1. BASIC TECHNIQUES FOR WORKERS COMPENSATION Presented by Richard B. Moncher, NCCI, Inc. Andrew J. Doll, General Casualty 1999 CAS Seminar on Ratemaking Nashville, Tennessee March 12, 1999 INT - 4

2. COURSE OUTLINE RICH MONCHER: OverviewOverview NCCI FilingNCCI Filing Overall Rate / LC Level ChangeOverall Rate / LC Level Change Class Rate / LC ChangesClass Rate / LC Changes 1

3. COURSE OUTLINE ANDY DOLL: Other Bureau RatemakingOther Bureau Ratemaking ExpensesExpenses Loss Cost MultipliersLoss Cost Multipliers Company Pricing ProgramsCompany Pricing Programs Current WC MarketCurrent WC Market 2

4. WC RATING PROCEDURE Exposure x Manual Rate = Manual Premium Manual Premium x Experience Mod = Standard Earned Premium - Premium Discount = Net Premium + Expense Constant 3

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 1998 Payroll = 1,500,000 1998 Payroll = 1,500,000 Exposure = Payroll / 100 = 15,000 Exposure = Payroll / 100 = 15,000 1999 Manual Premium = Rate x Exposure = 2.00 x 15,000 = 30,000 = 2.00 x 15,000 = 30,000 4

6. Example (cont’d) 1998 Payroll = 1,500,000 1998 Payroll = 1,500,000 1999 Payroll = 1,800,000 1999 Payroll = 1,800,000 20% increase in Payroll If same $ 2.00 Rate, then 1999 Manual Premium = 18,000 x 2.00 = 36,000 So, 20% increase in Premium 5

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 6

8. W.C. DATA BASES Financial Aggregate Calls Financial Aggregate Calls - Annual Data at Year End - Statewide & Assigned Risk W.C. Statistical Plan W.C. Statistical Plan - Class Detail (Approx. 600) - Payroll & Losses - 18, 30, 42, 54, 66 Months after Effective Date 7

9. 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 8

10. FINANCIAL AGGREGATE CALLS Purposes - Overall Rate/Loss Cost Level Change - Overall => Statewide, Voluntary, Assigned Risk - Trend Analyses 9

11. VALUATION OF FINANCIAL DATA POLICY YEAR ExpirationDateEffectiveDate PolicyYear1997 1/1/9712/31/9712/31/98 (1st report) 12/31/99 (2nd report) 10

12. VALUATION OF FINANCIAL DATA ACCIDENT YEAR 1/1/971/1/9812/31/98 (1st report) 12/31/99 (2nd report) AccidentYear1998ExpirationDateEffectiveDate 11

13. RATEMAKING: BIG PICTURE We start with historical data (premium and losses) usually one to two years oldWe start with historical data (premium and losses) usually one to two years old We use analysis and judgment to estimate the ultimate losses by adjusting historical lossesWe use analysis and judgment to estimate the ultimate losses by adjusting historical losses We adjust the premium (excluding expenses for loss cost states) from the historical data to simulate the (pure) premium currently in placeWe adjust the premium (excluding expenses for loss cost states) from the historical data to simulate the (pure) premium currently in place 12

14. RATEMAKING: BIG PICTURE We divide estimated losses by simulated premium to see if current rates/loss costs are adequate (i.e. If losses/premium = 1.0, then we have exactly enough premium to cover losses.We divide estimated losses by simulated premium to see if current rates/loss costs are adequate (i.e. If losses/premium = 1.0, then we have exactly enough premium to cover losses. If not then we must make new rates/loss costs.) If not then we must make new rates/loss costs.) 13

15. Does current premium level provide adequate funds for future benefits? 14

16. PREMIUM ON-LEVEL FACTORS Adjust historical premium to current rate/loss cost level based on subsequent rate/loss cost changes PY 1997 Premium = $100M 1/1/99 Loss Cost Change = - 5.0% PY 1997 Premium @ Current Loss Cost Level = $95M 15

17. LOSS ON-LEVEL FACTORS Adjust historical losses to current benefit level based on subsequent benefit (law) changes PY 1997 Medical Losses = $100M 1/1/99 Medical Fee Schedule Change = 10% savings PY 97 Medical Losses @ Current Benefit Level = $90M 16

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 Effective Trend Payroll Benefit Costs 17

19. LOSS EXPERIENCE INDICATION Estimate what the losses will be in 2000, and all the premium at the current 1999 loss costsEstimate what the losses will be in 2000, and all the premium at the current 1999 loss costs Divide the losses by the premium to see if we have enough premium to cover all of the lossesDivide the losses by the premium to see if we have enough premium to cover all of the losses 18

20. LOSS EXPERIENCE INDICATION This Ratio of losses to premium is called the Loss RatioThis Ratio of losses to premium is called the Loss Ratio – if there are more losses than premiums (i.e. the loss ratio > 1.00) then we need more premium, so we have to raise loss costs for 2000 – if there are less losses than premium (i.e. the loss ratio < 1.00) then we have too much premium, so we have to lower loss costs for 2000 19

21. 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 MiscellaneousMiscellaneous ­Trucking ­Logging ­Surface coal mining 20

