1. Workers Compensation Ratemaking— An Overview Rating Bureau Perspective Jay Rosen, NCCI, Inc. Insurance Company Perspective Dan Perry, QBE Regional Companies (N.A.), Inc. CAS 2012 Ratemaking and Product Management Seminar Philadelphia, Pennsylvania – March 20, 2012

2. Rating Bureau Perspective Workers Compensation Ratemaking— An Overview

3. 3 Rating Bureau Perspective Outline Overview of Workers Compensation Insurance NCCI Filing Overall Rate / Loss Cost Level Change Classification Rate / Loss Cost Changes

4. 4 In general, a loss cost represents a provision for losses and LAE per $100 of payroll for each classification Loss costs are not final rates because they do not include provisions for the remaining expenses (including production expenses, profit and contingencies, etc.) of an insurer Loss Costs—What Are They?

5. 5 Workers Compensation Rating Laws LOSS COST (31) LOSS COST/INDEP RTG BUREAU (7) MONOPOLISTIC (4) RATES (5) RATES/INDEP RTG BUREAU (4)

6. 6 NCCI Workers Compensation Databases Financial Aggregate Calls – Used for aggregate ratemaking WC Statistical Plan (WCSP) – Used for class ratemaking

7. 7 Financial Aggregate Calls Collected annually – Policy and calendar-accident year basis – Statewide and assigned risk data Premiums, losses and claim counts – Evaluated as of December 31 Purpose – Basis for overall aggregate rate indication – Research

8. 8 Designated Statistical Reporting (DSR) Level Premium Common benchmark level at which carriers report premium on the financial calls The DSR level represents the “approved” loss cost and assigned risk rate levels Varies by policy year and state

9. 9 Ratemaking—The Big Picture Projected losses & Loss Adjustment Expense* Premium at current loss cost level * Not all states include loss adjustment expense in the calculation. = Indicated overall average loss cost level change For the upcoming loss cost effective period:

10. 10 NCCI Typically Uses the Two Most Recent Policy Years of Data 1/1/1012/31/101/1/091/1/1312/31/13 Policy Expiration Date Policy Effective Date Policy Year 2009 Policy Year 2010 Policy Year 2013

11. 11 Derivation of Projected Losses Adjustments to reported losses: Benefit (loss) on-levels Loss development Trend

12. 12 Changes that occur subsequent to the filing data must be reflected: Legislated benefit changes Court decisions New regulations Benefit Changes

13. 13 Loss On-level Factors Adjust Data to the Current Benefit Level 1/1/1012/31/101/1/091/1/1312/31/13 Policy Effective Date Policy Year 2009 Policy Year 2010 Policy Year 2013 Benefit Change Effective March 1, 2010

14. 14 The ultimate cost of a reported claim may not be known for many years. Therefore, an initial estimate of the ultimate settlement value is made at the time the claim is reported. This estimate may change over time as the prognosis of the injury changes, the expected life-span shortens/ lengthens, the cost of medical services increases/ decreases, etc. Loss Development

15. 15 Loss Development Factors Are Used to Estimate Ultimate Liabilities Over time, the % of ultimate losses that are paid increases PY2009 1st Rpt PY2009 2nd Rpt PY2009 3rd Rpt PY2009 Ultimately... Paid Case Reserves Case Reserves Case Reserves IBNR IBNR: Reserves set aside for claims that have been Incurred But Not yet Reported.

16. 16 Trend compares movements in indemnity and medical costs to movements in payroll Data in Filing Time Filing Effective } Trend Benefit Costs Payroll Trend

17. 17 Fitting curves to Historical Loss Ratios Use of Frequency and Severity Data Econometric Analysis Outside Sources (AHA, DOL) A positive trend assumes that losses are growing faster than wages. A negative trend assumes the opposite. Techniques to Measure Trend

18. 18 Derivation of Premium at Current Loss Cost Level Adjustments to reported financial data premium: Premium on-levels Policy year premium development

19. 19 Premium On-level Factors Adjust Historical Premium to the Current Approved Level 1/1/1012/31/101/1/091/1/1312/31/13 Policy Effective Date Policy Year 2009 Policy Year 2010 Policy Year 2013 Loss Cost Level Change Effective July 1, 2010

