THE INCREDIBLE SHRINKING
RESIDUAL MARKET
Session: PL-39
Presented by:
Tom Daley, ACAS, MAAA, NCCI
John Winkleman, Jr., FCAS, AIPSO
Richard Amundson, FCAS, MN DOC
WORKERS
COMPENSATION
Presented By: Tom Daley
© 2000 National Council on Compensation Insurance, Inc.
OUTLINE
• Historical Perspective
• How did it get so large?
• Impact of a large residual market
• What caused the shrinkage?
• Ratemaking implications today
• How will we keep it from growing again?
© 2000 National Council on Compensation Insurance, Inc.
RESIDUAL MARKET ESTIMATED ULTIMATE PREMIUMS
AS OF 9/30/2000
6.0
4.80
5.0
4.39
4.09
3.96
4.0
Premium
3.0
($Billions)
3.49
2.60
3.08
2.84
2.11
1.96
2.0
1.00
2000
1998
0.33 0.27 0.30
1997
1996
1995
1994
1993
1992*
1991*
1990*
1989*
1988*
1987
1986
0.0
0.57
1999
1.0
Policy Year
®
*
Excludes Maine Residual Market Pool
© 2000 National Council on Compensation Insurance, Inc.
HOW DID IT GROW SO LARGE?
• Inadequate rates
• Overly generous benefits
• Lack of cost containment
• Poor underwriting results
© 2000 National Council on Compensation Insurance, Inc.
RESIDUAL MARKET UNDERWRITING GAIN/LOSS
AS OF 9/30/2000
23
0.0
-21
-40
-45
1999
126
1998
103
1997
500.0
-139
-500.0
Underwriting
Gain\Loss -1000.0
($Millions)
-558
-1140
-1500.0 -1354
-1596
-2000.0
Policy Year
* Excluding Maine
** Excluding Maine and New Mexico
# Excluding New Mexico
1996
1995
1994
1993#
1992**
1991**
1990**
1989*
1988*
1987
1986
-2500.0
-1760 -1848
-2018
®
© 2000 National Council on Compensation Insurance, Inc.
IMPACT OF A LARGE RESIDUAL MARKET
• Carriers stop writing WC
• AR plans grow larger and larger
• Rates increase (both markets)
• Employers costs rise
• Movement towards self-insurance
© 2000 National Council on Compensation Insurance, Inc.
WHAT CAUSED THE SHRINKAGE?
• Reform at all levels of stakeholder
• Residual Market pricing programs
• New state funds
• Increased competition/capacity
© 2000 National Council on Compensation Insurance, Inc.
NCCI RATEMAKING IN TODAY’S
ASSIGNED RISK MARKET
The NCCI approach for overall indication:
1.
Use total market data (most states)
2. Use AR data to establish differential
over voluntary market
© 2000 National Council on Compensation Insurance, Inc.
RESIDUAL MARKET COMBINED RATIOS
AS OF 9/30/2000
190
170 164 168 165
158
Combined Ratio 150
(%)
141
127
126
112
104
2000
98
117
1999
94
1995
1994
1993
1992*
1991*
1990*
1989*
1988*
1987
90
1986
97
1997
104
1996
110
112
1998
130
Policy Year
®
* Excludes Maine Residual Market Pool
© 2000 National Council on Compensation Insurance, Inc.
Residual Market Policy Size
Large (PY93) Vs. Small (PY2000)
All NCCI States
Premium Range
$0 - $2,499
$2,500 -$4,999
$5,000 - $9,999
$10,000 - $49,999
$50,000 - $99,999
$100,000 - $499,999
$500,000 and over
Total
PY 93
Policy Count
% of
Total
PY 2000
Policy Count
% of
Total
271,768
56,229
36,491
36,697
5,558
3,536
66.2%
13.7%
8.9%
8.9%
1.4%
0.9%
75,684
8,161
4,238
3,611
398
230
82.0%
8.8%
4.6%
4.0%
0.4%
0.3%
163
0.0%
6
>.01%
410,442
100.0%
92,330
100%
NCCI ASSIGNED RISK RATEMAKING
Biggest challenges facing NCCI:
• Volatility of assigned risk data due to low volume
• Increasing expense provisions as % of
premium
• Maintaining Servicing Carrier capacity
• Affordability vs. subsidies (break-even
pricing)
© 2000 National Council on Compensation Insurance, Inc.
HOW DOES ONE KEEP RESIDUAL
MARKETS SMALL?
• Strive for rate adequacy
• Retain pricing programs in AR market
• Help prevent erosion to reforms
• Maintain a target goal of underwriting loss
to voluntary premium ratio <1.0%
• Examine alternative Residual Market Structures
© 2000 National Council on Compensation Insurance, Inc.
PRIVATE PASSENGER
RATEMAKING
ASSIGNED RISK
John Winkleman, Jr.
AIPSO
RATEMAKING METHODOLOGY
BASED ON SIZE OF PREMIUM
 TOTAL PREMIUM < $1.0M

