2. BASIC TECHNIQUES FOR WORKERS COMPENSATION Presented by Richard B. Moncher, Protegrity Services Andrew J. Doll, General Casualty 2001 CAS Seminar on Ratemaking Las Vegas, Nevada March 13, 2001 WCP - 16

3. 2 SESSION OUTLINE RICH MONCHER: Overview of WCOverview of WC NCCI FilingNCCI Filing Overall Rate / LC Level ChangeOverall Rate / LC Level Change Class Rate / LC ChangesClass Rate / LC Changes

4. 3 SESSION OUTLINE ANDY DOLL: Other Bureau RatemakingOther Bureau Ratemaking ExpensesExpenses Loss Cost MultipliersLoss Cost Multipliers Company Pricing ProgramsCompany Pricing Programs Current WC MarketCurrent WC Market

5. 4 Exposure x Manual Rate = Manual Premium Manual Premium x Experience Mod = Standard Premium - Premium Discount = Net Premium WC RATING PROCEDURE

6. 5 Example: Loss Cost = 1.60Expenses = 0.40 Loss Cost = 1.60Expenses = 0.40 Rate = 1.60 + 0.40 = 2.00 Rate = 1.60 + 0.40 = 2.00 2000 Payroll = 1,500,000 2000 Payroll = 1,500,000 Exposure = Payroll / 100 = 15,000 Exposure = Payroll / 100 = 15,000 2000 Manual Premium = Rate x Exposure = 2.00 x 15,000 = 30,000 = 2.00 x 15,000 = 30,000

7. 6 Example (cont’d) 2000 Payroll = 1,500,000 2000 Payroll = 1,500,000 2001 Payroll = 1,800,000 2001 Payroll = 1,800,000 20% increase in payroll If same $2.00 Rate, then 2001 Manual Premium = 18,000 x 2.00 = 36,000 36,000 / 30,000 = 20% increase in premium

8. 7 ADVANTAGES OF PAYROLL Inflation Sensitive Inflation Sensitive - Payroll up Premium up Tracks with Indemnity Benefits Tracks with Indemnity Benefits Verifiable / Auditable Verifiable / Auditable - Less potential for fraud Readily Available Readily Available

9. 8 WC DATA BASES Financial Aggregate Calls Financial Aggregate Calls - Annual Data at Year End - Statewide & Assigned Risk WC Statistical Plan - Detail By Class WC Statistical Plan - Detail By Class - Payroll & Losses - Five Evaluations

10. 9 FINANCIAL AGGREGATE CALLS Purposes - Overall Rate/Loss Cost Level Change - where overall means statewide, voluntary or assigned risk - Trend Analyses - changes in historical loss ratios

11. 10 FINANCIAL AGGREGATE CALLS Experience - By Policy Year - By Calendar-Accident Year Data Elements Data Elements - Std Earned Premium at DSR Level - Std Earned Premium at Company Level - Net Earned Premium - Benefit Costs: Indemnity/Medical/Total - Payments (Paid Losses) - Case Reserves - Bulk & IBNR Reserves

12. 11 VALUATION OF FINANCIAL DATA POLICY YEAR ExpirationDateEffectiveDate PolicyYear1999 1/1/9912/31/9912/31/00 (1st report) 12/31/01 (2nd report)

13. 12 VALUATION OF FINANCIAL DATA ACCIDENT YEAR 1/1/991/1/0012/31/00 (1st report) 12/31/01 (2nd report) AccidentYear2000ExpirationDateEffectiveDate

14. 13 RATEMAKING: THE BIG PICTURE Start with historical (premium and loss) data usually one to two years oldStart with historical (premium and loss) data usually one to two years old Use analysis and judgment to estimate the ultimate losses by adjusting historical lossesUse analysis and judgment to estimate the ultimate losses by adjusting historical losses Adjust the premium (excluding expenses for loss cost states) from historical data to simulate the (pure) premium currently in placeAdjust the premium (excluding expenses for loss cost states) from historical data to simulate the (pure) premium currently in place

15. 14 RATEMAKING: THE BIG PICTURE Divide ultimate losses by simulated premium to obtain loss ratio.Divide ultimate losses by simulated premium to obtain loss ratio. Trend loss ratio to effective period. Trend loss ratio to effective period. Check if current rates / loss costs are adequate. If trended loss ratio is close to 1.0, then no rate / lost cost change may be needed. Otherwise, revised rates / loss costs are needed.Check if current rates / loss costs are adequate. If trended loss ratio is close to 1.0, then no rate / lost cost change may be needed. Otherwise, revised rates / loss costs are needed.

