Strengthening Ohio’s Workers’ Compensation System Group Rating/Experience Rating – Actuarial Perspective Jeffery W. Scholl, FCAS, MAAA William Hansen, FCAS, MAAA Columbus, Ohio Oliver Wyman Actuarial Consulting, Inc.

2  Principles of Ratemaking 2  Experience Rating Plans6  Timeframes, Considerations and Conclusions14

Principles of Ratemaking

4 Statement of Principles Regarding Property & Casualty Insurance Ratemaking – Adopted by CAS in 1988 Statement defines ratemaking as “the process of establishing rates used in insurance or other risk transfer mechanisms.”

5 Principles of Ratemaking Principle 1 A rate is an estimate of the expected value of future costs. It is prospective because the rate must be developed prior to the transfer of risk. Principle 2 A rate provides for all costs associated with the transfer of risk It should provide for all costs so that the insurance system is financially sound. Principle 3 A rate provides for the costs associated with an individual risk transfer. It should provide for the costs associated with an individual risk transfer so that equity among insureds is maintained. Principle 4 A rate is reasonable and not excessive, inadequate, or unfairly discriminatory if it is an actuarially sound estimate of the expected value of all future costs associated with an individual risk transfer. Rates will be actuarial sound if the estimation is based on Principles 1, 2, and 3.

Experience Rating Plans

7 Experience Rating Plans Presentation Outline Attributes of a good experience rating plan Explanation of 2 plans: Ohio BWC NCCI

8 Experience Rating Plans Attributes of a good experience rating plan 1. Serves the needs of the organization (BWC and Employers) using them 2. Appropriately balances risk bearing and risk sharing 3. Not subject to internal or external pressures 4. Simple to administer 5. Easy to understand 6. Responsive to individual risk experience 7. Stable—does not subject the affected entities to large fluctuations in costs from year-to-year

9 Experience Rating Plans Ohio Plan Minimum Expected Loss to qualify is $8,000 Non-split plan (4 years of experience) Maximum loss varies by expected loss, from $12,500 for small risks to $250,000 for largest risks Credibility varies by expected loss size (see table) Maximum credibility of 90% at $1 million Formula: Example: $1,000,000 manual premium pays $280,000 after the credit modification

10 Experience Rating Plans

11 Experience Rating Plans NCCI Plan Split plan Primary Loss is first $5,000 of a claim Medical Only limited to 30 percent of loss Maximum loss capped at state limit (i.e. $250,000) Credibility varies by expected loss size Maximum credibility of 91 percent for primary, 80 percent for excess Formula: [W and B are the credibility components divided between primary and excess] Example: $1,000,000 manual premium pays $580,000 after the credit modification

12 Experience Rating Plans NCCI Plan Split plan Primary Loss is first $5,000 of a claim Medical Only limited to 30 percent of loss Maximum loss capped at state limit (i.e. $250,000) Credibility varies by expected loss size Maximum credibility of 91 percent for primary, 80 percent for excess Formula: Frequency Severity

13 Experience Rating Plans Retrospective Performance Tests * NCCI plan factors used for these scenarios are estimates based on other state plans; use of experience rating parameters based on Ohio data would improve performance <=$25, >$25,000 and <=80, >$80,000 and <=$250, >$250,000 and <=$800, >$800,000 Plan* 60%90% Premium ranges NCCI Max Cred Policy Year Experience Rating Plan Scenarios—Loss Ratio Relativities

14 Primary LossScenario Increase over Base Case Increase over 90% Max CredExcess Loss Experience Rating Plans Hypothetical Examples 34%7% 0.78 $640,000 $ 60,000NCCI PlanLosses 58%12% 0.82 $ 700,00060% Max Cred $ 1,000,000Two $250k 161% 0.73 $ 700,00090% Max CredBase plus 17%35% 0.68 $395,000 $ 55,000NCCI PlanLoss 29%33% 0.67 $ 450,00060% Max Cred $ 1,000,000One $250k 80% 0.51 $ 450,00090% Max CredBase plus 107% 0.58 $150,000 $ 50,000NCCI Plan 86% 0.52 $ 200,00060% Max Cred $ 1,000,000Case 0.28 $ 200,00090% Max CredBase Experience Mod Experience Rating Plan Expected Losses

15 Experience Rating Plan Expected LossesScenario Experience Rating Plans Hypothetical Examples 38%28% 1.28 $ 10,000 $ 20,000NCCI Plan Expected 3%0% 1.00 $ 30,00060% Max Cred $ 30,000Equals 5% 1.00 $ 30,00090% Max Cred Total Loss 16%1% 1.08 $ 35,000 $ 10,000NCCI Plan Loss 8%-2% 1.05 $ 45,00060% Max Cred $ 30,000One $25k 12% 1.07 $ 45,00090% Max Cred Base plus -2% 0.93 $ 15,000 $ 5,000NCCI Plan 2% 0.97 $ 20,00060% Max Cred $ 30,000Case 0.95 $ 20,00090% Max Cred Base Increase over Base Case Increase over 90% Max Cred Experience ModExcess LossPrimary Loss

16 Experience Rating Plans Real Policy Examples * Increase/Decrease Measure is relative to the 90 percent maximum credibility level 82% $ 46,000 $ 80,000NCCI Plan 59% $ 173,00060% Max Cred $ 1,500,000Rated base $ 173,00090% Max Cred Group -26% $ 73,000 $ 16,000NCCI Plan (Penalty) -25% $ 60,00060% Max Cred $ 40,000Rated base $ 60,00090% Max Cred Debit -19% $ 15,700 $ 6,000NCCI Plan -11% $ 16,00060% Max Cred $ 72,000Rated base $ 16,00090% Max Cred Credit Increase/ Decrease*Excess LossPrimary Loss Experience Rating PlanExpected LossesType

Timeframes, Considerations and Conclusions

18 Conclusion Timeframes Desirable to phase in changes to minimize disruption Several alternative solutions are possible Considerations Need to evaluate best parameters to fit Ohio data Must consider implementation challenges and premium impacts Familiarity within and outside of Ohio Competition Safety—frequency of claims as a predictor of future losses Equity can be improved significantly by either the current Ohio plan or the NCCI plan if parameters are selected appropriately: Still need to address group rules (plan changes won’t achieve balance between group and non-group) Need to identify what is most important: fairness, stability, responsiveness, and ease-of-use Oliver Wyman Recommendation: move to 60 percent credibility in the short term and transition to NCCI plan when practical

Strengthening Ohio’s Workers’ Compensation System