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
 COURSE OUTLINE

RICH MONCHER:

• Overview
• NCCI Filing
• Overall Rate / LC Level Change
• Class Rate / LC Changes

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 COURSE OUTLINE

ANDY DOLL:

• Other Bureau Ratemaking

• Expenses
• Loss Cost Multipliers
• Company Pricing Programs
• Current WC Market

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 WC RATING PROCEDURE

Exposure x Manual Rate = Manual Premium

Manual Premium x Experience Mod

= Standard Earned Premium

- Premium Discount = Net Premium

+ Expense Constant

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Example:

Loss Cost = 1.60 Expenses = 0.40

Rate = 1.60 + 0.40 = 2.00
1998 Payroll = 1,500,000
Exposure = Payroll / 100 = 15,000

1999 Manual Premium = Rate x Exposure

= 2.00 x 15,000 = 30,000

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Example (cont’d)

1998 Payroll = 1,500,000

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

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ADVANTAGES OF PAYROLL

• Inflation Sensitive
- Payroll up Premium up

• Tracks with Indemnity Benefits

• Verifiable/Auditable
- Less potential for fraud

• Readily Available

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 W.C. DATA BASES

• Financial Aggregate Calls

- Annual Data at Year End
- Statewide & Assigned Risk

• W.C. Statistical Plan

- Class Detail (Approx. 600)
- Payroll & Losses
- 18, 30, 42, 54, 66 Months after Effective Date

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 FINANCIAL AGGREGATE CALLS
• Experience
- By Policy Year
- By Calendar-Accident Year

• 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
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 FINANCIAL AGGREGATE CALLS

• Purposes

- Overall Rate/Loss Cost Level Change

- Overall => Statewide, Voluntary, Assigned Risk
- Trend Analyses

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 VALUATION OF FINANCIAL DATA
POLICY YEAR

Expiration
Date

Policy
Year
1997
Effective
Date
1/1/97 12/31/97 12/31/98 12/31/99
(1st report) (2nd report)

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 VALUATION OF FINANCIAL DATA
ACCIDENT YEAR

Expiration
Date
Accident
Year
1998

Effective
Date
1/1/97 1/1/98 12/31/98 12/31/99
(1st report) (2nd report)

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 RATEMAKING: BIG PICTURE

• We 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 losses

• We adjust the premium (excluding expenses for loss cost

states) from the historical data to simulate the (pure) premium
currently in place

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 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.
If not then we must make new rates/loss costs.)

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Does current premium level provide
adequate funds for future benefits?

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 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

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 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

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• Trend Factors
- Compares movements in indemnity and medical
benefits to movements in payroll
- Applied to loss ratio =
(Adjusted losses)/(adjusted premium)

Benefit Costs
} Trend

Payroll

Data in Filing
Time Effective
Filing

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 LOSS EXPERIENCE INDICATION

• Estimate 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 losses

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 LOSS EXPERIENCE INDICATION

• This 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

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 OVERALL CHANGE TO INDUSTRY
GROUPS
• Overall change is distributed to industry groups and
then to individual classes

• Manufacturing • Miscellaneous
­ Textiles • Contracting • Office &
• Goods & ­ Trucking
­ Cabinets ­ Plumbing Clerical
Services ­ Logging
­ Automobiles ­ Roads ­ Clerical
­ Restaurants ­ Surface coal
­ Houses office
­ Retail sales mining
employees
­ Nursing
­ Outside
sales
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 MANUFACTURING INDUSTRY GROUP
CHANGE
Analysis shows that:
• Overall (statewide) change is +10%
• Manufacturing industry group experience is 10% worse
that statewide so,

Mfg. Industry Statewide Industry Group -

= x 1
Group Change Change Differential
= (1.1) (1.1) - 1
= 1.21 - 1
= 21%
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 W.C. STATISTICAL PLAN

• Experience by Policy

• Classification Details
- Exposure / Premium / Exper. Mod
- Individual Claim Records
Indemnity / Medical
Case Incurred Values
By Injury Type (Fatal, PT, etc.)

