Workers Compensation Large Deductible Issues

1. Workers Compensation Large Deductible Issues Matt Hayden, FCAS, MAAA Liberty Mutual Holmes Gwynn, ACAS, MAAA Texas Department of Insurance September 12,2005

2. Introductory Comments • Why High Deductible WC is a Topic • Large Deductible Study by the NAIC/IAIABC Joint Working Group • Regulatory Concerns • The Liberty Mutual Approach

3. Why is this a Topic • In 2001 37% of “manual-equivalent premium” was written using a deductible of $100,000 or greater. • In Texas the percentage was 52%. • The insurer has responsibility for first dollar losses if the policyholder fails to meet obligations.

4. Chain of Security for First Dollar Losses • The Policyholder/Employer • The Employers Estate • The Insurer writing the deductible policy • Guaranty Funds

5. Employer Insolvency • Employer bankruptcy triggers: • Automatic stay of adjudication preventing/delaying reimbursements to insurer. • Chapter 11 requires the employer to keep appropriate workers comp coverage. • Insurance policy persists after bankruptcy. • Even if the insurer has collateral, access to that collateral may require litigation in the bankruptcy court given that such collateral is an asset of the estate.

6. Insurer Risk - Financial • First dollar loss can become the responsibility of the insurer with very little premium to cover those losses. • Some large companies have had to face up to the problem of: • Questionable underwriting, • Lack of securitization.

7. Insurer Risk – Claims Handling • Degree of self adjusting of claims • Degree of coordination and reporting with primary insurer • TPAs are often in the middle.

8. Insurer Insolvency Considerations • Should reimbursements for claims paid by guaranty fund go back to guaranty fund or assets of the estate.

9. Equity Issues Relating to Taxation & Funding of Residual Markets • Taxes for a states general revenue are usually a % of direct written premium. • Assessments to support Second Injury Funds, • Support of Residual Markets.

10. Regulatory Concerns • Policies leverage a high volume of claims to a small premium, i.e. credit risk traded for underwriting risk. • An insurer insolvency will produce uncertainties about the status of recoverables. • Current knowledge of claims and claim practices are uncertain when & if intervention is needed.

11. Texas Administrative CodeTitle 28, Part 1, Chapter 8, Subchapter A, Rule 8.4 • Hazardous Condition Rule Related to High Deductible Workers’ Comp Policies • Web-site is: • http://info.sos.state.tx.us/pls/pub/readtac$ext.TacPage?sl=R&app=9&p_dir=&p_rloc=&p_tloc=&p_ploc=&pg=1&p_tac=&ti=28&pt=1&ch=8&rl=4

12. Regulatory Enforcement (TX) Hazardous Condition Rule so before enforcement, determination is made to see if the insurer is in hazardous condition. Once determined hazardous, we have an exhibit for the insurer to fill out. Identifies the insured and the ultimate losses under that contract. We expect collateral equal to the ultimate loss reserves. We expect annual actuarial certification of those reserves.

13. Financial Reporting of Large Deductible Data • Industry Reporting • Reported to NCCI on a Unit Record basis after policy expires. • NCCI uses the data for classification ratemaking. • Not used for rate level analysis. • Statutory Reporting • Losses & Premiums reported net of deductible. • Retro rated polices report losses and premiums.

14. Profesessional Employer Organizations (PEOs) • Employees are hired by the contractor or small businessman, who makes them employees of the PEO. • The PEO generally provide a range of services including payroll, health coverage, and workers comp coverage. • The PEO buys a high deductible policy, with the understanding that sub-accounts self insure for first dollar losses.

15. PEOs Continued • Chain of security now may dip down to sub account. • The losses occur and the contractor quits the PEO. Reimbursements are uncollectible. • The PEO can’t keep up with the loss reimbursements owed to the insurer. • Policy is cancelled. • The insurer gets his actuarial opinion and is in turn bankrupt.

