July 16, 2007
Pricing Excess US Workers
Compensation
CARe Meeting
Jose Couret
London Underwriting Center
Outline
Terminology
Exposure Rating
Experience Rating
Impact of Benefit Changes
Questions
1
Terminology
Terminology
Workers Compensation
 Workers Compensation Policy
– Coverage A Workers Compensation
– Coverage B Employers Liability
 Workers compensation coverage is statutory; benefits are unlimited.
 Employers Liability Losses generally make up less than 1% of the
loss dollars (excluding F-classes and Maritime Classes).
– Not separately rated
– Limited, but increased limits available
3
Terminology
State Versus Federal Benefits
 Benefits are state-specific; however, some classes are subject to the
Federal Act.
 “F-Class”: longshoremen, harbor workers, etc.
 http://www.dol.gov/esa/owcp/dlhwc/lstable.htm
 Federal benefits tend to be higher
– Maximum weekly indemnity benefit is higher for F classes.
– Currently, wage replacement is capped at $1,114.44 /week
– Wages relatively high
 Federal benefits subject to escalation
 Ratio of loss assessments to pure loss is much higher.
– Important if assessments are part of UNL
 Other acts: Merchant Marine Act (Jones Act) / FELA, FECA
4
Terminology
Premium
 Manual Premium=Payroll in Hundreds x Manual Rate
– Exceptions (e.g. per capita classes)
 Standard Premium includes experience modification but is prior to the
application of adjustments such as retrospective rating plan
adjustments, schedule rating, and premium discounts.
– Note: Unit Statistical Plan definition may vary.
 Net Premium is used to refer to the premium actually charged – as
opposed to the manual premium or modified premium. Does not mean
net of reinsurance in this context.
 “Industry rate changes” sometimes refer to changes in bureau rates or
standard premium. During a soft market the “industry rate changes”
may be flat while actual prices are plummeting.
5
Terminology
Premium On-Level Factor
Net Premium On-Level Factor (AY) =
Standard Premium On-Level Factor (AY)
x Ratio of Net to Standard (Future)
/ by Ratio of Net to Standard (AY)
6
Exposure Rating
Exposure Rating
Discussion

Exposure rating is essentially a two-step process
– step 1: come up with a ground-up loss ratio or loss by state and hazard
group
– step 2: allocate ground-up expected losses by layer

Within a given state, the manual rates are grossed up to the same
permissible loss ratio—so the expected loss ratio (to manual premium) is
state-specific, not hazard group specific.

The percent allocation of loss by layer varies by HG, the more severe hazard
groups having the higher excess loss costs.

Rating bureaus provide excess loss factors that specify the percent of
ground-up loss in excess of a given percentage.
– NCCI (20K/year)
– WCIRBonline.org (California)
 LERs
– Other Independent Rating Bureaus
8
Exposure Rating
Useful Data Sources (NCCI)

Annual Statistical Bulletin
– Must have!

NCCI Calendar-Accident Year Underwriting Results (by State)
– Free download at NCCI.com
– Latest accident year now available is 2005
– Source of default loss ratios by state
 Need to adjust for subsequent rate level changes and trend

NCCI State Advisory Forum Presentations
– Free downloads at NCCI.com
– Great source of rate adequacy information
– “crucial information with workers compensation system stakeholders”

