1. The New NCCI Hazard Groups Greg Engl, PhD, FCAS, MAAA National Council on Compensation Insurance CASE Fall Meeting September 13, 2006

2. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 2 Agenda History of previous work Methodology employed Impact of remapping

3. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 3 Current Hazard Groups HG Number of Classes Standard Premium % of Total Premium I401,262,958,3740.9% II41767,150,463,29645.5% III30375,288,994,32551.1% IV1003,623,213,8322.5%

4. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 4 Assigning Classes to HGs Prior NCCI Method California Approach ELF Based Method

5. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 5 Prior NCCI Method Hazardousness “Excess loss potential”

6. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 6 For each state, the following seven quantities were measured by class and expressed as ratios to the corresponding statewide value:  Claim Frequency  Indemnity Pure Premium  Indemnity Severity  Medical Pure Premium  Medical Severity  Total Pure Premium  Serious Severity (including Medical) Hazardousness Variables

7. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 7 California Methodology Group classes with similar loss distributions together Need to precisely define ‘similar’

8. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 8 Crossover

9. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 9 Crossove r California ELF Curves 12351046789

10. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 10 Crossover California ELF Curves

11. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 11 HG Remapping Rationale What are HGs used for? Determining ELFs

12. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 12 Kentucky 9/1/04 Filing

13. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 13 Kentucky ELPPFs

14. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 14 Kentucky ELPPFs

15. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 15 Kentucky ELPPFs

16. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 16 Kentucky ELPPFs

17. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 17 Kentucky ELPPFs

18. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 18 HG Remapping Approach Makes sense to sort classes by ELF vectors Class ELF vectors approximated by HG ELF vectors ELF curves characterize loss distribution

19. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 19 Excess Ratio Calculations

20. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 20 HG Remapping Basic Data For each class code,, we have a vector of ELFs: Credibility weight with current HG ELF vector

21. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 21 Current Hazard Groups

22. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 22 Current Hazard Groups

23. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 23 New 4 Hazard Groups

24. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 24 New 4 Hazard Groups

25. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 25 4 Hazard Group Comparison Number of Classes per Hazard Group

26. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 26 4 Hazard Group Comparison Percent of Premium Per Hazard Group Current Mapping 45.5% 51.1% 2.5% 0.9% New Mapping 17.9% 37.8% 39.2% 5.1% HG 1 HG 2 HG 3 HG 4

27. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 27 Hierarchical Collapsing of New Mapping AB C DEF G 1 2 34

28. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 28 New Hazard Groups

29. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 29 New Hazard Groups

30. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 30 New Hazard Groups

31. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 31 Percent of Premium Moved Current Mapping to New 4 Hazard Groups * Number above bar represents the number of classes in each category. 0% 10% 20% 30% 40% 50% 60% 70% 80% No Movement Up 1 HGDown 1 HGUp 2 HGsDown 2 HGs Movement Percent of Premium 586 51 219 3 1

32. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 32 Movement of Classes

33. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 33 Number of Hazard Groups Calinski and Harabasz Number of HGs4 CH Statistic2317 5 3310 6 3213 7 3442 8 3297 9 3102

34. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 34 Number of Hazard Groups Cubic Clustering Criterion Number of HGs4 CCC Statistic89 5 110 6 108 7 112 8 111 9 125

35. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 35 Number of Hazard Groups Calinski and Harabasz Number of HGsAll Classes50% Credibility ClassesFull Credibility Classes 42317793433 53310759393 63213705450 7 34421025638 83297958620 93102915584 Cubic Clustering Criterion Number of HGsAll Classes50% Credibility ClassesFull Credibility Classes 4895137 51105034 61084836 7112 5942 81115741 9 125 5640

36. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 36 Three Key Ideas Map based on ELFs Compute ELFs by class Cluster Analysis

37. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 37 HG Remapping Objective Break C = set of all class codes, into Hazard Groups:

38. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 38 HG Remapping Basic Data For each class code,, we have a vector of ELFs:

39. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 39 Using Hazard Groups (HG mean) approx by for Want as close as possible to

40. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 40 HG Remapping Method k-means Splits classes into HGs to minimize

41. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 41 Optimal HGs % of total variance explained Analogous to an R-squared k-means maximizes this

42. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 42 R-squared

43. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 43 Optimal HGs Want well separated, homogeneous HGs Minimize within variance Maximize between variance

44. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 44 Optimal HGs Between variance vs. within variance Have one variance for each variable (ELFs at different attachment points) Need to consider variance-covariance matrices

45. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 45 Optimal HGs Dispersion matrix of whole data set is given by

46. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 46 Dispersion Matrix

47. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 47 Optimal HGs Dispersion matrix of HG i is given by

48. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 48 Optimal HGs If we let Then

49. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 49 Optimal HGs Pooled within group dispersion matrix Weighted between group dispersion matrix

50. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 50 Optimal HGs Between variance vs. within variance T = B + W k-means minimizes trace W

51. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 51 Credibility Compute class ELFs Assign a credibility to each class Use current HG as complement

52. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 52 History Hazard Groups were last remapped in 1993 Prior to that, Hazard Groups were remapped in 1981 Same credibility method used both times

53. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 53 Pseudo-Bühlmann where n = number of claims

54. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 54 Pseudo-Bühlmann A class with the average number of claims gets 75% credibility. Classes with twice the average number of claims get full credibility. Based on n/n+k

55. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 55 Pseudo-Bühlmann Credibility

56. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 56 Pseudo-Bühlmann Credibility Credibility Size Range Claims per Year Number of Classes % Premium 0%  Z < 10% 0-2373551.2% 10%  Z < 20% 238-511891.3% 20%  Z < 30% 512-831611.6% 30%  Z < 40% 832-1209562.7% 40%  Z < 50% 1210-1662462.5% 50%  Z < 60% 1663-2216342.5% 60%  Z < 70% 2217-2909464.8% 70%  Z < 80% 2910-3800354.3% 80%  Z < 90% 3801-4987294.0% 90%  Z < 100% 4988-6650183.2% Z = 100%  6651 10171.8%

57. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 57 Number of Classes by Claim Count

58. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 58 Number of Classes by Claim Count

59. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 59 Number of Classes by Claim Count

60. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 60 Revenue Neutrality Overall average ELF’s unaffected, therefore no overall premium effect. Individual risks may experience increases or decreases. Individual risk equity improved. For deductibles of $5,000 or less, the impact of the revised credit on the loss cost premium of most risks will be less than 5%.

61. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 61 Impact of New HGs on ELFs ELFs computed by HG New HGs alone change ELFs Extra year of trend Change in ELF Calculations

62. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 62 ELF Calculation Changes Average with last year’s ELFs –Loss limits adjusted for inflation –Provides additional stability Additive differential trend adjustment Recognizes that med loss trend higher than indemnity

63. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 63 Additive Adjustment to ELFs* all states, all HGs Loss limitAdjustment 0-$125,000.000 $150,000-$225,000.001 $250,000-$700,000.002 $800,000-$1,000,000.003 $2,000,000-$5,000,000.002 $6,000,000-$10,000,000.001 Over $10,000,000.000 *Included in B-1403.

64. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 64 Movement of Classes

65. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 65 Movement of Classes General movement of classes to lower HGs Classes with high ELFs moving to lower HGs General increase in HGs ELFs

66. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 66 Impact of Remapping on ELFs

67. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 67 Impact of Remapping on ELFs

68. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 68 Old and New Hazard Groups

69. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 69 New Hazard Groups

70. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 70 Impact of Remapping on ELFs

71. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 71 Impact of Remapping in AL

72. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 72 Impact of Remapping in IL

73. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 73 Change in Excess Ratios HG I to HG 1

74. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 74 Change in Excess Ratios HG I to HG 1

75. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 75 Change in Excess Ratios HG I to HG 1

76. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 76 Change in Excess Ratios HG II to HG 2

77. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 77 Change in Excess Ratios HG II to HG 2

78. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 78 Change in Excess Ratios HG II to HG 2

79. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 79 Change in Excess Ratios HG III to HG 3

80. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 80 Change in Excess Ratios HG III to HG 3

81. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 81 Change in Excess Ratios HG III to HG 3

82. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 82 Change in Excess Ratios HG IV to HG 4

83. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 83 Change in Excess Ratios HG IV to HG 4

84. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 84 Change in Excess Ratios HG IV to HG 4

85. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 85 Change in HG Excess Ratios Biggest increases at higher limits in HG I and IV Considerable variation by state Total change due to remapping, trend, and calculation changes

86. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 86 Excess Ratio Calculations

87. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 87 % Change in Average Cost per Case Injury Type Hazard Group 1234 Fatal+48.6%+14.0%+2.2%-5.3% PT+18.7%+4.0%+3.4%+29.2% PP+2.1%+9.1%+2.8%-6.0% TT-3.3%+4.8%+1.1%-5.8% Med Only-6.8%+2.9%+1.4%-9.5%

88. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 88 PT Average Cost per Case Hazard Group 4 HG IV $413,376 HG 4 $533,913 $ 214,619$ 573,275$ 450,789

89. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 89 % Change in Injury Type Weights Injury Type Hazard Group 1234 Fatal+133.3%+30.0%+3.8%-23.4% PT+12.1%+8.2%0.0%+39.4% PP-1.6%+2.7%+0.7%-1.5% TT-4.7%-3.3%-1.3%-2.3% Med Only+15.2%-13.2%-5.2%-29.2%

90. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 90 PT Weight Hazard Group 4 HG IV 10.4% HG 4 14.5% 4.1%15.7%12.0%

91. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 91 Impact of Remapping vs. Trend, and ELF Calculation Changes

92. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 92 Change in Excess Ratios HG I to HG 1

93. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 93 Change in Excess Ratios HG II to HG 2

94. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 94 Change in Excess Ratios HG III to HG 3

95. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 95 Change in Excess Ratios HG IV to HG 4

96. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 96 Change in Excess Ratios HG I to HG 1

97. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 97 Change in Excess Ratios HG II to HG 2

98. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 98 Change in Excess Ratios HG III to HG 3

99. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 99 Change in Excess Ratios HG IV to HG 4

100. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 100 Key Transitions

101. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 101 Largest Class Codes Transitioning From II to B Class Code Description Premium Size (8810 = 1000) 8017Store: Retail NOC451* 8018Store: Wholesale NOC271 8868 College: Professional Employees and Clerical 223 9052 Hotel: All Other Employees and Salespersons, Drivers 219 9101 College or School: All Other Employees 162 *Indicates premium 45.1% of 8810 premium.

102. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 102 Largest Class Codes Transitioning From II to C Class Code Description Premium Size (8810 = 1000) 8810Clerical Office Employees NOC1000 8829 Convalescent or Nursing Home— All Employees 293 8033 Store: Meat, Grocery and Provision (Combined)—Retail—NOC 248 8833Hospital: Professional Employees214 9014 Buildings—Operation by Contractors 189

103. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 103 Change in HG II Excess Ratios

104. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 104 Change in HG II Excess Ratios

105. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 105 Change in HG II Excess Ratios

106. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 106 Change in HG II Excess Ratios

107. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 107 Change in HG III Excess Ratios

108. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 108 Change in HG III Excess Ratios

109. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 109 Change in HG III Excess Ratios

110. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 110 Change in HG III Excess Ratios

111. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 111 Largest Class Codes Transitioning From III to E Class Code Description Premium Size (8810 = 1000) 8742 Salespersons, Collectors or Messengers—Outside 453 5190 Electrical Wiring—Within Buildings and Drivers 399 5183Plumbing NOC and Drivers366 7228 Trucking—Local Hauling Only—All Employees and Drivers 325 5221 Concrete or Cement Work—Floors, Driveways, Yards or Sidewalks— and Drivers 250

112. © Copyright 2006 National Council on Compensation Insurance, Inc. All rights reserved. 112 Largest Class Codes Transitioning From III to F Class Code Description Premium Size (8810 = 1000) 5645 Carpentry—Detached One or Two Family Dwellings 500 7229 Trucking—Long-Distance Hauling—All Employees and Drivers 416 5403Carpentry NOC289 5022Masonry NOC285 3724 Machinery or Equipment Erection or Repair NOC and Drivers 272