1. 8/29/2000 1 Casualty Loss Reserve Seminar Session Number 7 Workers Compensation Reserving: How Do You Slice the Cake? September 19, 2000 Panelists:Tracy A. Ryan, FCAS Associate Actuary - Liberty Mutual Group Mark J. Mahon, FCAS Consulting Actuary - MBA, Inc. Moderator:Timothy L. Wisecarver, FCAS President - Pennsylvania Compensation Rating Bureau Delaware Compensation Rating Bureau, Inc.

2. 8/29/2000 2 Why Do You Slice the Cake? Availability Credibility Homogeneity Emergence Patterns Settlement Patterns Development Patterns Loss Frequency Loss Severity Factors Affecting Decisions Concerning Data Organization

3. 8/29/2000 3 Slices Related to What Item(s) Are Being Reserved  Benefits vs. Loss Adjustment  Medical Benefits vs. Indemnity Benefits  Medical-Only Benefits vs. Medical Benefits on Indemnity Claims  Vocational Rehabilitation vs. Other Indemnity Benefits

4. 8/29/2000 4 Slices Related to Who Administers The Item(s) Being Reserved  Branch Office or Region  Business Unit (within an Insured or Self-Insured Risk)  Case Reserver(s)  Insurance Company  PPO/CCO Arrangements vs. “Market” Medical Providers  Producer  Reinsurance Arrangements (Assumed vs. Ceded vs. Direct Business  Self-Administered Losses vs. TPA or Other Vendor-Administered  Voluntary Market vs. Assigned Risk (Services vs. Direct Assignment)

5. 8/29/2000 5 Slices Related to Rules Applicable to the Item(s) Being Reserved Deductibles (Large vs. Small vs. None) Jurisdiction (i.e., USL&HW, FELA, State Act, etc.) State of Coverage (for State Act Benefits)

6. 8/29/2000 6 Slices Related to Special Features of the Insured(s) Industry Group (or Classification(s) ) Large Accounts vs. Other Policies Anomalous Accounts vs. Other Policies Loss-Rated vs. Guaranteed Cost Policies Participating vs. Non-Participating Policies

7. 8/29/2000 7 Slices Related to Known or Anticipated Features of Item(s) Being Reserved Large or Catastrophic Losses vs. Other Claims Layer of Loss Open Cases vs. Closed Cases Traumatic vs. Occupational Disease Type of Injury (Death, Permanent/Temporary, Total/Partial, Medical Only)

8. Workers Compensation Reserving How Do You Slice the Cake? Mark J. Mahon, FCAS, MAAA MBA, Inc.

9. 8/29/2000 9 It’s Easy to Want the Data - Receiving It Is Not So Easy  To Start - Keep Things Simple  Follow the Client’s Operations  Why Do You Want the Data?  Time Consuming and Expensive

10. 8/29/2000 10 Traumatic vs. Occupational Disease (Black Lung)  Coal Mine Compensation Rating Bureau of Pennsylvania.

11. 8/29/2000 11 Traumatic vs. Occupational Disease (Black Lung)  Comparison of OD to Traumatic –Cumulative –Long Report Time –Claims take time to Adjudicate –Lifetime Benefits –Low Frequency/High Severity

12. 8/29/2000 12 The OD System  Frequency times Severity.

13. 8/29/2000 13 The OD System  IBNR Claims –Uses Typical Accident Year Triangles –Claims assigned to Year based on Last Date of Exposure –Claim Count Development used to estimate IBNR Claims

14. 8/29/2000 14 OD Frequency  Three Pieces –Known Claimants Receiving Benefits at the valuation date (Awarded Claims) –An Estimate of Pending Claims that will be Awarded –An Estimate of IBNR Claims that will be Awarded

15. 8/29/2000 15 The OD System  Awarded Claims

16. 8/29/2000 16 OD Severity  Life Tables  Lifetime Benefits  Claimant’s Age  Annual Benefits  Marital Status  Escalation (State - No, Federal- Yes)

