Experience Rating Current Challenges Presented by Tony DiDonato, NCCI, Inc CAS Seminar on Ratemaking San Antonio, Texas March 28, 2003 WCP-2

2 NCCI Perspective - Outline I. ER Basics II. Off-Balance in NCCI States III. ERA – Experience Rating Adjustment IV. Performance Testing Results for NCCI States

3 Actual / Expected A p + A e (W) + E e (1-W) +B E + B NCCI Plan - ER Basics The formula: A = Actual E = Expected p = primary e = excess B = Ballast W = Weight Some Qualifications: Premium thresholds Actual Losses limited Mods limited ERA

4 Countrywide* Off-Balance Factors p Year Off-Balance * NCCI states

5 Theoretical off-balance increases by about for every percentage point of unanticipated frequency change. Theoretical off-balance increases by about for every percentage point of unanticipated severity change. -20%-12%-4% 0% 4%12%20% -20% % % % % % % Theoretical Off-balance Total Unanticipated % Change in Frequency Unanticipated Frequency and Severity: How is Off-Balance Impacted?

6 -20%-5%-1% 0% 1%5%20% -20% % % % % % % Theoretical off-balance increases by about for every unanticipated additive percentage point in the D-ratio. Theoretical Off-balance Theoretical off-balance increases by about for every percentage point of unanticipated losses. Total Unanticipated % Change in Total Losses Sensitivity of Off-Balance to: Total Losses vs. Primary/Excess Split

7 D-ratio Changes Over Time The primary change is due to severity trend Since severity generally increases over time, the d-ratio generally decreases ERA allows for a trended split point which would tend to stabilize the d-ratio, but trend has not yet been used on the split point

8 Primary ActualPrimary ExpectedDifference Between ExperienceTotal Actual // Total Actual/ Total ExpectedActual D-ratioAverage Rating YearsTotal Expected(Actual D-ratio)(Expected D-ratio)Expected D-ratioMod (0.01) (0.02) 0.95 Total Losses and Primary/Excess Split: Forecast vs. Actual Results Intrastate Risks – NCCI States

9 Countrywide (NCCI states) Off-Balance has increased in each of the last three years. Total actual losses that were less than total expected losses is the major reason for the relatively low Off- Balances from While the split between claim frequency and severity did not drive the low Off-Balances, it did dampen the Off-Balance increases in the last three years. Unanticipated claim frequency has slightly more of an impact than does unanticipated severity on Mods. Experience Rating Plan Off-Balance– Historical Analysis

10 Manual loss ratios for the smallest premium sizes and for unrated risks are higher than the all-risk average. If the off-balance is 1.00, then there is no standard premium price differential between experience rated and unrated risks. Having an off-balance less than 1.00 can partially address the difference. The indicated standard premium level is still correct even if there is a net off-balance. What Should the Experience Rating Plan Off-Balance Be ?

11 Developed Manual Loss Ratios by Policy Manual Premium (State X, Five Recent Policy Years)

12 Developed Manual Loss Ratios (State X, Five Recent Policy Years) 0% 20% 40% 60% 80% 100% 120% Unrated IntrastateInterstate

13 Unrated RisksRated Risks % of Manual Premium Manual Loss Ratio Actual Loss / Expected Loss Mod Needed to Equalize Standard Premium Loss Ratios Mod if Unrated Risks are Subsidized 10.0% 83.6% % 55.3% Average 100.0% 58.1% Simplified Hypothetical Illustration of Experience Rated vs. Unrated Impact on Off-Balance

14 Summary of ERA Changes (1) Using only 30% of med-only claims in the Experience Rating formula (2) The Weighting Value (W) was increased (3) The primary/excess split point (currently $5,000) will be adjusted over time ERA was designed to increase the incentive for employers to report small med-only claims and to improve the performance of the Plan. This was accomplished by the following three changes to the Plan: The effective date of ERA varies by state. The earliest effective date is 7/1/98, which is applicable in several states.

15 Compared changes in the proportion of med-only claims in states adopting ERA vs. states that had not Changes in the average severity of med-only claims were also reviewed This review did not reveal a significant impact on the reporting of med-only claims due to ERA ERA Impact on Med-Only Losses

16 * State 1 reflects a 2-yr change Med-Only Changes in Late 1990s From policy period beginning 11/95 to policy period beginning 11/98 ERA States Non-ERA States

mods were calculated for intrastate risks in the 9 states adopting ERA on Initially all rated under GERT, then all re-rated under ERA ERA showed slightly more accurate results Performance Testing: GERT vs. ERA

18 Performance Testing: GERT vs. ERA

19 Col (2): The actual losses are unlimited losses from WCSP data, generally at a 2 nd report or subsequent. The rates/loss costs in effect during the appropriate time period were used as a proxy for expected losses. The column (2) ratios have been normalized to 1.00 to minimize differences between the actual and expected losses related to development, expenses, etc. Col (3) shows the deviation of each quintile group from the overall total. Col (4) reflects the normalization from Col (2), but after application of the Mod (in the denominator) the results were NOT re-normalized. This has no impact on the result in Col (5). The mean value shown is an intermediate step in the calculation and has no particular meaning. Col (5) shows the deviation of each quintile group from the overall total. The test statistics shown at the bottom of each analysis are key. A statistic less than 1.00 is expected from an Experience Rating Plan. Lower values of the statistic indicate better performance. Brief Summary of Quintile Testing

20 Actual / Modified Expected Loss Performance Testing: GERT Correlation =

21 Performance Testing: ERA Correlation =

22 Countrywide* Quintile Testing Results Includes Interstate and Intrastate Risks Policy periods 7/1/97–6/30/98 and 7/1/98–6/30/99 were reviewed Two quintile groupings were tested: – quintile groups which equalized risk count – quintile groups which equalized expected losses * NCCI states

23 Countrywide* Quintile Testing Results ALL RISK SIZES Policy Effective Period 7/1/97 - 6/30/98 * NCCI states

24 Countrywide* Quintile Testing Results ALL RISK SIZES Policy Effective Period 7/1/98 - 6/30/99 * NCCI states

25 Individual State Quintiles ALL RISK SIZES Policy Effective Period 7/1/97 - 6/30/98 Correlation =

26 Correlation = Individual State Quintiles ALL RISK SIZES Policy Effective Period 7/1/98 - 6/30/99

27 Quintiles by Risk Count Test Results by Size of Risk * The risk count underlying each policy period and range is uniformly distributed among quintile stratum.

28 Quintiles by Expected Losses Test Results by Size of Risk * The expected loss volume underlying each policy period and range is uniformly distributed among quintile stratum.

29 Performance Testing: Next Steps Currently reviewing the 30% factor for Med-only claims under ERA Reviewing treatment of small risks Alternative performance measures are being reviewed Continued monitoring of ER Plan and performance