Workers Compensation Ratemaking—An Overview

Rating Bureau PerspectiveJay Rosen, NCCI, Inc.

Insurance Company PerspectiveDan Perry, QBE Regional Companies (N.A.), Inc.

CAS 2012

Ratemaking and Product Management Seminar

Philadelphia, Pennsylvania – March 20, 2012

Rating Bureau Perspective

Workers Compensation Ratemaking—An Overview

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Rating Bureau Perspective Outline

• Overview of Workers Compensation Insurance

• NCCI Filing

• Overall Rate / Loss Cost Level Change

• Classification Rate / Loss Cost Changes

4

In general, a loss cost represents a provision for losses and LAE per $100 of payroll for each classification

Loss costs are not final rates because they do not include provisions for the remaining expenses (including production expenses, profit and contingencies, etc.) of an insurer

Loss Costs—What Are They?

5

Workers Compensation Rating Laws

LOSS COST (31)LOSS COST/INDEP RTG BUREAU (7)MONOPOLISTIC (4)RATES (5)RATES/INDEP RTG BUREAU (4)

6

NCCI Workers Compensation Databases

• Financial Aggregate Calls– Used for aggregate ratemaking

• WC Statistical Plan (WCSP)– Used for class ratemaking

7

Financial Aggregate Calls

• Collected annually– Policy and calendar-accident year basis– Statewide and assigned risk data

• Premiums, losses and claim counts– Evaluated as of December 31

• Purpose– Basis for overall aggregate rate indication– Research

8

Designated Statistical Reporting (DSR) Level Premium

• Common benchmark level at which carriers report premium on the financial calls

• The DSR level represents the “approved” loss cost and assigned risk rate levels

• Varies by policy year and state

9

Ratemaking—The Big Picture

Projected losses & Loss Adjustment Expense*Premium at current loss cost level

* Not all states include loss adjustment expense in the calculation.

= Indicated overall average loss cost level change

For the upcoming loss cost effective period:

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NCCI Typically Uses the Two Most Recent Policy Years of Data

1/1/10 12/31/101/1/09 1/1/13 12/31/13

Policy Expiration Date

Policy Effective Date

Policy Year2009

Policy Year2010

Policy Year2013

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Derivation of Projected Losses

Adjustments to reported losses:

• Benefit (loss) on-levels

• Loss development

• Trend

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Changes that occur subsequent to the filing data must be reflected:

• Legislated benefit changes

• Court decisions

• New regulations

Benefit Changes

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Loss On-level Factors AdjustData to the Current Benefit Level

1/1/10 12/31/101/1/09 1/1/13 12/31/13

Policy Effective Date

Policy Year2009

Policy Year2010

Policy Year2013

Benefit Change Effective March 1, 2010

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The ultimate cost of a reported claim may not be known for many years. Therefore, an initial estimate of the ultimate settlement value is made at the time the claim is reported.

This estimate may change over time as the prognosis of the injury changes, the expected life-span shortens/ lengthens, the cost of medical services increases/ decreases, etc.

Loss Development

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Loss Development Factors Are Used to Estimate Ultimate Liabilities

Over time, the % of ultimate losses that are paid increases

PY20091st Rpt

PY20092nd Rpt

PY20093rd Rpt

PY2009Ultimately

. . .

. . .

Paid

Paid

Paid

Paid

CaseReserves

CaseReserves

CaseReserves

IBNR

IBNR IBNR

IBNR: Reserves set aside for claims that have been Incurred But Not yet Reported.

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Trend compares movements in indemnity and medical costs to movements in payroll

Data in Filing

Time FilingEffective

} TrendBenefit Costs

Payroll

Trend

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• Fitting curves to Historical Loss Ratios

• Use of Frequency and Severity Data

• Econometric Analysis

• Outside Sources (AHA, DOL)

A positive trend assumes that losses are growing faster than wages. A negative trend assumes the opposite.

