October 6, 2010
Christopher A. Citko, Esq.
Senior Staff Counsel
California Department of Insurance
Government Law Bureau
45 Fremont Street, 23rd Floor
San Francisco, CA 94105
RE: California Workers’ Compensation Insurance Pure Premium Rates and
Claims Cost Benchmark Effective January 1, 2011
Dear Mr. Citko:
The purpose of this letter is to comment on the California Workers’ Compensation
Insurance Rating Bureau (WCIRB) pure premium rate and claims cost benchmark
filing for policies effective January 1, 2011 through December 31, 2011 (the Filing). I
am a member of the WCIRB Actuarial Committee representing the Public Members
of the Governing Committee.
I believe that the rates recommended by the WCIRB are at the high end of the range
of what is reasonable. The following table outlines a range of justifiable rate
changes. Each of the major components of the rates is included.
Table 1: Range of Pure Premium Rate Indications
WCIRB1
Recommended
Loss to Pure Premium
Indemnity
0.324
Medical
0.731
Total
1.055
Loss Adj. Expense/Loss
ULAE
9.3%
ALAE
11.7%
Total
21.0%
Legal
0.0%
2
Total Rate Change
27.7%
1
2
Low
High
0.978
0.997
1.055
19.7%
0.0%
17.1%
19.7%
0.0%
19.3%
21.0%
4.1%
32.9%
WCIRB 1/1/11 Rate Filing, Page B-41
Rate Change = (Total Loss to Pure Premium) x (1 + Total Loss Adj. Expense/Loss) - 1
1
Range
Middle
Regarding the “middle range” projections, the difference between the WCIRB and
BRS projections are due to differences in assumptions regarding adjustments for
closing rates, trend factors, and loss adjustment expense.
The following is a description of the assumptions used to develop the range of
indications in the preceding table.
1. Ultimate Medical & Indemnity Losses AY 2009 & Prior: The Filing uses these
estimates as a basis for projecting PY 2011 rates. Consistent with prior filings,
the WCIRB has estimated the ultimate costs using the paid loss development
method. The development factors are adjusted for the reforms. For the first time
the WCIRB selections adjust for changes in the closing rate and insurer mix. The
general method used to make the adjustment is commonly referred to as
“Berquist-Sherman”.
While the rate at which claims are closing has been decreasing over the past few
years, we are not convinced that the Berquist-Sherman method adjustment is
warranted at this time for several reasons:
a. Track Record: This adjustment has little track record, so we don’t know
how accurate or stable it is over time. None of the prior rate filings or
actuarial committee meeting agendas include projections utilizing the
particular method recommended by the WCIRB in this filing.
b. Stability: The little history that we do have regarding the Berquist Sherman
adjustment suggests that the adjusted results are only marginally more
stable than the unadjusted results.
c. Black Box: Key portions of the adjustment are a “black box”, so the
accuracy of the calculations cannot be verified by the actuarial committee
or by an independent actuary. Specifically, the adjustment for the change
in insurer mix is not detailed, probably because that would require
divulging information that is traceable to specific insurers. As a result the
accuracy of this adjustment must be accepted on faith by the public and
even by the WCIRB actuarial and governing committee members.
d. Data Quality: Key data included in the calculation – such as closed claim
counts – is of lower quality than that of payments and case reserves. This
is evident in the closed claim data correction which occurred between data
valued as of 3/31/10 and 6/30/10. This correction caused a 5-10 point
increase in the indication based on the method which was the basis for the
original WCIRB recommendation regarding 1/1/11 rates. While we hope
that the revised data is correct, this highlights that the closed claim data is
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less reliable than payments and case reserves. In addition, it is likely that
different insurers have different practices regarding when a claim is
considered to be closed.
Aside from changing closing rates, there are two indicators that the BerquistSherman method should be utilized: first, the unadjusted estimates should
substantially change over time, and second, the Berquist-Sherman estimates
should be more stable than the unadjusted estimates. Neither of these conditions
has been met over the past year.
One of the assumptions of the Berquist-Sherman method is that decreasing
closing rates should cause the unadjusted ultimate paid loss projections to be too
low. Therefore the unadjusted ultimate paid loss projections should increase over
time, as actual experience replaces the projected experience. The following chart
shows that the unadjusted paid ultimate loss projections for the years 2005 –
2008 have not increased substantially between the data valued as of 3/31/09 and
3/31/10.
Chart 1: Ultimate Paid Loss Ratio – 3/09 vs. 3/10 Valuations
Medical and Indemnity Combined
0.800
0.688
0.700
0.600
0.551
0.690
0.553
0.500
0.402
0.400
0.304
0.399
0.301
0.300
0.200
0.100
2005
2006
2007
Accident Year
3/31/2009
3/31/2010
3
2008
In addition, if the Berquist-Sherman adjustment is warranted, then the ultimate
loss projections reflecting the Berquist Sherman adjustment should be more
stable than the unadjusted paid development projections. In an environment in
which closing rates are decreasing, the Berquist-Sherman projections should be
unbiased, while the unadjusted projections should increase over time. The
following chart shows that between 3/31/10 and 6/30/10 the indications increased
for the paid methods that were not adjusted for changes in closing rates as well
as for those that were adjusted. This raises questions regarding the
appropriateness of the Berquist Sherman closing rate adjustment in this case.