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 W.C. STATISTICAL PLAN

• Purposes
- Classification Relativities
- Experience Rating
- Retrospective Rating
- Research

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 VALUATION OF W.C. STATISTICAL PLAN
DATA

1st 2nd 3rd 4th 5th

Report Report Report Report Report
Valuation Valuation Valuation Valuation Valuation

Policy
Effective 7/1/96 7/1/97 7/1/98 7/1/99 7/1/00
1/1/95

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DISTRIBUTION OF INDUSTRY GROUP
CHANGE TO CLASS
• Unit Reports

• Relativities (between classes)

- five years of WCSP data
- current loss cost/rate - adjusted
- adjusted national experience for class

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 BASIC TECHNIQUES FOR
WORKERS COMPENSATION

Company Perspective

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INDEPENDENT BUREAU VS.
NCCI FILING ACTIVITIES
● California
● Massachusetts
● Minnesota
● New Jersey
● New York
● Pennsylvania/Delaware
● Texas
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 LOSS COSTS - WHY?
● McCarran-Ferguson Debate
● Antitrust Concerns
● Ease of Developing Final Rates

Note: 15 years ago all states were rate states.

Now, almost all NCCI states are loss costs.

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 COMPONENTS OF A RATE
● Losses
● Loss Adjustment Expenses
● Expenses and Profit
● Loss Assessments

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

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COSTS AS A PERCENTAGE OF FIRST
$5,000 OF STANDARD PREMIUM
Profit
Taxes
General

Production

Loss &Loss Loss

Adjustment Assessments

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 EVALUATION OF THE NEEDS
OUTSIDE OF THE LOSS COST
Items always Outside the Loss Cost
● Production
● Taxes, Licenses, and Fees
● General
● Profit and Contingencies

Items sometimes Outside the Loss Cost

● Loss Adjustment Expenses
● Loss Based Assessments

Items rarely Outside the Loss Cost (MN)

● Trend
● Loss Development beyond 8th report
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COMPONENTS OF A RATE IN OR OUT
OF THE LOSS COST
Loss
Assessments

Expense and
Profit

Losses

Loss
Adjustment
Expense

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 HOW TO ACCOUNT FOR ITEMS
OUTSIDE THE LOSS COST

The Loss Cost Multiplier (LCM)

● Factor to multiply loss costs by to load in insurer’s

expense and profit
● Must also consider other items not included in the
Loss Cost
● Loss Cost x LCM = Rate
● Insurance Companies must file LCM’s for approval
in loss cost states
● Also known as a Pure Premium Multiplier
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DERIVATION OF A LOSS COST
MULTIPLIER
● State A: Loss Cost includes Loss, Loss
Adjustment expense, and Assessments
● State B: Loss Cost includes Loss and Loss
Adjustment expense
● State C: Loss Cost includes Loss

In all three cases, loss includes full trend and

loss development

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 DERIVATION OF A LOSS COST
MULTIPLIER
Portion of Standard Premium
State
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) 36
 DERIVATION OF A LOSS COST
MULTIPLIER
Portion of Standard Premium
State
A B C
Expenses .275 .275 .275
Profit .025 .025 .025
Loss Assessments (% Prem) .020 .020
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) 37
 DERIVATION OF A LOSS COST
MULTIPLIER - ALTERNATIVE APPROACH
● Prior methodology assumes that all items included in the
LCM are related to Premium
● Loss Adjustment Expenses and Assessments may not
have a stable relationship to Premium
● An alternative approach for states that require a loading
for “loss related” items is:

1 + Loss Related Items (% Loss)

LCM =
1 ­ Premium Related Items (% Premium)

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ADDITIONAL CONSIDERATIONS FOR
THE LOSS COST MULTIPLIER
● Administered Pricing vs. Competitive Rating
When to use a LCM?
● 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?
● Consideration of the Company’s experience
How does your experience compare?
Are there changes to consider?
When will you be implementing a change?
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MANUAL RATE IS STARTING POINT FOR
DETERMINING COST OF WORKERS
COMPENSATION INSURANCE
Additional Factors

● Prospective Experience Rating

● Premium Discounts
● Deviations
● Schedule Rating
● Retrospective Rating
● Dividend Plans
● Deductibles (Small and Large)

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

● Retrospective Rating ­ premium depends on the

experience generated by the insured during the time the
policy is in force
● Large Deductibles ­ similar to retrospective rating, but
can often allow for cash flow benefits to the insured

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