) to estimated

prospective premium (payroll) to estimate ultimate ground-up losses


Unlimited TrendedOn-Level Incurred Loss Unlimited

Accident Earned Losses Development Trend to Ultimate LossYear Premium @12/31/02 Factor 2003 Losses Ratio

(1) (2) (3) (4) (5) (6)=(5)/(1)=(2)x(3)x(4)

1998 1,000,000 600,000 1.120 1.159 779,032 77.9%1999 1,000,000 700,000 1.150 1.126 906,035 90.6%2000 1,000,000 500,000 1.200 1.093 655,636 65.6%2001 1,000,000 600,000 1.300 1.061 827,502 82.8%2002 1,000,000 400,000 1.700 1.030 700,400 70.0%Total 5,000,000 2,800,000 3,868,605 77.4%

2003 1,000,000 770,000 77.0%

(6) ELPPF @ 100,000 0.250(7) 2003 Estimated Losses in 192,500 Excess of 100,000 = (4) x (6)

Loss Ratio Method Example


• Loss Ratio (or Loss Cost) Method– Advantages

• useful when exposure detail (payroll by class) is not available

• useful when industry expected loss costs are not available

– Disadvantage• loss cost method does not contemplate changes in

mix of business historically or prospectively


• Experience Modified Loss Cost Method– Apply industry loss costs by class (trended to historical

periods and at historical benefit levels) to historical payroll by class to calculate industry expected losses

– Estimate expected reported (or paid) losses as of the current evaluation date

– Divide actual reported (or paid) losses by expected to calculate historical experience modification factors

– Select experience modification factor (mod)– Apply selected mod to expected prospective losses to

estimate ultimate ground-up losses


Expected ActualIndustry Expected Reported Reported Experience

Accident Average Expected Percent Losses Losses ModificationYear Payroll Loss Cost Losses Reported @12/31/02 @12/31/02 Factor

(1) (2) (3) (4) (5)=(3)x(4) (6) (7)=(6)/(5)=(1)x(2)/100

1998 40,000,000 3.00 1,200,000 89.3% 1,071,429 600,000 0.5601999 42,000,000 2.90 1,218,000 87.0% 1,059,130 700,000 0.6612000 44,000,000 2.80 1,232,000 83.3% 1,026,667 500,000 0.4872001 46,000,000 2.70 1,242,000 76.9% 955,385 600,000 0.6282002 48,000,000 2.60 1,248,000 58.8% 734,118 400,000 0.545Total 4,846,728 2,800,000 0.578

2003 50,000,000 2.50 1,250,000 0.580

(8) 2003 Selected Ultimate Losses = (3) x (7 selected) 725,000(9) ELPPF @ 100,000 0.250(10) 2003 Estimated Losses in Excess of 100,000 = (8) x (9) 181,250

Experience Modified Loss Cost Example

Note: It is recommended that the calculations in columns (2) through (7) be performed capped at a working limit to reduce the impact of volatility due to large claims on the selection of the experience modification factor (mod). The final selected mod should be applied to expected unlimited losses to select ultimate unlimited losses.


• Experience Modified Loss Cost Method– Advantages

• reflects changes in mix of business• allows for adjustment for potential benefit level changes

or changing medical trends

– Disadvantages• requires payroll by class historically and prospectively -

sometimes difficult to obtain• development of industry expected losses by class code

and incorporation of benefit levels and trends can be time consuming and complex


Estimating excess portion of ultimate losses• Industry ELPPFs• Entity-Specific Excess Ratios• Large Loss Experience Method


• Industry ELPPFs– Available by state, by hazard group, by limitation– Separate selected ground-up ultimate losses into

the four hazard groups– For each hazard group, multiply ground-up

ultimate losses by ELPPF at desired loss limitation and add all hazard groups together to derive expected excess losses


• Industry ELPPFs– Advantages

• readily available• easy to use

– Disadvantages• not unique to the entity• only 4 possible ELPPFs for a given state and loss

limitation, and most entities fall in hazard groups 2 and 3


• Entity-Specific Excess Ratios– Estimate average severity by type of injury (TOI) – Divide the loss limitation (specific retention) by the average

severity to calculate an “entry ratio” by TOI – Use the entry ratio as an “index” into the loss distribution