17. 8/29/2000 17 OD Severity  Life Tables used to Model Future Benefits

18. 8/29/2000 18 OD Severity  Act 57 –Only Claims Filed After Mid 1996 –WC Benefits Reduced for Social Security –WC Benefits Reduced for Pensions –AMA Guidelines Made it Harder To Achieve PT Disability Status

19. 8/29/2000 19 The OD Reserve  Three Pieces >Known Awarded Claims: Sum of Each Claimant’s future payments from severity model >Pending Claims: Pending Claims x Award Ratio x Average Severity of Pending Claims >IBNR Claims: IBNR Claims x Award Ratio x Average Severity of Awarded and Pending Claims

20. 8/29/2000 20 OD System - Concluding Remarks  Lifetime Payments/Long Tail  Relatively Few Claims  Parallels Actual Process  Reviewed by Interested Parties  Expensive  Is This Really the Only Way to Make Estimates?

21. 8/29/2000 21 Traumatic - Indemnity vs. Medical  Very Common Split  Also Breakdown Medical into Medical Only and Medical on Indemnity  Different –Development –Inflation –Law Changes

22. 8/29/2000 22 Tail Factor - Inverse Power Curve

23. 8/29/2000 23 Tail Factor - Relate to Larger Body

24. 8/29/2000 24 Tail Factor - Decay Factor

25. 8/29/2000 25 Traumatic Losses By Injury Type  Death, Permanent Total, Permanent Partial and Temporary Claims  Proportion of Losses by Injury Type –Act 57 Impacts Largest Claims –Severity Subsequent to Law Change should be Smaller

26. 8/29/2000 26 Traumatic Losses By Injury Type  Act 57 Also made it Easier to Settle Claims –Fewer Claims Being Reported as PT –Retroactive - Existing PT’s Settled and Reclassified –Incurred Loss Triangles Double Count Impact of Settlements –Paid Triangles Overstate Impact

27. 8/29/2000 27 Traumatic Losses By Injury Type  Permanent Total Claim Count Development

28. 8/29/2000 28 Traumatic Losses By Injury Type  PT Count Development after Act 57

29. 8/29/2000 29 Traumatic Losses By Injury Type  Safety Program Impact –Drop in Number of Injuries –Shift to less Severe Accidents

30. 8/29/2000 30 Losses in Higher Layers  Be Careful - Reserves in Higher Layers may be Inadequate  Loss Development Under Estimates Higher Layers in Most Recent AY –Immature years don’t yet have any big losses –Change in claims handling –Historically there are no Higher Layer Losses in layer but because of new severe classes or inflation new losses are expected

31. 8/29/2000 31 Losses in Higher Layers  Latest Years’ Lower than Historical

32. 8/29/2000 32 Losses in Higher Layers  Immature Years has No Losses

33. 8/29/2000 33 Losses in Higher Layers  Use Industry Statistics to Fill-in Excess Losses –Payroll x Loss Cost x Excess Loss Factor –As AY matures rely on actual data more and more  For Insurers Do Gross, Ceded and Net Separately

34. 8/29/2000 34 Losses By Business Segment  Many Self-Insureds have Different Operating Units –E.g., Construction vs. Shipbuilding –Financial Data Already Split –Usually Easy to get Actuarial Data as Coding already there

35. 8/29/2000 35 Losses By Business Segment  Many Self-Insureds have Different Operating Units –E.g., Construction vs. Shipbuilding –Financial Data Already Split –Usually Easy to get Actuarial Data as Coding already there  Data by Jurisdiction –USL&H Benefits Higher than State Benefits

36. 8/29/2000 36 Combining Data  Increases Credibility for Companies with Sparse Data  Provides a Guide to Overall Level  Use Combined Data as Minimum as usually the Sum of the Slices are greater than the Total –Less Variation in Total –Smaller Slice with Tail muted by Larger Slice without Tail –Shifting Losses to Longer Tail Slice