Techniques to Measure Trend

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Derivation of Premium at CurrentLoss Cost Level

Adjustments to reported financial data premium:

• Premium on-levels

• Policy year premium development

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Premium On-level Factors Adjust Historical Premium to the Current

Approved Level

1/1/10 12/31/101/1/09 1/1/13 12/31/13

Policy Effective Date

Policy Year2009

Policy Year2010

Policy Year2013

Loss Cost Level Change Effective July 1, 2010

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Jan 1st Dec 31st Dec 31st

Last Policy

Expires

MostAudits

Complete

Mar 31st

PY Financial Data1st Report

Policy Year

Policy Year Premium Development(Due to payroll audits)

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WC Statistical Plan (WCSP) Data

• Experience by policy detail– Exposure, premium, experience rating modifications– Individual claims by injury type

• Purposes– Classification relativities– Experience Rating Plan– Research

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Valuation of WCSP Data

PolicyEffective

18 Months

1stReport

Valuation

2ndReport

Valuation

3rdReport

Valuation

4thReport

Valuation

5thReport

Valuation

30 Months42 Months

54 Months66 Months

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The overall average change is distributed to industry groups and then to individual classes

Distribution of Overall Change to Industry Groups

ManufacturingTextilesCabinetsAutomobiles

ContractingPlumbingRoadsHouses

Goods & ServicesRestaurantsRetail salesNursing

Office & ClericalOutside salesClerical office

employees

Miscellaneous Trucking Logging Surface coal mining

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M anufacturing+1.3%

Contracting+4.4%

Office & Clerical-2.1%

Goods & Services+0.4%

M iscellaneous+1.7%

Overall Change+2.0%

State XYZChanges by Industry Group

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Individual Classifications

• Five years of WCSP experience used

• Individual claims are limited

• Credibility is assigned

• National data is used in low volume/credibility classes

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Formula Pure Premiums

+

+

Z = Credibility %

State Z XIndicated Pure Premium(State data, five years)

National Z XNational Pure Premium(National data adjusted)

Remaining Z XPresent on Rate Level Pure Premium(approved)

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Test Correction Procedure

Iterative process to ensure that:

• class swing limits are adhered to

• the Industry Group change is achieved

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Classification Swing Limits

Individual class loss costs prior to swing

limits

(A) = Indicated changes exceeding the upper swing limit(B) = Indicated changes within the swing limits(C) = Indicated changes less than the lower swing limit

Industry Group Change

+25%

-25%

B

C

A

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• Add in a provision for Loss Adjustment Expense (Expenses of an insurer which are directly chargeable to the settlement of claims—such as investigating cases and defending law suits)

• May also include loss-based assessments

Loss Adjustment Expense

Developed and Trended Losses

Loss Cost including LAE

Final Loss Cost

Insurance Company Perspective

Workers Compensation Ratemaking—An Overview

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• Expenses

• Loss Cost Multipliers

• Company Pricing Programs

• Predictive Modeling

• Current Workers Compensation Market

Insurance Company Perspective Outline

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A provision for each expense item is added to the final loss cost to produce a full manual rate

Profit & Contingencies

Taxes, Licenses & Fees

Production &General Expense

Loss Adjustment Expense

Developed and Trended Losses

Full Rate

Components of a Rate

• Losses

• Loss Adjustment Expenses

• Loss-Based Assessments

• Expenses and Profit

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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 of the Loss Cost– Production– Taxes, Licenses, and Fees– General– Profit and Contingencies

• Items Sometimes Outside of the Loss Cost– Loss Adjustment Expenses– Loss-Based Assessments

• Items Rarely Outside of the Loss Cost (MN)– Trend– Loss Development beyond 8th report

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Costs as a Percentage ofStandard Premium

TaxesGeneral

Profit

Loss Adjustment

Loss Assessments

Production

Loss

Almost Always in the Loss Cost

Most of the time in the Loss Cost

Sometimes in the Loss Cost

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How to Account for ItemsOutside of 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 insurer’s expense and profit

• Must also consider other items not included in the Loss Cost (trend, development, etc.)