Chart 2: % Change in Ultimate Paid Loss Ratio 3/31/10 to 6/30/10
Berquist-Sherman vs. Unadjusted
Medical and Indemnity Combined
2.5%
2.0%
2.0%
1.8%
1.5%
Unadjusted*
1.0%
0.7%
0.5%
Berquist-Sherman**
0.3%
0.0%
2008
2009
Accident Year
* Paid development method utilized to support WCIRB 1/1/10 recommendation
** Method utilized to support current WCIRB 1/1/11 recommendation
Since it is not clear that the projections adjusted for Berquist-Sherman are
superior to the unadjusted projections, our middle estimates are based on a
50%/50% weighting of these two sets of projections.
2. Claims Severity: Projected ultimate medical and indemnity severity per indemnity
claim has been decreasing rapidly over the past few accident years. As a result
our projections regarding claim severity are lower than those of the WCIRB. Our
middle projection is based on 75% weight given to long-term average severity
increases and 25% weight given to more recent years.
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Chart 3: On-Level Medical Severity
Annual % Change
Only Includes Indemnity Claims
16.0%
14.7%
13.7%
14.0%
12.5% Avg. 2005-09=11.2%
12.0%
10.0%
WCIRB Selected = 9.0%
8.0%
BRS Selected = 8.2%
6.0%
3.9%
4.0%
Avg. 1991-2003=7.2%
2.0%
0.0%
2006
2007
2008
2009
Accident Year
WCIRB 1/1/11 Rate Filing page B-36
5
2010
2011
Chart 4: On-Level Indemnity Severity
Annual % Change
Only Includes Indemnity Claims
12.0%
10.4%
Avg. 2005-09=5.2%
10.0%
8.0%
6.0%
WCIRB Selected = 6.0%
5.8%
5.6%
BRS Selected = 3.3%
4.0%
2.0%
-1.2%
0.0%
2006
-2.0%
2007
2008
2009
Avg. 1991-2003=2.7%
2010
2011
Accident Year
WCIRB 1/1/11 Rate Filing page B-35
3. Loss Adjustment Expense: Our LAE projections are similar to those of the
WICRB except that ours exclude the experience of the State Compensation
Insurance Fund.
4. Legal Decisions: There is a substantial amount of uncertainty related to the
impact of the Almaraz/Guzman and Ogilvie cases on workers’ compensation
costs. For the middle scenario we agree with the WCIRB decision not to make a
specific adjustment for these cases, assuming that their impact is already
included in the loss data.
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Other Comments
In addition to providing an analysis of the proposed WCIRB 1/1/11 claims cost
benchmark, the following are comments related to the WCIRB or California workers’
compensation in general which we believe are important to consider.
1. Potential Areas to Affect Costs: In November 2009 the Commission on Health
and Safety and Workers’ Compensation (CHSWC) released estimates of cost
impacts related to changes in the workers’ compensation system. The major
issues as well as the percentage rate impact are outlined below. This indicates
that there are areas in the workers’ compensation system that could lead to
significant changes in rates.
Table 2: Potential Rate Impact
Issue
Rate Impact
Low
High
Savings
Clarification of PDRS Intent
Lien Proposal
Elimination of Tiered PD Benefit
Repeal of Supplemental Job Displacement Benefit
Elimination of Duplicate Payment for Spinal Implants
Setting Ambulatory Surgical Center Fees at 120% of
Medicare ASC Fees
Elimination of Return to Work Program LC 139.48
Subtotal excluding Clarification of PDRS Intent
Total Savings
Increase in PD Benefits
1.7%
0.7%
1.3%
0.6%
0.4%
5.8%
1.1%
1.3%
0.6%
0.7%
0.7%
0.0%
3.6%
0.7%
0.0%
4.4%
5.4%
10.5%
??
??
Source: CHSWC Staff Estimates for Labor & Employer Discussions, 11/4/09
2. Response of the Market to Historical Rate Increase Recommendations: For the
past few years the Commissioner has denied rate increases recommended by
the WCIRB. The following table compares the WCIRB recommended and CDI
approved benchmark rate changes:
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Table 3:
CA WC Recommended and CDI Approved Pure Premium Rate Changes
Date
WCIRB
CDI
Recommended
Approved
1/1/08
5.2%
0.0%
1/1/09
16.0%
5.0%
7/1/09
23.7%
0.0%
1/1/10
22.8%
0.0%
1/1/11
27.7%
??
