Mary Gaillard AIG March 11, 2004 Terrorism Ratemaking Methods for Workers’ Compensation 2004 CAS Ratemaking Seminar Mary Gaillard AIG March 11, 2004

Unique Challenges Associated with TRIA Federal regulation with deductible that applies to all states, all designated TRIA lines Lack of relevant historical data to use for making rates Frequency, severity, location, and nature of future events unpredictable

TRIA Deductible 7% of 2002 Direct Earned Premium - 2003 Deductible is determined by all TRIA lines, whether or not coverage for terrorism is purchased

In the event of a terrorist attack, what is the “loss” under TRIA? Maximum loss to Company A under TRIA is the Company’s deductible for that year plus 10% of losses above the deductible. The total loss payable for one or more events by insurance companies and the federal government combined is capped at $100 Billion in any one year.

Actuarial Literature Regarding Ratemaking Guidelines Statement of Principles Regarding Property and Casualty Insurance Ratemaking “Report to NAIC Terrorism Insurance Implementation Working Group on Ratemaking Issues Related to the Terrorism Risk Insurance Act,” prepared by the P/C Extreme Events Committee, American Academy of Actuaries, March 4, 2003

Statement of Principles... “A rate is an estimate of the expected value of future costs.” “Considerations” that do not apply: organization, homogeneity and credibility of available data “Considerations” that may apply: other influences, risk, actuarial judgment

AAA Report to NAIC…. “Since traditional ratemaking methods will not work for developing rates for the risk of foreign terrorism, insurers must rely on their own judgment and that of terrorism experts to develop rates. In fact, judgment, including judgment about the the selection of historical data, is a critical part of all ratemaking. Because of the limited amount of data available for terrorism ratemaking, judgment becomes the overriding factor.”

Funding the TRIA Deductible Approach Determine rates for terrorism by line and by state in order to collect enough premium to fund the deductible over a reasonable period of time

Workers’ Compensation and TRIA Compare Terrorism pricing as a percent of premium to percent of payroll

Example: State X for Company A Determine need, say, 4% of premium for WC Compare expected revenue using bureau rate per $100 of payroll. Assume rate of .03 Using Company A distribution by class, calculate rate per $100 of payroll that generates 4% of premium.

Advantages of the Percent of Premium Method Appropriately reflects the difference in benefit levels by state Distributes dollar charge by classification more evenly than rate per $100 payroll Direct correlation of the charge for terrorism to the increase in the TRIA deductible