22. MANUFACTURING INDUSTRY GROUP CHANGE Analysis shows that: Overall (statewide) change is +10%Overall (statewide) change is +10% Manufacturing industry group experience is 10% worse that statewide so,Manufacturing industry group experience is 10% worse that statewide so, Mfg. Industry Group Change = StatewideChange x Industry Group Differential =(1.1) (1.1) - 1 =1.21 - 1 =21% - 1 21

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

24. W.C. STATISTICAL PLAN PurposesPurposes - Classification Relativities - Experience Rating - Retrospective Rating - Research 23

25. VALUATION OF W.C. STATISTICAL PLAN DATA 7/1/98 PolicyEffective1/1/95 7/1/967/1/97 7/1/997/1/00 1stReportValuation2ndReportValuation3rdReportValuation4thReportValuation5thReportValuation 24

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 25

27. BASIC TECHNIQUES FOR WORKERS COMPENSATION Company Perspective 26

28. INDEPENDENT BUREAU VS. NCCI FILING ACTIVITIES l California l Massachusetts l Minnesota l New Jersey l New York l Pennsylvania/Delaware l Texas 27

29. LOSS COSTS - WHY? l McCarran-Ferguson Debate l Antitrust Concerns l Ease of Developing Final Rates Note: 15 years ago all states were rate states. Now, almost all NCCI states are loss costs. 28

30. COMPONENTS OF A RATE l Losses l Loss Adjustment Expenses l Expenses and Profit l Loss Assessments 29

31. EXPENSE COMPONENTS l Production - commissions, premium collection, underwriting l Taxes, Licenses, and Fees - various premium taxes, bureau and filing fees l General - overhead, audits, general administration l Profit and contingencies - combined with investment income 30

32. COSTS AS A PERCENTAGE OF FIRST $5,000 OF STANDARD PREMIUM 31

33. EVALUATION OF THE NEEDS OUTSIDE OF THE LOSS COST Items always Outside the Loss Cost l Production l Taxes, Licenses, and Fees l General l Profit and Contingencies Items sometimes Outside the Loss Cost l Loss Adjustment Expenses l Loss Based Assessments Items rarely Outside the Loss Cost (MN) l Trend l Loss Development beyond 8th report 32

34. COMPONENTS OF A RATE IN OR OUT OF THE LOSS COST 33

35. HOW TO ACCOUNT FOR ITEMS OUTSIDE THE LOSS COST The Loss Cost Multiplier (LCM) l Factor to multiply loss costs by to load in insurer’s expense and profit l Must also consider other items not included in the Loss Cost l Loss Cost x LCM = Rate l Insurance Companies must file LCM’s for approval in loss cost states l Also known as a Pure Premium Multiplier 34

36. DERIVATION OF A LOSS COST MULTIPLIER l State A: Loss Cost includes Loss, Loss Adjustment expense, and Assessments l State B: Loss Cost includes Loss and Loss Adjustment expense l State C: Loss Cost includes Loss In all three cases, loss includes full trend and loss development 35

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) 36

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) 37

39. DERIVATION OF A LOSS COST MULTIPLIER - ALTERNATIVE APPROACH l Prior methodology assumes that all items included in the LCM are related to Premium l Loss Adjustment Expenses and Assessments may not have a stable relationship to Premium l 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) 38

40. ADDITIONAL CONSIDERATIONS FOR THE LOSS COST MULTIPLIER l Administered Pricing vs. Competitive Rating When to use a LCM? l 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? l Consideration of the Company’s experience How does your experience compare? Are there changes to consider? When will you be implementing a change? 39

41. MANUAL RATE IS STARTING POINT FOR DETERMINING COST OF WORKERS COMPENSATION INSURANCE Additional Factors l Prospective Experience Rating l Premium Discounts l Deviations l Schedule Rating l Retrospective Rating l Dividend Plans l Deductibles (Small and Large) 40

42. PROGRAMS THAT CAN BE USED TO BETTER REFLECT INDIVIDUAL RISK CHARACTERISTICS l Experience Rating - mandatory tool that compares actual and expected losses l Premium Discounts - by policy size; reflects that relative expense is less for larger insureds l Expense Constant - reflects expense gradation for smaller insureds l Deviations - filed by companies (LCM or rate) to reflect anticipated experience differences l Schedule Rating - reflects characteristics not reflected by experience rating l Dividend Plans - means to reflect favorable experience; similar to schedule or retro rating 41

43. PROGRAMS THAT CAN BE USED TO REFLECT ACTUAL LOSS EXPERIENCE l Retrospective Rating - premium depends on the experience generated by the insured during the time the policy is in force l Large Deductibles - similar to retrospective rating, but can often allow for cash flow benefits to the insured 42

44. WORKERS COMPENSATION CLIMATE AND THE ROLE OF THE ACTUARY l Rates/Loss Costs continue to decrease in many jurisdictions, but starting to moderate l Market remains relatively soft, with continued use of pricing tools (schedule rating, dividends) l Industry results deteriorating on an accident year basis l Actuaries must be aware of changing environments, how pricing tools are used, and how that will impact results l Actuaries must communicate findings with management 43