CARe Reinsurance Boot
Camp on Pricing Techniques
Workers Compensation
Robert S. Yenke, ACAS
August 9, 2007
The views and opinions expressed
in this presentation are solely my
own, and do not necessarily reflect
the views or opinions of Odyssey
America Reinsurance Corporation.
2
Outline
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Workers Compensation Background
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Quota Share Treaties
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Excess of Loss Treaties
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Catastrophe Treaties
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Facultative
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Workers Compensation
Background
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Started in U.S. in early 1900’s, before Social Security,
before Federal Income Tax Withholding
Benefits were low
Early 1970’s National Commission of State Workers
Compensation Laws
Frequency declines, severity increases
4
Workers Compensation
Background
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Independent Bureau states: California,
Delaware, Indiana, Massachusetts, Michigan,
Minnesota, New Jersey, New York, North
Carolina, Pennsylvania, Texas, Wisconsin
Monopolistic state Funds: North Dakota, Ohio,
Washington, West Virginia, Wyoming
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Workers Compensation
Background
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Extremely long tail
Annuity-type benefits for Survivors and
Permanent Total claims
Benefits defined by state law, not by courts
 Indemnity and Medical benefits
 Benefits, to some degree, vary by state
No policy limits
 Essentially unlimited medical coverage
No-Fault system
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Quota Share Treaties
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Does the treaty cover losses up to a dollar
amount, such as the first million, or the
ceding company’s Net?
If Net, what happens if the ceding company
does not renew its Excess of Loss treaties?
What if there is a loss above the top of the
ceding company’s reinsurance?
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Quota Share Treaties
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Quota Share up to a dollar limit - What is the
cost of Excess of Loss reinsurance treaties?
Compare Premium Net of Reinsurance Cost to
Expected Losses at dollar limit
Keep Actuaries Honest
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Quota Share Treaties
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Is the ceding company writing Retrospectively Rated
policies? If so, how are premium adjustments
accounted for.
Benefit level changes for states in analysis need to be
included in estimate of projected loss ratio
Use state specific trends if ceding company is
predominately in only one or a small number of states
In addition to filed rate changes, need to obtain impact
of Schedule Rating, Group Discounts, etc.
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Quota Share Treaties
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Standard Quota Share Treaty issues including: Ceding
commission versus actual expenses, Impact of Sliding
Scale Commission or Profit Commission
What is considered ALAE vs. ULAE?
What is included in definition of Subject Premium,
e.g. Expense Constant?
For smaller companies and start-up operations you
can obtain state specific loss and ALAE ratios from
bureaus – usually a little old
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Quota Share Treaties

Quota Share of Excess WC Insurance

Who is handling the ground-up claims?

Reinsurer is relying on Excess Insurer to audit
original claims adjustors. There could be
many different entities handling the claims –
scary!
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Excess of Loss Treaties
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Typical layers of $4M xs $1M, $3M xs $2M
Working layers of $750K xs $250K, $500K xs $500K are
less common than they used to be
Occasionally there are requests for lower layers, but in
most cases the primary company decides to keep the
layer Net
Some layers are unusual, such as $6M xs $1M, or
$8.75M xs $1.25M
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Excess of Loss Treaties
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Many treaties have free and unlimited reinstatements
Some treaties have a limited number of free
reinstatements, often expressed as a maximum
aggregate recoverable e.g. $4M xs $1M with four
reinstatements = $20M aggregate cap

Usually the aggregate cap is set high, so there is a low
a probability that it will be exceeded, still nice to have

Some treaties have Annual Aggregate Deductibles
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Excess of Loss Treaties
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Most treaties are flat rated
Some treaties have adjustable features such as Swing
Rating, Profit Commissions or Reinstatement
Premiums
The long loss reporting patterns make the number of
potential premium or commission adjustments very
large
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Excess of Loss Treaties
Claims
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WC Injury Types
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Death
Permanent Total
Major Permanent Partial
Minor Permanent Partial
Temporary Total
Medical Only
Only the first three impact most Excess of Loss Treaties
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Excess of Loss Treaties
Claims
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Some claims are recognized quickly as high cost, e.g.
multiple person catastrophes
Many claims are take years and years to develop into
excess layer
Injured Worker Mortality – how different from
standard population mortality?
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Excess of Loss Treaties
Claims

