Casualty Loss Reserve Seminar September 2003

1. Casualty Loss Reserve Seminar September 2003 Workers Compensation Emerging Issues- California Workers Compensation Insolvencies Ron Dahlquist, FCAS, MAAA California Dept. of Insurance

2. Workers Compensation Insolvencies: Scope of the Problem • most California WC specialty companies insolvent • Superior National insolvency the largest in state history • CIGA (California Insurance Guarantee Association) WC fund running out of money • Current estimates- 5% annual assessment required to pay for insolvencies • SCIF (State Compensation Insurance Fund) is financially strained

3. Causes of Insolvencies • Reserve Deficiencies the proximate cause • Deficiencies caused by confluence of events: • Severe medical inflation • Slowdown in payment pattern disguised trends • Extreme competition put pressure on financials; encouraged wishful thinking?

4. Actuarial Opinions Postmortem • Most insolvent carriers had clean actuarial opinions: • in Annual Statement immediately preceding insolvency • In all Annual Statements in 3 to 5 year period between CDI Financial Examinations • Most showed analyses that did not respond sufficiently to the CA WC climate

5. WCIRB Pure Premium Rate Analysis Track Record • Analysis similar to more aggressive than Appointed Actuaries rendering opinions on subsequently insolvent companies • Relied exclusively on paid development method • Trended loss development factors • Trending used for last several filings • Seen as aggressive • Estimates of ultimate loss have proven to be far short of subsequent estimates

6. CALIFORNIA WORKERS' COMPENSATION WORKERS' COMPENSATION INSURANCE RATING BUREAU ANALYSIS CHANGE IN ESTIMATED ULTIMATE LOSS RATIOS Estimated Ultimate Loss Ratios: as of as of as of as of as of Accident Earned Year Premium 3-31-1999 3-31-2000 3-31-2001 3-31-2002 3-31-2003 1995 4,953,140,036 79.7% 81.6% 85.1% 87.9% 89.9% 1996 4,779,939,440 88.3% 91.6% 96.7% 100.7% 103.0% 1997 5,140,962,619 94.5% 98.3% 104.2% 109.3% 112.2% 1998 5,357,298,977 99.3% 106.2% 116.8% 123.8% 126.8% 1999 5,800,510,083 110.6% 121.4% 131.2% 135.6% 2000 7,590,342,836 104.9% 116.4% 121.9% 2001 10,991,490,553 95.6% 105.0% 2002 14,577,469,571 88.9% 59,191,154,115

8. Characteristics of CA WC Experience • Paid loss development pattern lengthening • Paid loss age-to-age factors getting bigger over time- increases substantial, consistent over time since 1995 • True for both medical and indemnity • More dramatic for medical • Claim closing rate declining- decline substantial, consistent over time • Mix by type of injury changing over time- • medical only claims, temporary disability claims declining • permanent partial disability claims (especially majors) increasing • Other possible issues- • Increasing use of large deductibles • Increasing billing disputes with medical providers?

9. Characteristics of CA WC Experience • Show paid development triangle

10. Characteristics of CA WC Experience

11. Characteristics of CA WC Experience

12. Characteristicsof CA WC Experience

13. Reserve Analysis- Principles and Assumptions • Several methods should be used • Underlying assumptions of each method should be tested • Retrospective adequacy tests should be applied to each method whenever possible • If changes in conditions cause key assumptions to be violated, data should be adjusted if possible to attempt to remove distortions • Relative weights given to the results of each method should give consideration to the extent to which each method’s key assumptions hold true

14. CA WC Reserve Analysis- Comments re: Principles • Heavy (or exclusive) reliance on unadjusted paid loss development method was (and is) typical • Paid loss development method assumes constant payment pattern, closing rate over time- clearly not true in this case • Mix of claim types is also changing • Retrospective tests of the paid loss development method have consistently shown prior estimates to have been inadequate • Paid development methods applied in practice often used selections such as averages of latest three years’ age-to-age factors- • Clearly not sufficiently responsive

15. CA WC Reserve Analysis- Possible Alternatives • Incurred Loss Development Method • Not generally used: explanation given is presumption that case reserves have been strengthened • Some evidence for this- but high medical inflation rate (18%+!) might be misinterpreted as “strengthening” • “Other side of the coin”- incurred development method should recognize increase in medical inflation faster than paid development method • Current WCIRB paid loss development estimates exceed WCIRB incurred loss development estimates from prior years! • Incurred method adjusted for case reserve strengthening • should be used, isn’t used commonly • Without some adjustment for slowdown in closing rate, this method should also underestimate

16. CA WC Reserve Analysis- Possible Alternatives (2) • Berquist-Sherman adjustment for slowdown in settlement rate • Typically not used due to concern that partial payments won’t slow down as much as claim closings • This assumption hasn’t been adequately tested? • Valid as measure of outside limit of effect of slowdown? • Paid loss development method is definitely too low without adjustment

17. Concluding Thoughts • Why weren’t Appointed Actuaries trying harder? • Distortions in basic data clear and obvious • Assumptions and selections not sufficiently responsive to changing conditions • Alternative methods not given enough weight • Situation called for more conservatism than was exercised • Do Regulators, Investors, Management, and Appointed Actuaries have the same perspective with respect to the proper role of the Appointed Actuary? • What does this performance say about the value of the Actuarial Opinion?