(curves available by state benefit characteristics, by TOI from the NCCI)

– The portion of claims in excess of the entry ratio (excess ratio) is returned (see Retrospective Rating: Excess Loss Factors by William R. Gillam for technical details on excess ratio derivation)

– For each TOI, multiply ground-up ultimate losses by the excess ratio, and sum to derive expected excess losses


• Entity-Specific Excess Ratios– Advantages

• unique to the entity, allows for price differentiation among various entities of similar risk levels

• most responsive to entity experience and risk level if average severities are estimated not only by TOI, but even more refined to the class code level

– Disadvantages• difficult to estimate average severities and ultimate losses by

TOI, much less by class

• entity experience at this level of detail lacks credibility, and to compile industry statistics of this nature to complement entity experience would be extremely difficult and time consuming


• Large Loss Experience Method– Use actual large loss experience to select

ultimate losses in a working layer– Based on loss distribution curves, estimate the

relationship of expected losses in the higher pricing layer to expected losses in the working layer

– Apply that relationship to the selected losses in the working layer to price the higher layer


• Large Loss Experience Method– Advantages

• May be useful when ground-up loss data is not available, and only large loss experience is provided for pricing

• Relationship of higher layer to a working layer may be more reliable than relationship of higher layer to ground-up losses

– Disadvantages• Does not contemplate change in exposure level or mix of

business• Large loss data lacks credibility


• Credibility– Credibility of industry and entity data

should be considered in all of the methods discussed

– In addition to formula driven credibility, qualitative information can lend credibility to and assist the actuary in interpreting the quantitative analysis


Qualitative Considerations– Self-insured’s attitude/commitment

regarding its workers compensation program

– Quality of third party claim administrator (TPA)

– Quality of loss control vendor/program

Pricing Excess Workers Compensation• Self-Insured’s Attitude/Commitment

Regarding its Workers Compensation Program– Proper use of safety committees– Accountability for safety at appropriate

management levels– Timeliness of claim/incident reporting– Supervisor contact with injured employees– Returning injured employees to work (light duty

programs)– Frequency of changing TPA and loss control

vendors


• Quality of TPA– Medical management– Lost time claim management– Catastrophic claim management– Case resolution/settlement philosophy– Case reserving practices


• Quality of Loss Control Vendor/Program– Professional qualifications of vendor

personnel– Supervisor/employee safety training– Engineering/loss control analysis– Employee safety incentive programs


• Issues for Consideration– How much “soft” knowledge can be

gathered in a cost efficient manner?– How much knowledge is enough?– How much impact do “best practices” have

on retained losses?– Where does the impact occur (e.g.,

frequency, severity, tail factors,…)?– How can other disciplines help you?


Applying Risk Loadings• High Retentions• Terrorism


• Risk Loading for High Retention– Expected losses in high layers are low– Underlying exposure to loss could be very high– If premium is close to expected losses, it could

take hundreds of policies to cover one actual loss

– A risk load should be used


• Loading for Terrorism– NCCI filed primary loss cost loadings of

around $0.02 per $100 payroll– A terrorism event would be considered a

single occurrence excess insurance would effectively turn into primary insurance

– Excess insurance should apply similar $0.02 loading


• Terrorism loading examplePrimary Policy– $100M payroll– Average rate of $2 premium of $2M– Terrorism loading of $0.02 total premium of $2,020,000 – Terrorism load is 1%

Excess Policy– $100M payroll– Average manual rate of $2 manual premium of $2M– SIR of $300,000– Excess rate of 5% excess premium of $100,000– Terrorism loading of $0.02 (per $100 payroll) total premium of $120,000 – Terrorism load is 20%


• Managing Terrorism– Load premium for terrorism– Put specific limits on your policies – Manage your concentration of risk by

knowing• where your business is

• number of insured employees within a certain square mile range

• probable maximum loss within a certain square mile range

• total loss your company is willing to bear

Documents

Pricing Excess Workers Compensation 2003 CAS Ratemaking Seminar Session REI-5 By Natalie J. Rekittke, FCAS, MAAA Midwest Employers Casualty Company