20. 20 Jan 1 st Dec 31 st Last Policy Expires Most Audits Complete Mar 31 st PY Financial Data 1 st Report Policy Year Policy Year Premium Development (Due to payroll audits)

21. 21 WC Statistical Plan (WCSP) Data Experience by policy detail – Exposure, premium, experience rating modifications – Individual claims by injury type Purposes – Classification relativities – Experience Rating Plan – Research

22. 22 Valuation of WCSP Data Policy Effective 18 Months 1st Report Valuation 2nd Report Valuation 3rd Report Valuation 4th Report Valuation 5th Report Valuation 30 Months 42 Months 54 Months 66 Months

23. 23 The overall average change is distributed to industry groups and then to individual classes Distribution of Overall Change to Industry Groups Manufacturing Textiles Cabinets Automobiles Contracting Plumbing Roads Houses Goods & Services Restaurants Retail sales Nursing Office & Clerical Outside sales Clerical office employees Miscellaneous Trucking Logging Surface coal mining

24. 24 State XYZ Changes by Industry Group

25. 25 Individual Classifications Five years of WCSP experience used Individual claims are limited Credibility is assigned National data is used in low volume/credibility classes

26. 26 Formula Pure Premiums + + Z = Credibility % State Z X Indicated Pure Premium (State data, five years) National Z X National Pure Premium (National data adjusted) Remaining Z X Present on Rate Level Pure Premium (approved)

27. 27 Test Correction Procedure Iterative process to ensure that: class swing limits are adhered to the Industry Group change is achieved

28. 28 Classification Swing Limits Individual class loss costs prior to swing limits (A) = Indicated changes exceeding the upper swing limit (B) = Indicated changes within the swing limits (C) = Indicated changes less than the lower swing limit Industry Group Change +25% -25% B C A

29. 29 Add in a provision for Loss Adjustment Expense (Expenses of an insurer which are directly chargeable to the settlement of claims—such as investigating cases and defending law suits) May also include loss-based assessments Loss Adjustment Expense Developed and Trended Losses Loss Cost including LAE Final Loss Cost

30. Insurance Company Perspective Workers Compensation Ratemaking— An Overview

31. 31 Expenses Loss Cost Multipliers Company Pricing Programs Predictive Modeling Current Workers Compensation Market Insurance Company Perspective Outline

32. 32 A provision for each expense item is added to the final loss cost to produce a full manual rate Profit & Contingencies Taxes, Licenses & Fees Production & General Expense Loss Adjustment Expense Developed and Trended Losses Full Rate Components of a Rate Losses Loss Adjustment Expenses Loss-Based Assessments Expenses and Profit

33. 33 Expense Components Production – commissions, premium collection, underwriting Taxes, Licenses, and Fees – various premium taxes, bureau and filing fees General – policy processing, overhead, premium audits, actuarial Profit and Contingencies – combined with investment income

34. 34 Evaluation of the Needs Outside of the Loss Cost Items Always Outside of the Loss Cost – Production – Taxes, Licenses, and Fees – General – Profit and Contingencies Items Sometimes Outside of the Loss Cost – Loss Adjustment Expenses – Loss-Based Assessments Items Rarely Outside of the Loss Cost (MN) – Trend – Loss Development beyond 8th report

35. 35 Costs as a Percentage of Standard Premium Almost Always in the Loss Cost Most of the time in the Loss Cost Sometimes in the Loss Cost

36. 36 How to Account for Items Outside of the Loss Cost The Loss Cost Multiplier (LCM) Also known as a Pure Premium Multiplier Loss Cost x LCM = Rate Factor to load loss costs for insurer’s expense and profit Must also consider other items not included in the Loss Cost (trend, development, etc.) Insurance companies must file LCMs for approval in loss cost states

37. 37 Derivation of a Loss Cost Multiplier State A: Loss Cost includes Loss, Loss Adjustment Expense, and Assessments State B: Loss Cost includes Loss and Loss Adjustment Expense State C: Loss Cost includes Loss Only In all three cases, loss includes full trend and loss development

38. 38 Portion of Standard Premium State A B C Total of Items to Load on Loss Cost.300 Indicated Loss Cost Multiplier 1.429 = 1/(1 - Load Needed) Loss Assessments (% Prem).020.020 Loss Adj. Expense (% Prem).080 Expenses.275 Profit.025.275.275.025.025.320.400 1.471 1.667 Derivation of a Loss Cost Multiplier