Workers have lower Mortality than general population

Injured Workers identified as Permanently Disabled
have similar Mortality as population
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Sometimes severely injured workers die before being
classified as Permanently Disabled
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Medical care for WC injury may help early diagnoses of
other issues
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Claims can develop adversely years later
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Family stops taking care of claimant
Back injuries “creep” into the layer
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Excess of Loss Treaties
Loss Development
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Discounting of case reserves is standard
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Explicit: indemnity reserves on lifetime pension cases
discounted: 3.5% interest rate common
Implicit: medical – by not inflating projected future payments
Mortality assumptions used in setting reserves; Bureau
tables are used for Statistical Reporting, some
companies have mortality tables that vary with injury
severity.
Effect of unwinding of discount can be much larger on
an excess layer than the retained layer
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Excess of Loss Treaties
Loss Development

Long payment pattern, explicit discounting of
indemnity reserves, implicit discounting of medical
reserves produces large Excess LDF’s

Account specific LDF’s often have few claims, therefore
LDF’s are volatile for higher layers

RAA gathers data from reinsures every other year and
publishes LDF’s by line of business
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In the 2005 study, WC Treaty data included Accident
Years from 2004 back to 1958, 46 years!
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Excess of Loss Treaties
Loss Development
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My analysis produced a Treaty WC Incurred LDF from
12 months to ultimate of 11. Therefore, less than 10%
reported after one year
Gross Incurred LDF from 12 months to ultimate is 1.9
Treaty WC LDF from 156 months to ultimate LDF is 2.
Therefore, after 13 years, only 50% of ultimate losses
have been reported, the same as Gross LDF at 1 year!
The Incurred LDF from 45 to 46 is 1.01, there is still
IBNR at 45 years!
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Excess of Loss Treaties
Loss Development
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2005 RAA Study included Paid Loss Development data
My analysis of Treaty WC Paid LDF’s produced a 12
month to ultimate of 190; approximately 0.5% is paid at
12 months. The Gross LDF is 4.5
The Paid LDF to Ultimate reaches 2 at 22 years, i.e. 50%
paid at 22 years, the Gross LDF is 2 at 2 years
The Paid to Case Incurred Ratio at 46 years is 96% there are still open cases
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Excess of Loss Treaties
Impact on Reinsurer
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An injured worker is expected to live 10 years.
Weekly indemnity benefits are 500/wk = 26,000/yr
Expected indemnity benefit = 260,000
Discounted value at 3.5% interest = 220,000
Initial stabilizing medical expenses are 150,000
Annual medical expenses are 50,000/yr
Expected medical benefit = 650,000
Undiscounted case reserve = 260K + 650K = 910K
Discounted case reserve = 220K+ 650K = 870K
Expected loss to the 1M xs 1M reinsurer is zero.
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Excess of Loss Treaties
Implicit Discount Effect

Assume medical expenses are inflating at 6% per
year

Primary company books the ongoing medical loss at 500K,
implicitly discounting them at 6%/yr.

Total undiscounted ongoing medical expenses are really 680K
instead of the booked 500K

The total undiscounted loss is 260K + 150K 680K = 1,090K and
the 1M xs 1M reinsurer will see 90K of loss development

If the injured worker’s life expectancy is 20, 30, 40 or more
years, the impact is much larger
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Excess of Loss Treaties
Mortality Assumption Effect