• 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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Portion of Standard Premium

State

A B C

Total of Items to Load on Loss Cost .300

Indicated Loss Cost Multiplier 1.429

= 1/(1 - Load Needed)

Loss Assessments (% Prem) .020 .020

Loss Adj. Expense (% Prem) .080

Expenses .275

Profit .025

.275 .275

.025 .025

.320 .400

1.471 1.667

Derivation of a Loss Cost Multiplier

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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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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 thisapproach may produce more stable results over time

Derivation of the LCM—Alternative Approach

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For State D, a new Example

Derivation of the LCM—Alternative Approach

Year 1 Year 2 Year 3 AverageLoss Ratio 58.5% 87.8% 52.0% 65.0%

LAE Ratio 11.7% 17.6% 10.4% 13.0%% Loss 20.0% 20.0% 20.0% 20.0%

Commission 8.0% 8.0% 8.0% 8.0%U/W Exp 11.0% 11.0% 11.0% 11.0%Tax 3.0% 3.0% 3.0% 3.0%Profit 7.8% -27.3% 15.6% 0.0%

Selection

13.0%20.0%

8.0%11.0%3.0%2.5%

LCM using premium-based method: 1.538 1.600LCM using alternative method: 1.538 1.589

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The LCM +

• The LCM, as originally defined, requires the use of expense constants and premium discounts to more accurately charge for individual risks

• There is a method that can accomplish the same goal without the need for these two other components and can be developed by individual companies

• Disclaimer: All of the information that follows is completely fictitious and is not meant to resemble any actual carrier’s data or experience

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• First, let’s make some basic assumptions

General Information

Class code 1234Bureau Loss Cost $5.00Loss Adj Exp 17.0% as pct of loss

Other expenses/costs Premium tax 3.0% as pct of final premium Variable U/W 5.0% as pct of final premium Fixed U/W $700 per policy Profit 0.0% as pct of final premium

U/W expense = production and general expense

The LCM +

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Policy Specific Information

Policy Exposure CommissionNumber (Payroll) (% final prem)

1 50,000 12.0%2 100,000 12.0%3 150,000 12.0%4 200,000 12.0%5 500,000 9.0%6 600,000 9.0%7 700,000 9.0%8 800,000 9.0%9 1,000,000 6.0%10 1,500,000 6.0%11 2,000,000 6.0%12 2,500,000 6.0%

The LCM +

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Premium development formula

Premium =

* Premium variable items are variable underwriting expense, tax, commission, and profit.

Payroll/100 x Loss Cost + Fixed Expense1- sum of Premium variable items*

The LCM +

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Implied Fixed Variable NeededPolicy Number Loss+LAE Expense Expense Tax Commission Premium

1 2,500 700 200 120 480 4,0002 5,000 700 356 214 855 7,1253 7,500 700 513 308 1,230 10,2504 10,000 700 669 401 1,605 13,3755 25,000 700 1,548 929 2,787 30,9646 30,000 700 1,849 1,110 3,329 36,9887 35,000 700 2,151 1,290 3,871 43,0128 40,000 700 2,452 1,471 4,413 49,0369 50,000 700 2,948 1,769 3,537 58,95310 75,000 700 4,401 2,641 5,281 88,02311 100,000 700 5,855 3,513 7,026 117,09312 125,000 700 7,308 4,385 8,770 146,163

Total 505,000 8,400 30,249 18,149 43,184 604,983

The LCM +

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Determination of LCM - Traditional Method

Premium 604,983Pct of Prem

UW Expense 38,649 6.4%Tax 18,149 3.0%Commission 43,184 7.1%Total 99,983 16.5%

Implied LCM 1.198 = 1 / (1 - 16.5%)

The LCM +

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Implied Resulting Needed PercentPolicy Number Loss+LAE LCM Premium Premium Difference

1 2,500 1.198 2,995 4,000 -25.1%2 5,000 1.198 5,990 7,125 -15.9%3 7,500 1.198 8,985 10,250 -12.3%4 10,000 1.198 11,980 13,375 -10.4%5 25,000 1.198 29,950 30,964 -3.3%6 30,000 1.198 35,940 36,988 -2.8%7 35,000 1.198 41,929 43,012 -2.5%8 40,000 1.198 47,919 49,036 -2.3%9 50,000 1.198 59,899 58,953 1.6%10 75,000 1.198 89,849 88,023 2.1%11 100,000 1.198 119,799 117,093 2.3%12 125,000 1.198 149,748 146,163 2.5%

Total 505,000 604,983 604,983

Note: This is why there are premium discounts and expense constants in Workers Compensation. However, the following will show a direct method to calculate these and the final premium.