39. 39 Derivation of the LCM— Alternative Approach Prior methodology assumes that all items included in the LCM are related to Premium Loss Adjustment Expenses and Assessments may not have a stable relationship to Premium An alternative approach for states that require a loading for “loss-related” items is: 1 + Loss Related Items (% Loss) LCM = 1 - Premium Related Items (% Premium)

40. 40 For State C in the Prior Example Loss-related expenses total 10% of premium Loss equals 60% of premium Premium-related expenses total 30% of premium 1 + (10% / 60%) LCM = = 1.667 1 - (30%) The two methods are mathematically equivalent, but this approach may produce more stable results over time Derivation of the LCM— Alternative Approach

41. 41 For State D, a new Example Derivation of the LCM— Alternative Approach

42. 42 The LCM + The LCM, as originally defined, requires the use of expense constants and premium discounts to more accurately charge for individual risks There is a method that can accomplish the same goal without the need for these two other components and can be developed by individual companies Disclaimer: All of the information that follows is completely fictitious and is not meant to resemble any actual carrier’s data or experience

43. 43 First, let’s make some basic assumptions U/W expense = production and general expense The LCM +

44. 44 The LCM +

45. 45 The LCM +

46. 46 The LCM +

47. 47 The LCM +

48. 48 The LCM +

49. 49 The LCM +

50. 50 The LCM +

51. 51 The LCM +

52. 52 The LCM +

53. 53 Therefore, we should be able to solve for an accurate premium directly, without extra rating factors In addition, this would allow for a more company- and insured-specific price But,… This method requires a fixed/variable expense analysis, similar to what would go into the development of premium discount tables and expense constants. This is not a trivial task. The LCM +

54. 54 Additional Considerations for the LCM Bureau Rates vs. Loss Costs Evaluation of the Bureau Loss Cost Filing – Do you agree with the various assumptions? – How does your book compare? – Is there additional, more current info? Consideration of the company’s experience – How does your experience compare? – Are there changes in your company’s operations to consider? – When will you implement the change?

55. 55 Manual Rates Are Just the Beginning Deviations Premium Discount Expense Constant Schedule Rating Experience Rating Dividend Plans Retrospective Rating Deductibles (Small and Large) Additional Pricing Elements Are an Individual Company Decision

56. 56 Additional Pricing Elements Deviations – filed by companies to reflect anticipated experience differences (rate or LCM) Premium Discount – by policy size; reflects that relative expense is less for larger insureds Expense Constant – reflects that relative expense is greater for smaller insureds Schedule Rating – recognizes characteristics not reflected in experience rating

57. 57 A Predictive Modeling Application Schedule rating is defined as: “The premium for a risk may be modified according to the Schedule Rating Table to reflect such characteristics of the risk that are not reflected in its experience. Seven categories are considered when determining any credit or debit under this Plan: Premises Classification Peculiarities Medical Facilities Safety Devices Employees —Selection, Training, Supervision Management —Cooperation With Insurance Carrier Management —Safety Organization

58. 58 A Predictive Modeling Application Schedule rating table provides a range of credits/debits for each of the seven categories Quantifying specific characteristics within each category allows for more accurate account specific pricing May also be able to identify other characteristics that may not traditionally be considered in the seven categories The end result is to enhance the experience mod with an additional mathematical model

59. 59 Programs That Adjust Premium to Reflect Actual Loss Experience Experience Rating – Mandatory tool that compares actual and expected losses Dividend Plans – Meant to reflect favorable experience Retrospective Rating – Premium is adjusted based on insured’s experience during the time the policy is in force Large Deductibles – The employer opts to pay claims below a certain threshold (usually $100,000 or greater)

60. 60 Workers Compensation Climate and the Role of the Actuary Beginning in 2008, underwriting gains were no longer present on either a calendar year or an accident year basis During NCCI's 2011 filing season, for those states in which NCCI provides ratemaking services, over three-quarters of the filed rate / loss cost level changes were increases; the remainder either had no change or were decreases Current economic and market conditions may impact workers compensation results Actuaries must be aware of changing environments, how pricing tools are used, and how that will impact results Actuaries must communicate findings with management

61. Thank You for Your Attention! Questions/Comments?