NCCI “Status of Rate Revision”
– $500/year
– Latest bureau rate level information for NCCI states
9
Exposure Rating
Discussion
 A key element of the excess percentage is the frequency of loss by
injury type. Fatalities and permanent disabilities cost more than other
injury types; so when they have high relative frequency, more of the
claims cost arises from large losses.
 Relative Frequency = claim count for the injury type divided by the
claim count for temporary total.
 Relative frequency for the more serious injury types should increase as
one moves from a lower hazard group to a higher hazard group.
– Fatal
– Permanent Total
– Major Permanent Partial
10
Exposure Rating
An ELF is a Weighted Average of the ELFs by Injury Type
Fatal
PT
Major
Minor
TT
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
$0
$100,000
$200,000
$300,000
$400,000
$500,000
$600,000
$700,000
$800,000
$900,000
$1,000,000
$1,100,000
$1,200,000
$1,300,000
$1,400,000
$1,500,000
11
Exposure Rating
Variation in Excess Loss Costs – Within and Between Hazard Groups
Sample State, $4m XS $1M
40
A
20
0
40
B
20
0
H
a
z
a
r
d
40
C
20
0
40
D
G
r
o
u
p
20
0
40
E
20
0
40
F
20
0
40
G
20
0
0. 02775
0. 03675
0. 04575
0. 05475
0. 06375
Layer
Loss
0. 07275
Co s t
0. 08175
0. 09075
0. 09975
0. 10875
( %)
12
Exposure Rating
Rating by Class Versus Rating by Hazard Group
 Hazard group approach accurate for most treaty business, since most
books are sufficiently diversified within hazard groups.
 Hazard group approach is probably not sufficiently refined for
facultative pricing or specialty books.
13
Exposure Rating
Use of Payroll in Exposure Rating
 Are ground-up loss ratio picks reasonable?
 Rates/Loss Costs for NCCI states are available in electronic format.
– Cost for non-affiliates is $22K/year
– Available (free) for many independent states on bureau web sites.
– Also available through SilverPlume
 Apply bureau loss cost rates to account’s payroll distribution by state
and class.
– Result should be consistent with loss ratio assumption.
– Bureau loss cost rates typically are not pure loss
– include allocated and unallocated loss adjustment expense and,
sometimes, loss-based assessments.
 Use of payroll weights as a proxy for expected loss weights in
exposure rating understates excess loss costs since the average
rate increases with hazard group.
14
Exposure Rating
Maximum Any One Live (MAOL)
 Overwhelming majority of serious workers compensation occurrences
involve a single claimant.
 Bureau statistical plans collect data on multi-claim occurrences
impacting the same policy. Do not pick up clash between different
policies that may be in the reinsurance treaty.
 Surprisingly little difference between bureau per claim and per
occurrence excess loss factors. Not intended to incorporate terrorism
or certain “non-ratable” exposures.
 Construction classes have higher incidence of multi-claim occurrences
(anecdotal).
 What fraction of the $5M XS $5M layer loss is eliminated by a $5M
MAOL?
15
Exposure Rating
Miscellaneous
 Coding of premium to “governing class” (the class with the most
payroll) may distort exposure rating.
– A single policy may have exposure in multiple classes.
– Should be manual or standard premium by state and class
 Excess Loss Factors are produced by rating bureaus for Retrospective
Rating, not reinsurance pricing.
– Non-ratable classes with catastrophic experience not assigned a
hazard group.
– Example: 0766 is non-ratable component of 4766 “EXPLOSIVES
OR AMMUNITION MFG.”
 Ratio of ALAE to loss should reflect company experience.
 California bureau (WCIRB.com) plan has nine hazard groups. A
mapping to four hazard groups is available; however, these are NOT
equivalent to NCCI hazard groups.
16
Experience Rating
Experience Rating
Excess Loss Reporting Patterns
 Key driver: company case reserving practices with respect to medical
inflation
– Do medical case reserves incorporate a medical inflation
assumption?
– Company discounting practice
 Does the company have a Catastrophic Claims Unit?
 Practice of settling fatal claims at present value reduces exposure in
excess layers.
 Fatal and pt claims close for less than the carried reserve even if
reserves are inadequate.
18
Experience Rating
Ratio of Undiscounted to Discounted Annuities
4.50
4.00
e(x)/a(x;3%)
3.50
3.00
2.50
e(x)/a(x;5%)
2.00
1.50
e(x)/a(x;5%)
1.00
0.50
0.00
17
22
27
32
37
42
47
52
57
19
Experience Rating
Excess Loss Reporting Patterns
 At the May 11, 2007 AIS Research Workshop, NCCI released a study
of excess loss and claim count reporting patterns based on Call 31.
 https://www.ncci.com/ncci/media/pdf/AIS_2007_Excess_Loss_Develop
ment.pdf
 https://www.ncci.com/ncci/media/pdf/AIS_2007_WC_Appendix.pdf
 Statutory excess of various attachment points.
 Can be used in combination with ELFs to derive development patterns
for limited layers:
Layer LDF =
(ELF@AP – ELF@(AP+L))
)
(ELF@AP/LDF@AP - ELF@(AP+L)/LDF@(AP+L)
 Easy to build a spreadsheet tool to derive patterns for any layer.
20
Experience Rating
Excess Loss Reporting Patterns


Consider a layer with attachment point AP and Limit L.
The reporting pattern for statutory XS AP is a weighted average of the patterns for :
1. L XS AP
2. Statutory XS (AP +L)

Question: What if the average report lag for Statutory XS (AP +L) is shorter than that
for L XS AP? (This seems to be the case in NCCI’s study.)