Data Source: CHSWC 2009 Annual Report, page 175
Given this record of having recommended rate increases disapproved, one would
expect any of a variety of responses from the insurance market. First, one would
expect the spread between insurance company and CDI rates to increase. This
however, has not occurred through 2009. The following table shows the ratio of
insurer rates divided by CDI approved benchmark rates. The ratio is
understandably greater than 1.0, because insurer rates reflect brokerage,
acquisition, and other costs that are not reflected in the CDI benchmark pure
premium. It is important to note, however, that the ratio has not increased over
the past several years, and in fact it decreased between 2007 and 2009. In other
words, the spread between insurer and CDI rates decreased even as WCIRB
recommendations implied that CDI rates were becoming increasingly inadequate.
Table 4: CA WC Ratio of Insurer to CDI Pure Premium Rates
Accident
Ratio of Insurer
Change
Year
to CDI Pure
Premium Rates1
2004
1.396
2005
1.468
5.2%
2006
1.447
-1.4%
2007
1.493
3.2%
2008
1.434
-4.0%
2009
1.354
-5.6%
Data Source: WCIRB 1/1/11 Rate Filing page B-33
1
Insurer rates reflect all rating plan adjustments except deductible credits, retrospective rating plan adjustments, and
policyholder dividends
Given that the insurance industry rates did not increase even though substantial
rate increases were recommended and not approved, one would expect the
insurance industry financial results to be unfavorable and for insurance
companies to flee California. However, neither of these events occurred.
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The following table shows that the California workers’ compensation market was
reasonably profitable for the years 2007 and 2008. An underwriting ratio of 1.054
indicates that insurers expect to pay out $1.054 for every $1.00 they take in.
However, it is likely that the additional $0.054 in expense is expected to be offset
through investment income.
Table 5: CA WC Underwriting Ratios
Accident
Loss
LAE
Other
1
2
Year
Ratio
Ratio
Expense3
2007
0.581
0.15
0.184
2008
0.670
0.18
0.204
2009
0.700
0.22
0.219
1
2
3
Underwriting Ratio
0.915
1.054
1.139
Based on insurer estimates, WCIRB 1/1/11 Rate Filing page B-9
WCIRB Summary of 3/31/10 Insurer Experience, Exhibit 5
Sum of Commissions, brokerage, other acquisition expense, general expense, and premium & other taxes
WCIRB Report on 2009 California Workers’ Compensation Losses & Expenses, page 31
While it appears that the industry was not profitable in 2009, the deterioration is
mostly due to the insurers charging a lower multiple of the approved CDI Claims
Cost Benchmark as opposed to an underlying deterioration in the adequacy of
the Benchmark. Table 4 shows that in 2009 insurers reduced rates by 5.6% in
relation to the CDI Claims Cost Benchmark, and that accounts for the bulk of the
8% increase in the industry underwriting ratio between 2008 and 2009.
Aside from profitability, another potential financial concern regarding the
insurance industry is understatement of liabilities. However, it appears that it is
more likely that the industry has overstated rather than understated liabilities.
Every quarter insurance companies provide the WCIRB with updated loss,
payroll, and premium information. Included in this information are projected
ultimate losses on a direct basis. One way to measure insurance company
reserve adequacy is to compare the ultimate loss projections aggregated for all
insurers to those estimated by the WCIRB. The following table shows that for the
past 4 years insurance company liability projections have been consistently
higher than those of the WCIRB.
Table 6: CA WC Insurance Company Reserve Adequacy
($Billions)
Evaluation
Insurer minus WCIRB Estimated
Year
Ultimate Losses (aggregated)
2006
5.0
2007
6.7
2008
5.4
2009
5.3
Source: WCIRB Summary of 3/31/10 Insurer Experience, Exhibit 9.1
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It should be noted that the comparison of insurer and WCIRB ultimate costs are
on a direct basis. Net insurance company ultimate losses are affected by
deductibles, reinsurance, and other issues. Nevertheless, the preceding figures
should be a good indication of overall reserve adequacy.
Lastly, it also appears that plenty of companies have wanted to write workers’
compensation insurance in California in the past few years. The following table
shows that the State’s workers’ compensation insurance market became more
diversified between 2006 and 2009.
Table 7: CA WC % of Statewide Written Premium
Year
Top
Top 5
Top 10
Insurer
Insurers
Insurers
2006
32%
61%
77%
2007
27%
55%
72%
2008
23%
51%
70%
2009
19%
47%
65%
Source: CDI Market Share Reports, insurers are aggregated by group
3. Unallocated Loss Adjustment Expense (ULAE): We continue to believe that the
WCIRB rate indications and CDI approved rates should no longer include ULAE.
ULAE factors are not needed in order to promote competition. In addition, the
substantial variability of ULAE factors between companies – which has lately
reached extreme proportions – suggests that there really is no appropriate
statewide ULAE factor.
Thank you for your consideration of the issues outlined in this document. We will be
testifying at the rate hearing on October 12, 2010 and will be available to discuss
these issues in further detail at that time.
Respectfully Submitted,
BICKMORE RISK SERVICES
Mark Priven, Principal
Fellow, Casualty Actuarial Society
Member, American Academy of Actuaries
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