0 Terrorism Ratemaking Methods for Workers Compensation 2004 CAS Ratemaking Seminar Jeff Eddinger NCCI March 11, 2004

1 Impact of 9/11 on Workers Compensation Initial WC Loss Estimates (6,000 deaths) Morgan Stanley:$3 billion Tillinghast:$3 billion–$5 billion Current NCCI WC Loss Estimates (3,047 deaths / 2,250 injuries) Self-insured losses 15% (includes NY Firefighters/PD) Losses not covered by WC 5% Fatalities w/o dependents 20% (lump-sum $50k payment per person) Ultimate Direct Losses$1.3 B–$2.0 B Ultimate Net Losses$0.3 B–$1.2 B Impact on Net Acc Yr Combined Ratio 1%–4%

2 Unique Challenges of Workers Compensation and Terrorism Coverage Coverage mandated by law, exclusions are not possible Benefits are defined by law, limits aren’t possible Risks that aren’t written voluntarily will be backed by the voluntary market through the involuntary pool

3 Unique Challenges of Terrorism Ratemaking Terrorism is a relatively new peril and the future level of losses is very uncertain Lack of historical data precludes the use of traditional ratemaking methodologies Because the losses result from intentionally destructive human behavior, both frequency and severity are difficult to estimate Judgment of experts will play an important role in pricing of coverage

4 Issues Associated with TRIA TRIA does not address every substantive issue No guidance on how insurers should allocate multiline losses with respect to insurer retention Not clear how Treasury will pay losses for long-tail lines like Workers Compensation State law requires Workers Compensation policies to cover entire statutory liability while TRIA provides that insurers are not responsible for losses over $100 Billion

5 Examples of Possible Nontraditional Ratemaking Approaches Probability of ruin approach Probable Maximum Loss approach Consider the cost of funding terrorism through reinsurance or other mechanisms Catastrophe modeling

6 Catastrophe Modeling Windstorm models have existed for many years These models have evolved considerably since Hurricane Andrew in 1992 These models have become an extremely valuable tool in Property / Casualty ratemaking Terrorism modeling is still relatively new

7 Terrorism Modeling Issues There is relatively little data available for terrorism Regulatory scrutiny – “black box” There may be many models which produce a wide range of results Because of the cost associated with developing a model, modelers must be able to protect the confidentiality of their work Rely heavily on judgment

8 NCCI’s Terrorism Ratemaking Approach NCCI partnered with EQECAT, an Oakland, CA firm with a strong track record in catastrophe modeling EQECAT is a subsidiary of ABS consulting, one of the largest risk management firms who has been assessing terrorist threats for many years Terrorism was modeled at the local level, peril by peril Provisional nationwide assessment of frequency done by EQECAT with outside expert input Scenarios aggregated to get statewide expected losses

9 Blasts Chemical agents Biological agents Radiological agents Dam breaks Perils Modeled

10 Size of Events Modeled Only large events modeled (a priori expectation of $15 million to $20 million in WC losses) Large is defined by the size of agent rather than dollar threshold 400 lbs. equivalent TNT rather than 1 stick One ounce of anthrax (letters have significantly less)

11 A footprint is established for each peril The footprint defines the intensity of peril based on distance, size of source and wind conditions Injury distributions (as a function of peril intensity) are combined with worker density to get the number of injuries Calculations done at the census block level From Peril Event to Injury

12 Injury rates are combined with distribution of losses by injury type to get overall loss Distribution of losses are those underlying NCCI ELFs in Retrospective Rating Program State specific average benefits are used From Injury to Losses

13 Census blocks are aggregated to get total losses for each event The conditional severity of the event is multiplied by its frequency to get its annual cost Events are aggregated to get statewide expected losses for representative states From Event Losses to Aggregate Annual Losses

14 – New York– Pennsylvania – New Jersey– Texas – California– Ohio – Washington D.C.– Georgia – Illinois– Indiana – Florida– Arizona – Michigan– Iowa – Massachusetts– North Carolina States Modeled

15 Modeling Results for NCCI States

16 Impact of the Federal Backstop Domestic terrorism is assumed to be 10% of the total expected losses Federal share of certified losses range from 15% to 50% by state The larger the expected loss for a state, the larger the expected federal share The larger the expected loss for a state, the larger the reduction in loss costs

17 Pricing the Impact of the Federal Backstop The threshold is on an all lines basis The cap on Federal and industry losses is on an all lines basis The Workers Compensation portion of total losses is a key assumption Which claims (and therefore which line of business) will be allocated to the company retention is unclear – Will it be based on payment date of the claim? Report date?

18 What is the Workers Compensation Portion of All Lines Terrorism Losses? World Trade Center Workers Compensation losses were approximately 5% of total losses Extremely high mortality rate meant very few medical losses Prospectively, 10% is more likely If biological agents are used, the proportion could be even higher

19 Other Federal Backstop Analysis Issues The impact of the backstop depends on which companies get the bulk of the losses The backstop picks up relatively more of the state’s certified losses when there are regional monoline companies with high market shares Due to statutory nature of benefits, employers will not get the benefit of the $100 Billion cap There is a potential for the courts to overturn the application of the liability cap to WC insurers (NCCI’s loss costs consider this possibility) After generating many scenarios, NCCI used actuarial judgment to estimate the overall loss cost impact

20 The filing relied on EQECAT results in modeled states Proxy states were used for the other non-modeled states Voluntary loss costs were filed in most NCCI states Rates were filed in Florida, Idaho, Arizona, Illinois, Rhode Island and Iowa Assigned Risk rates were filed in 22 states NCCI’s Terrorism Filing

21 For the voluntary market, the effective date was December 20, 2002 For the residual market, most states have an effective date was January 1, 2003 The loss costs apply to new and renewal policies only The rates/loss costs are for foreign terrorism only (net of anticipated federal recoveries) NCCI’s Terrorism Filing

22 Rates/loss costs were filed on the Miscellaneous Values Page of NCCI’s Basic Manual It is a rate/loss cost per $100 of total payroll It is not subject to premium discount, experience rating, schedule rating or retrospective rating or deductible credits Because the non-terrorism rate/loss cost for clerical risks is lower than other risks, the terrorism charge has a larger percent impact on their premium Terrorism provisions have been approved in all NCCI states NCCI’s Terrorism Filing

23 NCCI established a new statistical class code (9740) for these premium charges The new code facilitates the tracking of premiums charged for terrorism exposure as defined in the federal Act NCCI filed a Terrorism Risk Insurance Act Endorsement for carriers to use to satisfy their policyholder disclosure obligations under the Act The new endorsement also addresses an insurer’s limit of liability for certified terrorism losses when aggregate losses exceed $100 billion Other NCCI Actions