Instead of a certain 10 year survival, there was a
50% probability of this worker living only 5 years and
50% of living 15 years.
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Losses paid if the claimant lives 5 years = 530K =
150K + (26K+50K) * 5
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Losses paid if the claimant lives 15 years = 1,290K
= 150K+(26K+50K) * 15
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There is a 50% probability, the 1M xs 1M reinsurer
will see no loss development and 50% probability the
reinsurers will see 290K of loss development
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Excess of Loss Treaties
Trend
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The long tail and unlimited medical benefits add to
the difficulty in estimating trends for Workers
Compensation.
In addition, states can – and do – change the WC
benefits, adding to the uncertainty.
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Excess of Loss Treaties
Impact of Non-uniform Frequency Trend
on Excess of Loss Pricing
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Exposure Rating
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Shape of the distribution changes, with more of the losses
coming from larger claims
Experience Rating
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Measured ground-up severity trend will increase from the
reduced frequency of the smaller claims
Assuming uniform trend by size of loss, the measured large
loss trend will be lower than the measured ground-up trend
This impact is mitigated by the less-negative frequency trend
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Excess of Loss Treaties
Trend Example
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Two types of claims, small and large.
In year 1, small claims have average severity of
100K, while large claims have average severity of
500K.
In year 1, there are an equal number of small and
large claims, say 50 of each claim
Total Losses are 30,000,000
Average Severity in year 1 is 300K
= (50*100k + 50*500k)/(50+50)
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Excess of Loss Treaties
Trend Example, continued
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In year 2, there are now 40 small claims (frequency trend =
-20%), while there are still 50 large claims (0% frequency
trend). Total frequency trend = -10%
The average severity for each claim type increases 10%
 Small claim severity = 110K
 Large Claim Severity = 550K
Total losses are not 31,900,000 an increase of 6%
But, the measured overall severity is now 354K
= (40*110K + 50*550K)/(40+50)
This is an 18% increase!
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Excess of Loss Treaties
Benefit Changes
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Most benefit changes are small, increase in maximum
weekly benefit, change in burial allowance, etc.
Large changes occur rarely, but sometimes in quick
succession – impact by injury type can be vary
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California AB 749 January 1, 2003 PT Benefit Impact +54%,
Overall Impact +5%
California AB 227, SB 228 January 1, 2004, Overall Impact 9%
California SB 899 April 19, 2004 Overall Impact -20%,
January 1, 2005 Overall Impact -14%
California January 1, 2006 Fatal Benefit Impact + 50%,
Overall Impact +3%
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Excess of Loss Treaties
Experience Rating
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Paid losses projections are not usable
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Size of incurred LDF’s gives projections low credibility
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Presence or absence of large loss in a recent period
produces large impact on projected losses to layer if
LDF method is used
B-F method, using Cape Cod method to estimate
initial loss cost
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Excess of Loss Treaties
Experience Rating
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Higher layers may have no reported losses to
develop.
I do not want to compare a zero from experience
rating to the loss cost obtained from exposure rating.
Use ratio of exposure rating loss cost of higher layer
to credible layer to apply to experience rating loss
cost of credible layer
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Excess of Loss Treaties
Exposure Rating
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Workers Compensation is similar to other
lines
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Compute overall expected losses
Allocate these losses to the layer being priced by
an industry size-of-loss curve
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Excess of Loss Treaties
Exposure Rating
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For lines with policy limits, like GL, the rating bureaus
publish ILFs, which are based on size-of-loss curves
But, WC doesn’t have policy limits.
Reinsurers use Retrospective Rating’s Excess Loss
Factors (ELF’s), even though they were not designed
for reinsurance
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Excess of Loss Treaties
Exposure Rating
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Excess Loss Factors tables are published by state,
typically for loss limits up to $10M, by Hazard Group
Variations by state are due to differences in benefit
levels
Variations by Hazard Group are due to differences in
the distribution of injury types by Hazard Group
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Excess of Loss Treaties
Exposure Rating
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2004 ELF changes
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More reliance on state data
Use empirical data for small claims, fit distribution for tail
Distributions fit for Fatal, Permanent Total, Permanent
Partial, Temporary Total and Medical Only
Comparison to Prior ELF’s
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Percent of total losses in low layers, less than $1M similar to
prior factors, some states increased, some decreased
Percent of total losses in layers above $1M dropped
significantly in almost every state
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Excess of Loss Treaties
Exposure Rating

Comparison to Prior ELF’s
 Refitting current data using prior procedure
produced ELF’s much closer to new procedure
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Conclusion – data, not procedural change, drove
most of the reduction in percent of losses in high
layers
Decline in claim frequency in 1990’s changed the
shape of the loss distributions
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Excess of Loss Treaties
Exposure Rating
How Many Hazard Groups?
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NCCI and the other bureaus used four Hazard Groups, however,
95% of the premium was in Hazard Group II or III. Mining,
explosive manufacturing, longshore, in HG IV. Much HG IV was in
Assigned Risk Pools, so business written Voluntarily included very
little HG IV business – excluded from many treaties – except for
“incidental”.
WCIRB adopted nine Hazard Groups A-I, which were subsequently
updated to J-R. A four Hazard Group set of LER’s was produced –
but class assignments did not match NCCI groupings.
NCCI did there own study and selected seven.
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Excess of Loss Treaties
Exposure Rating
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Seven Hazard Groups are A through G, collapsible
into four (1, 2, 3 and 4) A&B into 1, C&D into 2,
E&F into 3, G into 4
Premium by Hazard Group is much more evenly
split – Hazard Groups have really increased from 2
to 7
Improves estimates of losses by layer for
reinsurers and for primary companies, for example
Loss Rated Accounts
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Excess of Loss Treaties
Exposure Rating
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Suppose we’re pricing the $1M xs $1M layer
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Expected Loss Ratio = 70%
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ELF(1M) = 0.10;
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Losses in the layer = ELF(1M) – ELF(2M) = 4.0%
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4.0% of the total losses are in this 1M xs 1M layer
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Exposure Loss Cost = 70% * 4.0% = 2.8%
ELF(2M) = 0.06
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Excess of Loss Treaties
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Combine experience and exposure loss cost
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Discount?
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Load for internal and external expenses
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When do you know true result?
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Catastrophe Treaties
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Treaties requiring at least two injured workers,
usually above $5M
Maximum Any One Life (MAOL)
Example: $5M xs $5M, $5M MAOL requires the total
loss from one occurrence to exceed $5M, with no
single injured worker contributing more than $5M
Similarities to Property Cat Treaties
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Catastrophe Treaties
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Reinstatement terms – frequently one reinstatement
of limit with a premium expressed as a percent of
original reinsurance premium.
Reinstatement premiums are typically paid when
losses are paid – which can be many years from
inception, unlike Property Cat treaties.
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Catastrophe Treaties
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WC Catastrophe Layers extend up to $100M and
frequently higher, far beyond the ELF’s.
Pricing is frequently expressed as Rate on Line –
Premium / Limit