The LCM +

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Expenses come in two forms: those that vary with premium and those that are fixed with thepolicy. They are accounted for by the Variable Expense Multiplier and theFixed Expense Load.

The Variable Expense Multiplier (VEM) accounts for expenses that vary with premium.

VEM =

VariablePolicy Number Expenses VEM

1 - 4 20.0% 1.2505 - 8 17.0% 1.2059 - 12 14.0% 1.163

11- sum of Premium variable items

The LCM +

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The Fixed Expense Load (FEL) is designed to account for expenses that are fixed withthe policy.

FEL =

or

FEL =

The VEM is needed to reflect the fact that we will still pay tax, commissions, etc.on the premium collected due to the fixed expense load.

FixedPolicy Number Expenses VEM FEL

1 - 4 700 1.250 8755 - 8 700 1.205 8439 - 12 700 1.163 814

Fixed expense dollars per policy1- sum of Premium variable items

Fixed expense dollars per policy x VEM

The LCM +

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Final premium can be developed several ways, which are algebraically equivalent.Using the newly developed components yields the following formula:

Premium = Payroll/100 x Loss Cost x VEM + FEL

Alternatively, the step of calculating the FEL can be skipped simply by using this formula:

Premium = (Payroll/100 x Loss Cost + Fixed expense dollars per policy) x VEM

The LCM +

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Implied Resulting NeededPolicy Number Loss+LAE VEM FEL Premium Premium

1 2,500 1.250 875 4,000 4,0002 5,000 1.250 875 7,125 7,1253 7,500 1.250 875 10,250 10,2504 10,000 1.250 875 13,375 13,3755 25,000 1.205 843 30,964 30,9646 30,000 1.205 843 36,988 36,9887 35,000 1.205 843 43,012 43,0128 40,000 1.205 843 49,036 49,0369 50,000 1.163 814 58,953 58,95310 75,000 1.163 814 88,023 88,02311 100,000 1.163 814 117,093 117,09312 125,000 1.163 814 146,163 146,163

Total 505,000 604,983 604,983

The LCM +

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• Therefore, we should be able to solve for an accurate premium directly, without extra rating factors

• In addition, this would allow for a more company- and insured-specific price

But,…

• This method requires a fixed/variable expense analysis, similar to what would go into the development of premium discount tables and expense constants. This is not a trivial task.

The LCM +

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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 company’s experience– How does your experience compare?– Are there changes in your company’s

operations to consider?– When will you implement the change?

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Manual Rates Are Just the Beginning

• Deviations

• Premium Discount

• Expense Constant

• Schedule Rating

• Experience Rating

• Dividend Plans

• Retrospective Rating

• Deductibles (Small and Large)

Additional Pricing Elements Are an Individual Company Decision

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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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A Predictive Modeling Application

Schedule rating is defined as:

“The premium for a risk may be modified according to the Schedule Rating Table to reflect such characteristics of the risk that are not reflected in its experience. Seven categories are considered when determining any credit or debit under this Plan:

• Premises• Classification Peculiarities• Medical Facilities• Safety Devices• Employees —Selection, Training, Supervision• Management —Cooperation With Insurance Carrier• Management —Safety Organization

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A Predictive Modeling Application

• Schedule rating table provides a range of credits/debits for each of the seven categories

• Quantifying specific characteristics within each category allows for more accurate account specific pricing

• May also be able to identify other characteristics that may not traditionally be considered in the seven categories

• The end result is to enhance the experience mod with an additional mathematical model

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Programs That Adjust Premium toReflect 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 insured’s experience during the time the policy is in force

• Large Deductibles – The employer opts to pay claims below a certain threshold (usually $100,000 or greater)

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Workers Compensation Climateand the Role of the Actuary

• Beginning in 2008, underwriting gains were no longer present on either a calendar year or an accident year basis

• During NCCI's 2011 filing season, for those states in which NCCI provides ratemaking services, over three-quarters of the filed rate / loss cost level changes were increases; the remainder either had no change or were decreases

• Current economic and market 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

Thank You for Your Attention!

Questions/Comments?