©Towers Perrin Reserving in a Changing Environment Reserving for Workers Compensation Liabilities for Self-Insured Entities During Plant Closures, Downsizing & Layoffs September 13, 2004 Presented by: Atul Malhotra, FCAS, MAAA

©Towers Perrin 2 Introduction Corporations today are undergoing staff reorganizations frequently to respond to the rapidly changing external environment These staff reorganizations can have an adverse impact on the corporation’s workers compensation (WC) costs Reviewed the issues and potential impact of plant closures, downsizing and layoffs on the WC costs of self-insured entities The general methodology described here can also be adapted to reserving for WC liabilities for insurance companies Methods vs. Models – our approach to adapt traditional reserving methodologies to address the related issues

©Towers Perrin 3 Introduction (Cont’d) Data from Bureau of Labor Statistics – number of nationwide mass layoff events were steady from 1996 through 2000, jumped up in 2001 and 2002, have been gradually declining since A mass layoff event occurs when at least 50 initial unemployment claims are filed against an establishment during a consecutive 5- week period

©Towers Perrin 4 Impact of Staff Reorganizations Internal Factors “Downsizing” announcement tactics Employee loyalty Union relations Level of severance benefits Psychology of surviving employees Skill level of downsized employees and the opportunity and ability to learn new skills Overall impact dependent upon a number of internal and external factors including:

©Towers Perrin 5 Impact of Staff Reorganizations (cont’d) External Factors Economic environment in the local area Local unemployment rates Socioeconomic issues that can vary by geographic areas

©Towers Perrin 6 Impact of Staff Reorganizations (cont’d) Claim Frequency may increase Claim severity may increases Litigation rate may increase Change in claim reporting rates Change in claim settlement rates Based on a combination of the above factors, we observed an increase in WC costs from anywhere between 0% to 100% Some of the impacts observed are similar to the impacts observed during recessionary periods Most of the impact is limited to most recent two to three accident years It is impossible to completely delineate the impact of plant closures from other impacts.

©Towers Perrin 7 Claim Frequency WC benefits can partially substitute for loss of income The differential between full pay and WC benefits is absent Difficult to lay off employees with open WC claims WC benefits usually larger and paid over a longer period of time Additional surgeries/procedures may be scheduled Deterioration of relations between management and employees Lower compliance with appropriate safety behaviors Lower motivation to comply with appropriate safety behaviors The factors that may cause increased claim filings from laid-off employees are as follows:

©Towers Perrin 8 Claim Severity Shift medical costs for chronic injuries or ailments to WC system Absence of rehabilitation and return-to-work programs Distribution of surviving employees Distribution by type of claim Some chronic injuries concealed for a longer period of time may be revealed at the time of layoff Increase in disability duration due to the increased time to find re-employment Attorney involvement – class action suits, employment practices liability Moral hazard issues More frequent and larger lump sum settlements The reason for the increase in claim severity may be the following:

©Towers Perrin 9 Increase in Costs Increased average duration of temporary total disability cases Increased medical costs due to increased utilization of medical services Higher permanent partial disability ratings Increased claims for occupational disease or cumulative injury cases Other indemnity benefits More frequent and larger lump sum settlements Some of the literature we reviewed on the impact of recessions on WC costs cited the following reasons for the increase in costs:

©Towers Perrin 10 Diagnosing the Impact

©Towers Perrin 11 Diagnosing the Impact

©Towers Perrin 12 Diagnosing the Impact

©Towers Perrin 13 Diagnosing the Impact

©Towers Perrin 14 Diagnosing the Impact

©Towers Perrin 15 Discussion of Methodology The non-systemic nature of staff reorganizations can distort the results of standard reserving methodologies Standard methodologies may over react or under react to the changing conditions Non-standard methodologies such as the Berquist-Sherman and other similar methods may not be appropriate as the underlying exposure/propensity to loss changes as a result of these staff reorganizations Claims mix changes Employee distribution by type of occupation may change Other factors – employee psychology, employee management relations, etc. If sufficient data is available, try to segment the loss development data

©Towers Perrin 16 Discussion of Methodology (cont’d) Frequency /Severity Approach: Back to the basics – adopting a claim frequency severity approach to calculating ultimate loss and reserves Calculate ultimate claim severity by type of claim Review claims mix by type of claim Develop ultimate claim counts using development or Bornhuetter- Ferguson (B-F) approach Advantages of the frequency/severity approach in a staff reduction scenario: Avoids the non-systemic distortions caused in the latest diagonals Allows for explicit adjustment for changes in exposure and type of loss Allows for the calculation of cost impact for WC costs as result of staff reorganizations Estimates of ultimate loss form the frequency/severity method can be used as initial expected losses for the B-F techniques

©Towers Perrin 17 Discussion of Methodology (Cont’d) Modified Loss Development Pattern for use in the B-F Methodologies: Modify historical loss emergence patterns by adjusting for the emergence of the additional plant closure impact Input from the claim adjusting personnel and the company risk manager essential Use the modified loss emergence pattern and initial expected loss from the adjusted frequency/severity method to develop estimates based on B-F methods ALAE Modeling: Develop empirical model Model accident year paid ALAE to paid loss ratio using data on variables such as litigation rate of claims and indemnity to med-only claim ratios

©Towers Perrin 18 Conclusion Actuary should consider the impact of plant closures and layoffs when calculating WC liabilities for self-insured entities Loss estimates produced from the adjusted methods vary based on the assumptions and adjustments made Loss development methods without any adjustments too responsive B-F methods without any adjustments slow to respond to the changing conditions The adjustments made to the B-F method make it more responsive Using the frequency/severity approach allows the actuary to explore the changes in the underlying propensity to loss and incorporate the changes into the reserving methodology Most importantly, we should look for the impact and try to understand the changes and communicate these changes to the management