BASED ON COMPARISON TO NONSTD MARKET
 TOTAL PREMIUM > $1.0M

BASED ON PROSPECTIVE RATING
12 Months Ending
12
/00
12
/99
12
/98
12
/97
12
/96
12
/95
12
/94
12
/93
12
/92
12
/91
12
/90
12
/89
12
/88
12
/87
12
/86
12
/85
12
/84
12
/83
12
/82
12 Months Assigneds
Thousands
New York
PPNF Liability
1200
1000
800
600
400
200
0
12 Months Assigneds
Millions
Countrywide
PPNF Liability
4
3
2
1
0
/82
12
/83
12
/84
12
/85
12
/86
12
/87
12
/88
12
/89
12
/90
12
/91
12
/92
12
12 Months Ending
/93
12
/94
12
/95
12
/96
12
/97
12
/98
12
/99
12
/00
12
12 Months Ending
12
/0
0
12
/9
9
12
/9
8
12
/9
7
12
/9
6
12
/9
5
12
/9
4
12
/9
3
12
/9
2
12
/9
1
12
/9
0
12
/8
9
12
/8
8
12
/8
7
12
/8
6
12
/8
5
12
/8
4
12
/8
3
12
/8
2
12 Months Assigneds
Thousands
Countrywide
OTPP Liability
400
300
200
100
0
Residual Market Pricing
Richard Amundson, FCAS
Actuarial Director
MN Department of Commerce
A Model of Residual Market Pricing Some
assumptions
• Assigned Risk Plan (ARP) sets prices to break even based
on its own experience.
• ARP’s profit or loss is allocated to the voluntary market.
• Insurance is mandatory; 2 choices: voluntary or ARP.
• An insured buys from market with lowest price.
• Expenses are proportional to loss and will be ignored.
An Instructive Example
• Insurer needs $100 surplus for $200 yr-end loss.
• Insurer earns 5% risk-free on invested assets.
• Insurer needs a 15% return on equity.
Extreme case 1: ARP has 0 percent market share.
• Insurer collects $200 in premium, invests it & the $100 of surplus.
• Insurer earns $15 during the year.
• Year-end: insurer pays $200, has $100 plus $15 from investments.
Extreme case 2: ARP has 100% market share.
• Insurer has no voluntary premium, but retains responsibility for
ARP’s losses.
• Insurer still needs $100 of surplus: all the risk is still around and the
insurer still bears it all.
• Insurer has same risk as in case 1, same investment as in case 1, so
needs same return. ARP must charge full $200 in order to generate
same return.
Regardless of ARP market share, insurer needs the full $100
surplus and the full $200 prem.
FIGURE 1
MARKET RATES IN EQUILIBRIUM
PREMIUM
y
y=x
R
y = ax
x EXPECTED
R’ R
R = ARP price
ax = voluntary market price
LOSS
The Elusive Search For Equilibrium
What happens when ARP reviews rates?
• ARP overcharged insureds with expected losses between R’ and R and
undercharged insureds with expected losses > R. Net effect is
undercharge, but analysis will not necessarily indicate rate increase.
• ARP doesn’t include profit in its analysis. ARP may charge enough to
pay claims: analysis on non-profit basis may show need for rate
reduction. Whether analysis will show need for increase or decrease is
function of distribution of expected losses.
• Only sure way to remain in equilibrium is to ignore indications.
Figure 2
Market Rates With ARP Pricing To Break Even
PREMIUM
y
y=x
29.19
28.18
27.62
y = 27.62
y = ax
x EXPECTED
28 29
27.62 = ARP price
ax = voluntary market price
LOSS
How To Set ARP Rates
If consensus is in favor of keeping and controlling
residual market, break-even pricing is poor tool.
Assuming that ARP will exist, that it should not be too
burdensome on voluntary market and that it should not
have wild swings in market share, then there is a
reasonable solution to rate problem:
Base ARP rates on industrywide experience,
consistently higher than what a typical insurer
would need to charge in voluntary market.
Setting Specific Goals
Guidelines:
Bigger the voluntary market the better.
Residual market should not be unaffordable.
Expected assessment of residual mkt losses
on voluntary mkt insureds not excessive.
Rate changes should not be abrupt.
Example of Specific Goals
Possible goals for residual market:




Market share under 1%.
Rates under 150% of voluntary.
Expected assessment under 0.5%.
Annual rate changes < 10% (relative to voluntary
market) during catch-up period.
Using Goals To Set Prices
Residual market can set prices as multiple of voluntary
market and measure success directly from goals.
Should ARP move away from break-even
pricing even if already running smoothly?
Yes, to prevent future problems from arising.
The best time to repair the roof is when it isn’t
raining.
Market-based pricing gives ARP a built-in
stabilizer, a governor to keep the system from
breaking down.
If you don’t think the system can
break down:
Remember the Maine
If you don’t think the system can
break down:
State of
Remember theMaine
Recap: one last look at ARP’s burden
If you take one idea home with you, let it be this:
The burden that ARP puts on the voluntary
market is not simply ARP’s bottom-line losses.
The burden is reduced return on surplus, even if
ARP’s return is positive.
Recap: one last look at ARP’s burden
An Illustration
Put yourself in the shoes of the voluntary market where
you have $1 million each of premium and surplus,
and ARP has $500 million of premium & no surplus.
If ARP expects a bottom-line gain of 1% of premium,
would you like the right to the gain if it also obligates
you to pay in case of a loss?
If you say yes, I have some advice for you on behalf of
Governor Ventura and the Minnesota guaranty fund:
Stay out of Minnesota!