37. 8/29/2000 37 Keeping Score  Purpose of Slices - Improve Reserve Estimation Accuracy  Keep Tabs on your Estimates - Keep A Scorecard

38. 8/29/2000 38 Keeping Score

39. Workers Compensation Reserving How Do You Slice the Cake? Tracy A. Ryan, FCAS, MAAA Liberty Mutual Group

40. 8/29/2000 40  Large Dollar Deductibles  Primary vs. Excess  Unique Accounts  Industry Segments  IBNR Rule of Thumb Workers Compensation Reserving

41. 8/29/2000 41 10 15 20 25 30 35 40 909192939495969798p Calendar Year $ Billions p Preliminary Impact of Deductibles Workers Compensation Large Dollar Deductibles Net Written Premium

42. 8/29/2000 42 Workers Compensation Large Dollar Deductibles Loss Ratio First Dollar Large Dollar Deductible Los s $ 75 $ 15 Expens e $ 25 $ 23 Premium $100 $ 38 Loss Ratio 75% 40% (1 ) (2 )

43. 8/29/2000 43 Workers Compensation Large Dollar Deductibles Example *Assume deductible level remains the same each year. *Average deductible implies excess loss is 20% of ground-up loss. *Numbers are illustrative only.

44. 8/29/2000 44 Workers Compensation Large Dollar Deductibles Example Total incurred if all remains as first dollar business

45. 8/29/2000 45 Workers Compensation Large Dollar Deductibles Example Total first dollar + LDD incurred

46. 8/29/2000 46 Workers Compensation Large Dollar Deductibles Example

47. 8/29/2000 47 Workers Compensation Large Dollar Deductibles How to Calculate Ultimate Loss?  Develop losses net of deductible  Develop gross losses and apply a loss elimination ratio  Apply an expected loss ratio to premium  Use a Bornhuetter-Ferguson approach Sounds Easy … Right??

48. 8/29/2000 48 Workers Compensation Large Dollar Deductibles How to Calculate Ultimate Loss?  Develop Losses Net of Deductible –Highly Leveraged Loss Development Factors –Changing Retentions Over Time  Develop Gross Losses & Apply a Loss Elimination Ratio –Selecting the Loss Elimination Ratio –Changing Retentions Over Time  Apply an expected loss ratio to premium –Selecting the Expected Loss Ratio  Use a Bornhuetter-Ferguson approach –See above...

49. 8/29/2000 49 Workers Compensation Large Dollar Deductibles Educate your customer (risk manager, underwriter, internal management, etc.) on the peculiarities of net deductible loss - Severity of Excess Claims - Reporting and Payout Pattern of Excess Claims - Potential for Catastrophic Claims - Leveraged Impact of Inflation

50. 4/19/20008/29/2000 Liberty Mutual WC Claims Greater than $500,000 Percent of Total Reported Claims Dollars 0.05% 9%

51. 4/19/20008/29/2000 NCCI Data Workers Compensation Serious Claims vs All Claims Claim Counts$ Loss All Claims250,745$1,358m Serious Injuries 5,828$ 726m % Serious2%53%

52. 4/19/20008/29/2000 Liberty Mutual’s Oldest Open WC Claim Date of Accident State Description Injury Type Current Age Still Paying September 10, 1937 New Jersey Bilateral Hand Amputations Permanent Total 91 Years Old Weekly Compensation

53. 4/19/20008/29/2000 Acc After After After Years5 Years10 Years15 Years 1980-1989 1.0 2.1 3.3 For every 1 claim in excess of $500,000 as of 5 years, there will be 3.3 claims in excess of $500,000 as of 15 years. Workers Compensation Claims Greater than $500,000

54. 4/19/20008/29/2000 WC Excess Payout Pattern RetentionApprox. Years to Pay Half of Ultimate $ 0 2.5 $100k 7 $250k15 $500k19 $1m25

55. 4/19/20008/29/2000 How Big Can a WC Claim Be? A 25 year old quadriplegic Indemnity benefits = $23,400 per year Medical costs = $125,000 per year How much will this claim ultimately cost?