16. 15 Does current premium level provide adequate funds for future benefits?

17. 16 PREMIUM ON-LEVEL FACTORS Adjust historical premium to current rate / loss cost level based on subsequent rate / loss cost changes PY 1999 Premium = $100M 1/1/2001 Loss Cost Change = - 5.0% PY 1999 Premium at Current Loss Cost Level = $95M

18. 17 LOSS ON-LEVEL FACTORS Adjust historical losses to current benefit level based on subsequent benefit (law) changes PY 1999 Medical Losses = $100M 1/1/2001 Medical Fee Schedule Change = 10% savings PY 1999 Medical Losses at Current Benefit Level = $90M

19. 18 Trend FactorsTrend Factors - Compares movements in indemnity and medical benefits to movements in payroll - Applied to loss ratio = (Adjusted losses) / (Adjusted premium) (Adjusted losses) / (Adjusted premium) Data in Filing Time } Filing Filing Eff Date Trend Payroll Benefit Costs

20. 19 LOSS EXPERIENCE INDICATION Estimate ultimate losses at current benefit level.Estimate ultimate losses at current benefit level. Estimate premium at current loss cost level.Estimate premium at current loss cost level. Divide these losses by these premiums to obtain loss ratio.Divide these losses by these premiums to obtain loss ratio. Trend loss ratio to average accident date of effective period (PY 2002).Trend loss ratio to average accident date of effective period (PY 2002).

21. 20 LOSS EXPERIENCE INDICATION If loss ratio > 1.0, then more premium is needed. So, loss costs need to be increased for PY 2002.If loss ratio > 1.0, then more premium is needed. So, loss costs need to be increased for PY 2002. If loss ratio < 1.0, then less premium is needed. So, loss costs need to be decreased for PY 2002.If loss ratio < 1.0, then less premium is needed. So, loss costs need to be decreased for PY 2002.

22. 21 WC STATISTICAL PLAN PurposesPurposes - Classification Relativities - Industry Group Differentials - Experience Rating - Retrospective Rating - Research

23. 22 WC STATISTICAL PLAN Experience by PolicyExperience by Policy Classification DetailsClassification Details - Exposure / Premium / Experience Mod - Individual Claim Records Indemnity / Medical Case Incurred Values Case Incurred Values By Injury Type (Fatal, PT, etc.) By Injury Type (Fatal, PT, etc.)

24. 23 OVERALL CHANGE TO INDUSTRY GROUPS Overall change is distributed to industry groups and then to individual classes Overall change is distributed to industry groups and then to individual classes ManufacturingManufacturing ­Textiles ­Cabinets ­Automobiles Office & ClericalOffice & Clerical ­Clerical office employees ­Outside sales ContractingContracting ­Plumbing ­Roads ­Houses Goods & ServicesGoods & Services ­Restaurants ­Retail sales ­Nursing Homes MiscellaneousMiscellaneous ­Trucking ­Logging ­Surface coal mining

25. 24 MANUFACTURING INDUSTRY GROUP CHANGE Analysis shows that: Overall (statewide) change is +10%Overall (statewide) change is +10% Manufacturing industry group experience is 10% worse than statewide. So,...Manufacturing industry group experience is 10% worse than statewide. So,... Mfg Industry Group Chg = StatewideChange x Industry Group Industry Group Differential Differential =(1.10) (1.10) - 1 =1.21 - 1 =21% - 1

26. 25 VALUATION OF WC STATISTICAL PLAN DATA 7/1/99 PolicyEffective1/1/96 7/1/977/1/98 7/1/007/1/01 1stReportValuation2ndReportValuation 3rdReportValuation4thReportValuation 5thReportValuation

27. 26 DISTRIBUTION OF INDUSTRY GROUP CHANGE TO CLASS Unit ReportsUnit Reports Relativities (between classes)Relativities (between classes) - Five years of WCSP data - Current loss cost / rate (adjusted) - Adjusted national experience for class

28. 27 BASIC TECHNIQUES FOR WORKERS COMPENSATION Company Perspective

29. 28 INDEPENDENT BUREAU VS. NCCI FILING ACTIVITIES n California n Massachusetts n Minnesota n New n New Jersey York n Pennsylvania/Delaware n Texas

30. 29 LOSS COSTS - WHY? n McCarran-Ferguson Debate n Antitrust Concerns n Ease of Developing Final Rates n Note: Twenty years ago, all states were rate states. Now, almost all NCCI states are loss costs.