Rates on Line vary by layer and exposure
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Higher layers have lower Rates on Line
43
Catastrophe Treaties
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Exposure is not necessarily correlated to Workers
Compensation Premium – the Catastrophe risk is also
related to Payroll
Example – two employers with the same WC
Premium but the first has a WC rate 10 times as high
as the second. The second employer has a Payroll
10 times the first. The Catastrophe risk is not equal.
44
Catastrophe Treaties
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Earthquake exposed areas have higher Rates on Line
Hurricanes are not considered a significant exposure
for Workers Compensation – except for First
Responders, most workers are not at work when the
storm arrives
Areas considered at higher risk for Terrorism have
higher Rates on Line
45
Catastrophe Treaties
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Similar to Property Cat after Hurricane Andrew,
information has increased
Some submissions include information on
Payroll/Premium/Employee counts by insured, or zip
code, and time of day/shift or maximum exposed
employee counts
Similar to Property Cat, a number of reinsurers are
needed to provide layers requested. Some
participate on lower layers, others on higher layers.
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Catastrophe Treaties
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As with Property Catastrophe, modeling firms are
analyzing the exposures
As with Property Catastrophe, reinsurers monitor
their aggregate exposure to WC Catastrophe losses
Potential exists for a Property Catastrophe loss and a
Workers Compensation Catastrophe loss
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Catastrophe Treaties
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Much of the business was written in the London
market or by Life Insurers
Terrorism was not recognized as a risk
After 9/11, many participants suffered losses and left
the market
Rates on Line increased dramatically, attracting
traditional reinsurers
Coverage was restricted – i.e. limits on Terrorism
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Catastrophe Treaties

Rates on Line have been declining

Coverage has been expanding – more Terrorism coverage,
requests for including NBCR

Fortunately, there have been no significant losses to this book of
business since 9/11
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Unfortunately, a significant Workers Compensation Catastrophe
will eventually happen, whether a natural Catastrophe or a manmade Catastrophe
As with Property Cat pricing after a large event, pricing will
increase and coverage will be restricted.
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Facultative
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Individual account pricing.
By its very nature facultative reinsurance operates
based on adverse selections. Through careful
underwriting and pricing the reinsurers can establish
the proper pricing and terms which would be
profitable to the reinsurer.
The ceding companies will place facultative
reinsurance due to: class, exposures, to protect the
treaty, a treaty exclusion or cat exposures.
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Facultative
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Ceding companies are often looking for
reinsurance in Buffer layers such as $750K xs
$250K, $500K xs $500K
Underwriters use a combination of loss rating
and manual rating
Loss rating up to a loss limit, usually well
below reinsurance attachment point, then use
ELF’s to estimate layer loss cost
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Facultative
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Credibility weight loss rating with manual rating
Load expected loss cost for internal and external
expenses
In the current market ceding companies want the WC
facultative market to either match their pricing for
the layer or be less than what they price it for. In the
event that this can't be met then the ceding company
would retained the risk Net.
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Workers Compensation
Suggested Reading

Commentary on the New Hazard Groups by Jose Couret.
Presentation at Spring 2007 CAS Meeting

The 2004 NCCI Excess Loss Factors by Dan Corro and Greg
Engl. CAS Forum 2006

An Actuarial Note on Workers Compensation Loss Reserves –
25 Years Later by Lee Steeneck. CAS Forum 1996

Ratemaking for Excess Workers Compensation Insurance, by
Owen Gleeson. CAS Forum 2001

Levels of Determinism in Workers Compensation Reinsurance
Commutations by Gary Blumsohn. Proceedings 1999
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