©Towers Perrin September 13, 2004 Reserving Implications of Reform Workers Compensation David Mohrman John Booth

©Towers Perrin 2 Topics n Characteristics of workers compensation n Framework for analyzing workers compensation reforms n Examples n California n Florida

©Towers Perrin 3 WC Characteristics n Benefit structure defines how claims and losses emerge n What’s covered n Amounts n Limits n Durations n Process n General characteristics of WC systems n Most claims reported quickly (OD) n Partial payments n Medical inflation n Long Tail

©Towers Perrin 4 WC Characteristics n As a result: n Quick picture of how many claims (lost-time/medical only) n Hard part is determining the cost…  Severe claims are often hard to identify quickly n … and how these claims will emerge

©Towers Perrin 5 FELA is an exception n Tort system – includes non economic damages, pain and suffering, etc. n More like general liability n Claims often reported late and many close with no benefit payment n Class action type suits (hearing loss, toxic exposure) n Adverse jury verdicts n No statutory changes or reforms, but court rulings/precedents can cause significant changes (“fear” of asbestosis for example). n Lump sum payments, short tail n Large variance in payments for similar accidents

©Towers Perrin 6 Basic Frameworks n Measured by impact of reform on n Frequency n Severity n Timing n Reforms effect benefits: n What’s covered n Amounts n Limits n Durations n Processes

©Towers Perrin 7 Basic Frameworks n General Categories of Reforms: n Statutory Benefits  Wage replacement amounts  Duration  Other (apportionment, etc) n Permanency Threshold n Medical  Provider choice / Networks  Fee schedules  Treatment guidelines / Limits on visits n Adjudication / Dispute resolution / Administration

©Towers Perrin 8 Basic Frameworks Reform effective date Pricing analysis Frequency data Severity data and Development data time n Initial post-reform reserves should be based on pricing analysis n Less help for open claims n Actual data should be incorporated as it emerges

©Towers Perrin 9 Pricing analysis is good, but incomplete n Pricing analysis is a good place to start for changes in frequency and severity n Sometimes Impact on processes and utilization is wanting n Useful for setting initial reserve estimates n Loss ratios incorporating reforms, pricing changes and internal changes n Shortfall is on changes in development n Analysis of durations, if available can be converted to expected loss development n For reforms effecting claims retroactively, pricing analysis is usually of little help

©Towers Perrin 10 Pricing analysis should be adjusted for book of business n Reforms often have different impact by type of claim or payment n PTDs n Claim type shifts n Medical treatment/chiropractors n Medical costs n Attorney involvement n Managed care reforms effect depend on the intensity of current medical management activities n Claims department discussions are important for understanding the execution and measurement of reforms

©Towers Perrin 11 Claim frequency information can be incorporated relatively quickly n Changes in lost-time and medical-only claim activity can be measured quickly n Claim count emergence by type can be compared against the pricing analysis over a longer span n Has the emergence of claim counts changed? n Does frequency by claim type match expectations? n Has identification of problem claims become more or less difficult? n Use of Bornhuetter-Ferguson approach or frequency/severity approach is appropriate

©Towers Perrin 12 Actual claim severity and timing data should be incorporated as it emerges n Use of “operational” time instead of calendar time n Given milestones in the claim process how do results compare  With data prior to reform  With expected results post-reform n Basic concept of Berquist-Sherman approach n Analysis of closure rates and claim durations n Testing of development factors pre and post reform n Incurred and paid n Totals and average cost per claim n Loss development by injury type would be helpful

©Towers Perrin 13 Operational time example n Claim reporting n Speed-up in claim initial adjudication can be measured using accident month statistics  Observed speed-up averages 1 month  Implicit assumption is that claim adjusting is 1 month further along at any point in time n To analyze severity compare average incurred cost per claim post-reform at month = t to pre-reform lagged at month = t+1 n Comparison is useful for relative change, not absolute or ultimate differences n Good to use similar type claims (backs, PPDs,…)

©Towers Perrin 14 Reserving Implications in Florida n Industry impact estimated at -14% (per NCCI) n Impact is greatest on major claims PTD and PPD n Frequency change n Development change n Impact should vary by book of business n Construction vs service sector n Loss development by injury type or grouping would be useful n Need to track involvement of attorneys

©Towers Perrin 15 Reserving Implications in California n Reforms are designed to fundamentally alter behavior of key constituents (medical providers, claimants, judges, et al.) n Potential savings of 15% (per WCIRB not including impact of the permanent disability provisions effective in 2005) n Unintended consequences are expected, but unknown n Execution by insurers is key to savings potential n Expectation is that better ability to control treatment patterns will result in shorter durations n Limits on TTD treatments should also shorten durations n Apportionment should impact frequency and severity