Answer: The average report lag for the layer L XS AP will be greater than that for
Statutory XS AP

Illustration (fictitious numbers): AP=2M, L=1M
– Statutory XS 2M
 Report lag =7 years
 ELF=7%
– Statutory XS 3M
 Report lag =6 years
 ELF=5%
– 1M XS 2M
 Report lag=(7% x7 – 5% x 6)/(7% - 5%) =9.5 years
 ELF=2%
–
21
Experience Rating
Speculation on Excess Development Patterns
 Perhaps, the loss potential of very large claims, the kinds of claims
likely to breach a $3M layer, is to some extent recognized early on.
– Characterized by catastrophic medical costs
 Other claims eventually –over a long period of time – creep their way
into excess layers.
– Not characterized by catastrophic medical costs or potential not
recognized
– Excess development driven in part by unwinding of the discount.
– Such claims would perhaps eventually make it to $1M, but not $3M.
 The report lag for the lower layer would be lengthened by these slow
developing claims – but not the higher layer.
 Unfortunately, development to a 22nd report not available below $2M.
22
Experience Rating
Large Loss Severity Trend
 Using ground-up severity trends as a proxy for “large loss” trend in
experience rating seemingly has an upward bias.
– NCCI estimates that differential frequency trend accounted for
perhaps 2%-3% of the trend in the average cost per case.
– For a discussion of this effect, see NCCI’s 2006 State of the Line
Report.
 In many states, indemnity benefits for PT and Fatal do not escalate.
– Should consider changes in the maximum weekly benefit over the
trend period.
 Is inflation on attendant care more like wage inflation than medical
inflation?
 Second Injury Funds
23
Experience Rating
Large Loss Severity Trend
Fatal
PT
PP
Temp. Total
Med. Only
All
AY 2005
Frequency Severity
320 200,000
1,200 800,000
55,000
80,000
150,000
20,000
730,000
1000
936,520
9,774
AY 2006
Frequency
Severity
312
210,000
1,170
840,000
53,625
84,000
142,500
21,000
693,500
1050
891,107
10,407
% Change
Frequency Severity
-2.50%
5.00%
-2.50%
5.00%
-2.50%
5.00%
-5.00%
5.00%
-5.00%
5.00%
-4.85%
6.47%
In the above illustration, ground-up trend of 6.47% overstates the “true” large loss
trend of 5%. The effect results from differential frequency trend by injury type.
NOTE: For illustration only, not based on real data.
24
Impact of Benefit Changes
on Shape of Size-of-Loss
Distribution
Impact of Law Amendment Factors
Ground-Up Versus Excess
 Law amendment factors are used to adjust historical losses to prospective
benefit levels. Since rating bureaus derive these factors to estimate the
impact on ground-up loss costs of a law change, we must be extremely
careful when we apply these factors – sometimes unknowingly --in pricing
excess business.
 For example, some law amendment factors reflect a shift of losses from one
injury "bucket" to another. For example, a law that restricts access to
permanent total benefits by tightening the definition of "permanent total" will
have the effect of shifting claims from the permanent total category to the less
generous major permanent partial category.
– The expected dollars of pt loss will decrease significantly as a result of
such a law change while the dollars of major permanent partial indemnity
loss will increase by some less-than-offsetting amount.
– Overall, there will be a decrease.
 It is appropriate to apply such law amendment factors to ground-up losses in
pricing proportional business but perhaps incorrect for non-proportional
business.
26
Impact of Law Amendment Factors
Ground-Up Versus Excess (Illustration)
 Before Law Change
– 100 pt cases with an average severity of $1,000,000.
– Of these, 20 were borderline pt cases with an average severity of
$400,000.
– The remaining 80 claims had an average severity of $1,150,000.
(1,000,000 = .2 x 400,000 + .8 x 1,150,000)
– 700 major permanent partial cases with an average severity of
$200,000.
 Effect of the Law Change
– Shifts the 20 borderline pt claims to major pp.
– The average severity for the 20 claims will be $300,000 under the
less generous pp benefits.
27
Impact of Law Amendment Factors
Ground-Up Versus Excess (Illustration)
 The number of pt claims drops 20%.
 The average severity for pt claims increases from $1,000,000 to
$1,150,000 (+15%).
 The dollars of PT loss decreases by 8%, from $100,000,000 to
$92,000,000.
 The number of major pp claims increases by 20 claims (about 2.9%).
 The average severity for major pp claims increases by 1.4% (to
$202,778)
 The dollars of major pp loss increase by $6,000,000.
 Overall, losses are decreased by $2,000,000 due to the law change.
 There may be no effect excess of $1,000,000.
28
Impact of Law Amendment Factors
Conclusion
 Reinsurers who best predict the differential impact of law changes by
layer will have a competitive advantage.
 Sources for Information on Law Amendment Factors
– Annual Statistical Bulletin (ASB)
– WCIRB has extensive information.
– Other rating bureaus
 GOOGLE
29
Questions