56. 4/19/20008/29/2000 How Big Can a WC Claim Be? Years Until Medical Inflation Death 0% 5% 7% 9% 20$3.0 $4.6$5.6 $6.9 35$5.2 $12.1 $18.1 $27.8 50$7.4 $27.3$52.0 $103.0 65$9.6 $58.6 $144.8 $376.3

57. 4/19/20008/29/2000 The Impact of Inflation on Excess Pricing The customer has a $250,000 LDD policy Expect 1 claim each year Expected Loss = $360,000 Excess loss = $110,000. Excess premium = $55,000. Assuming the customer does not change their retention, how much must we charge for next year’s policy if we know losses are growing at 3% per year?

58. 4/19/20008/29/2000 The Impact of Inflation on Excess Pricing We have to charge 10% more next year. Why? Expected Loss = $370,800 ($360,000 * 1.03) Excess loss = $120,800. Excess premium = $60,400. $60,400 / $55,000 = 1.10

59. 8/29/2000 59 Workers Compensation Unique Accounts @ 6 months Claim Closure+17 points Average Open-36% Average Paid-32% To understand how a single large account can impact results, you must look at the diagnostics of the account versus the rest of the book:

60. 8/29/2000 60 Workers Compensation Industry Segments  Industry segments studied were contracting, goods and services, manufacturing, office and clerical, and miscellaneous  Over a five year period: -Medical severity increase ranges from 2% to 16% -Indemnity severity change ranges from -2% to 9%

61. 8/29/2000 61 Workers Compensation Buyouts  Development  Expenses  Taxes  Investment Income  Risk charge/profit

62. 8/29/2000 62 Workers Compensation Buyouts Policy year 1994 Incurred loss @ 12/99 = $2,500 Paid loss @ 12/99 = $2,450 Ultimate incurred estimate = $2,725 Ultimate paid estimate = $3,185 Average ultimate = $2,955

63. 8/29/2000 63 Question: In providing an actuarial reserve analysis to a large national account, the risk manager asked the question for workers compensation: “For every dollar of aggregate case reserve, how much IBNR should I expect?” Answer: For WC, aggregate IBNR reserves should vary between 80% and 90% of outstanding aggregate case reserves. Workers Compensation Rule of Thumb

64. 8/29/2000 64 Based on industry data and the following formula: IBNR Reserve= (Ultimate Loss - Incurred Loss) Case Reserve (Incurred Loss - Paid Loss) = (100% - % Incurred) (% Incurred - % Paid) = (1.0 - 1/Incurred CDF) (1/Incurred CDF - 1/Paid CDF) Workers Compensation Rule of Thumb

65. 8/29/2000 65 Workers Compensation Rule of thumb Amount of IBNR loss as a percent of case reserve Workers Compensation Aggregate IBNR-to-Case Ratio Using 2 year patternsUsing 5 year patterns Maturity Incurred CDF Paid CDF IBNR as a % of case Incurred CDF Paid CDF IBNR as a % of caseSelected 121.5964.24595.5%1.6104.37696.5%95% 241.2632.03969.1%1.2732.08470.2%70% 361.1871.63068.8%1.1891.64268.5%70% 481.1571.46375.1%1.1531.45873.1%75% 601.1401.37282.8%1.1331.36079.7%80% 721.1301.31592.4%1.1211.30087.9%90% 841.1211.27799.0%1.1111.26093.9%95% 961.1121.248102.8%1.1031.23099.8%100% Note: Ratio = (1.00 - 1/Incd CDF) (1/Incd CDF - 1/Paid CDF)

66. 8/29/2000 66 Factors Impacting Ratio:  Mix of years - Assumed that case reserves decrease as maturity increases.  Mix of states - Used only countrywide development factors.  Development pattern - Specific company patterns may differ from NCCI pattern. Workers Compensation Rule of Thumb