31. 30 COMPONENTS OF A RATE n Losses n Loss Adjustment Expenses n Expenses and Profit n Loss Assessments

32. 31 EXPENSE COMPONENTS n Production - commissions, premium collection, underwriting n Taxes, Licenses, and Fees - various premium taxes, bureau and filing fees n General - overhead, audits, general administration n Profit and contingencies - combined with investment income

33. 32 COSTS AS A PERCENTAGE OF FIRST $5,000 OF STANDARD PREMIUM

34. 33 EVALUATION OF THE NEEDS OUTSIDE OF THE LOSS COST Items always Outside the Loss Cost lProduction lTaxes, Licenses, and Fees lGeneral lProfit and Contingencies Items sometimes Outside the Loss Cost lLoss Adjustment Expenses lLoss Based Assessments Items rarely Outside the Loss Cost (MN) lTrend lLoss Development beyond 8th report

35. 34 COMPONENTS OF A RATE IN OR OUT OF THE LOSS COST

36. 35 HOW TO ACCOUNT FOR ITEMS OUTSIDE THE LOSS COST The Loss Cost Multiplier (LCM) lFactor to multiply loss costs by in order to load in insurer’s expense and profit lMust also consider other items not included in the Loss Cost lLoss Cost x LCM = Rate lInsurance companies must file LCMs for approval in loss cost states lAlso known as a Pure Premium Multiplier

37. 36 DERIVATION OF A LOSS COST MULTIPLIER n State A: Loss Cost includes Loss, Loss Adjustment expense, and Assessments n State B: Loss Cost includes Loss and Loss Adjustment expense n State C: Loss Cost includes Loss n In all three cases, loss includes full trend and loss development

38. 37 DERIVATION OF A LOSS COST MULTIPLIER Portion of Standard Premium State State A B C A B C Expenses.275 Profit.025 Total of Items to Load on Loss Cost.300 Indicated Loss Cost Multiplier 1.429 = 1/(1 - Load Needed) = 1/(1 - Load Needed)

39. 38 DERIVATION OF A LOSS COST MULTIPLIER Portion of Standard Premium State State A B C A B C Expenses.275.275.275 Profit.025.025.025 Loss Assessments (% Prem).020.020 Loss Assessments (% Prem).020.020 Loss Adj. Expense (% Prem).080 Loss Adj. Expense (% Prem).080 Total of Items to Load on Loss Cost.300.320.400 Indicated Loss Cost Multiplier 1.429 1.471 1.667 = 1/(1 - Load Needed) = 1/(1 - Load Needed)

40. 39 DERIVATION OF THE LCM ALTERNATIVE APPROACH n Prior methodology assumes that all items included in the LCM are related to Premium n Loss Adjustment Expenses and Assessments may not have a stable relationship to Premium n An alternative approach for states that require a loading for “loss related” items is: 1 + Loss Related Items (% Loss) 1 + Loss Related Items (% Loss) LCM = 1 - Premium Related Items (% Premium) 1 - Premium Related Items (% Premium)

41. 40 ADDITIONAL CONSIDERATIONS FOR THE LCM n Administered Pricing vs. Competitive Rating When to use a LCM? n 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? n Consideration of the Company’s experience How does your experience compare? Are there changes to consider? When will you be implementing a change?

42. 41 MANUAL RATE IS STARTING POINT FOR DETERMINING COST OF WORKERS COMPENSATION INSURANCE Additional Factors lProspective Experience Rating lPremium Discounts lDeviations lSchedule Rating lRetrospective Rating lDividend Plans lDeductibles (Small and Large)

43. 42 PROGRAMS THAT CAN BE USED TO BETTER REFLECT INDIVIDUAL RISK CHARACTERISTICS n Experience Rating - mandatory tool that compares actual and expected losses n Premium Discounts - by policy size; reflects that relative expense is less for larger insureds n Expense Constant - reflects expense gradation for smaller insureds n Deviations - filed by companies (LCM or rate) to reflect anticipated experience differences n Schedule Rating - reflects characteristics not reflected by experience rating n Dividend Plans - means to reflect favorable experience; similar to schedule or retro rating

44. 43 PROGRAMS THAT CAN BE USED TO REFLECT ACTUAL LOSS EXPERIENCE n Retrospective Rating - premium depends on the experience generated by the insured during the time the policy is in force n Large Deductibles - similar to retrospective rating, but can often allow for cash flow benefits to the insured

45. 44 WORKERS COMPENSATION CLIMATE AND THE ROLE OF THE ACTUARY n Industry results deteriorating on calendar and accident year bases n Rates / Loss Costs changes vary by jurisdiction, from decreases to increases n Changes are not reflective of deterioration in results n Actuaries must be aware of changing environments, how pricing tools are used, and how that will impact results n Actuaries must communicate findings with management