16. Findings & Recommendations • Report makes 17 findings and/or recommendations to both the NAIC and/or the IAIABC. • Most deal with what needs to be done to increase consistency and solidify policy on the treatment of claims. • Two are directed to the Casualty Actuarial Task Force (CATF).

17. Of Consequence to Actuaries • 14. “Annual Statement reporting should be amended to show worker’s compensation losses under the deductible threshold on a state-by-state basis.” • Columns showing: • Paid, incurred, and unpaid deductible losses; • Written, earned and perhaps unearned deductible premiums.

18. More Actuarial Interest • 15. “Further study should be done with regard to apparent “disconnects” in accounting requirements for loss recoveries under large deductible programs.” • More specifically the CATF should examine the reserving and booking of losses due to policyholder default so there is consistency in the handling of these losses.

19. Summary • Read the: Workers’ Compensation Large Deductible Study, latest version 6/8/2005, By the NAIC/IAIABC Joint Working Group • Alan Wickman of Nebraska was the principle author. • The CATF will be considering these recommendations at some point. • They will likely involve industry input through the Academy’s, COPLFR.

20. Writing Workers’ CompensationLarge Deductible Business Casualty Loss Reserve Seminar September 12, 2005 Boston, MA Matt Hayden, Liberty Mutual Group

21. Key Issues • Underwriting Considerations • Pricing • Systems Issues/Data Capture • Loss Reserving

22. Underwriting Considerations • Accurate and Detailed Historical Loss and Exposure Information • Credit Analysis • Quality of Security • Reasons for LDD

23. Pricing • Loss forecast at deductible limit + exposure based excess pricing + table M aggregate. • If losses below deductible not credible or not available, may use experience modified manual rates. • How to incorporate experience in excess portion (primary mod or excess experience)?

24. Systems Issues/Data Capture • Do your systems have data capture capabilities consistent with pricing methodology? • NCCI unit reporting still required on this business.

25. Loss Reserving • Split between per occurrence and aggregate excess if data permits. • Exposure-based methods preferred but parameterization challenging. • Parameter estimates dependent on quality and volume of data. • May use individual account or book of business/average approach.

26. Loss ReservingBornhuetter-Ferguson Parameters Expected Losses • Ground-up loss estimates with ELPPF’s or LER’s (per occurrence XS). • Ratio of aggregate XS to ground-up losses on mature years, judgment on newer years (aggregate XS). • Model output on individual accounts. • Premium/payroll applied to loss ratios/rates.

27. Loss ReservingBornhuetter-Ferguson Parameters Expected Loss Example – Per Occurrence Ground-Up Expected YearUltimateLERNet Loss 2001 1,000 90% 100 2002 1,100 88% 132 2003 1,200 86% 168 2004 1,300 85% 195 Total 4,600 595

28. Loss ReservingBornhuetter-Ferguson Parameters Loss Development Factors • Use of actual, net loss triangles requires more data than likely available. • Can use excess experience for similar book (per occurrence XS). • Aggregate XS should behave like truncated, limited ground-up.

29. Loss ReservingBornhuetter-Ferguson Parameters LDF Example – Incurred Per Occurrence Excess % Excess % Weighted Year500k LDF500k1M LDF1MLDF 2001 2.000 50% 2.500 50% 2.222 2002 2.500 45% 3.500 55% 2.966 2003 3.000 40% 4.000 60% 3.529 2004 5.000 35% 6.000 65% 5.607

30. Loss ReservingBornhuetter-Ferguson Total Example Expected Weighted Actual Estimated Actual/ YearNet LossLDFReportedUltimateExpected 2001 100 2.222 40 95 89% 2002 132 2.966 50 137 112% 2003 168 3.529 45 165 95% 2004 195 5.607 40200115% Total 595 175 597 102%

31. Closing Thoughts • Deductible play trades credit risk for underwriting risk. • Data is king. • In the past, soft market has grossly under-priced excess, particularly aggregate excess.