Pricing ACC Work Cover

Pricing ACC Work Cover Tim Spicer Stephen Jeffery Gavin Pearce

Overview • Work Cover Products and Coverage • Standard employer • Self-employed • Partnership programme (PP) • Pricing Philosophy • Top-Down/Bottom-Up • Stop-Loss + Individual XOL for PP • Residual Account

Product Coverage and Expenditure • First 7 days covered by employer/self-employed • Chart shows standard employers breakdown of $308m ultimate claim expenditure expected from 2003/04 accident year

Standard Employer and Self-Employed Levies - 2003/04 accident year • Rates are per $100 of liable earnings (i.e. % of liable earnings) • Liable earnings are the lesser of actual earnings and $87,000 (the current maximum annual compensation rate) • Self-employed has separate income and non-income benefit rates. The non-income rate is applied to the lesser of liable earnings and $15,000 (with the result being at least $32)

Pricing Philosophy • ACC is non-profit, non-tax-paying, nationalised monopoly provider of accident cover…therefore… • Pricing philosophy is largely “cost-plus” • Overall price levels directly linked to the annual liability valuation PPCIs • Exception to pure “cost-plus” philosophy is that we have a prudential margin (15%) in the rates to guard against adverse claims experience and investment returns

Pricing Process • Marriage of “Top-Down” (i.e. we develop an overall average levy rate for each account using aggregate data) and “Bottom-Up” (i.e. we build up risk group rates using individual claim data) • Liable earnings weighted average of risk group rates must regenerate the overall average rate

Overall Average Levy Components

Risk Premium For each claim payment type* calculate: Exposure (projected liable earnings)  Projected Incurred Claim Frequency = Number of Incurred Claims  Payments Per Claim Incurred (PPCIs) = Payment Run-Off Pattern with discounting and summation gives Incurred Claim Cost = Risk Premium *Entitlement, Social Rehab and Total

Reserve Adjustment • Targeted funding position for all accident years post-1999 is 115% of liabilities (3 years hence) • Reserve adjustment in two parts • Adjustment for all past accident years (1999/00 - 2002/03) - can be negative (i.e. a “refund”) if opening fund position is sufficiently favourable • Adjustment for new accident year (2003/04) - always positive • Overall reserve adjustment can be negative

Reserve Adjustment (cont’d) • Reserve adjustment mechanism is such that it is always aiming for 115% funding in 3 years from start of new accident year e.g. for 2003/04 year, the reserve adjustment will be aiming for 115% funding by 31 March 2006 • At the end of the 2003/04 year, the 2003/04 liabilities fall into the past accidents “pot”, 2004/05 is the new year, and we will now be aiming for 115% funding by 31 March 2007

STD EMPLOYERS “Risk Premium” = 0.73% Full Funded Rate* = 0.84% Loss Ratio = 73/84 = 87% *excludes WSMP loading SELF-EMPLOYED “Risk Premium” = 1.28% Full Funded Rate = 1.75% Loss Ratio = 128/175 = 73% Summary of “Top-Down” Process Recommended Rates Final rates approved by Cabinet may be different to these !!

Bottom-Up Process • Each work-related claim is allocated to an ANZSIC-based Classification Unit (“CU”) and accident year • CUs are collections of workers engaged in the same or very similar business activities • The Bottom-Up process starts with the allocation of claims, and hence incurred claim costs, to the various CUs (There are currently over 550 CUs)

Incurred Claim Costs • Each claim in the claim file has two components: 1. Claim payments made to date 2. Claim payments outstanding (zero for closed) • The PV of all outstanding claim payments across all incurred cases should, theoretically, give the outstanding claims liability from the valuation - want results broken down by accident year • Only difference is the date to which payments are discounted (for valuation - to 31/03/2002, for pricing - to start of accident year)

Allocating Costs to CUs • Each open (reported) claim is given an individual case estimate (serious or statistical) equalling PV of outstanding claim payments • Summing across all such cases from a given accident year gives a result typically less than the valuation result (allowance for IBNR and re-opening) • To allocate IBNR costs to CUs (and accident year) we “calibrate” the case estimates so that sum of calibrated case estimates = o/s claims liability for each accident year

Allocating Costs to CUs (cont’d) • Final step is to combine all the claim payments made to date with the calibrated case estimates (gives the “lifetime” claim cost) and then summarise costs in CU/accident-year “cells” • Our risk measure is the “lifetime claims/earnings ratio” so it is now a matter of dividing the lifetime claim costs in each CU/accident-year cell by the corresponding liable earnings in the cell • For each CU we can now produce a claims/earnings (“c/e”) ratio history

Forming Levy Risk Groups • Many CUs have too little claims experience from which to develop a reliable rate - we pool the 550+ CUs together into 130 credible sized risk groups • By examining the c/e ratio histories, we formed the “Pricing Hierarchy” • Each Levy Risk Group (130 for 2003/04) should have CUs from the same industry and with a similar c/e ratio history (i.e. same industry and similar risk level) • Hierarchical structure adopted is similar to British Columbia scheme but based on ANZSIC rather than North American industry classification

Example c/e history and projection Farmers - LRG 120 (9 CUs pooled)

Setting risk premiums for risk groups using the Hierarchy

Credibility Adjustment • The 130 risk rates thus far were found by working down the Hierarchy • Work back up the hierarchy using credibility weighting until you strike a fully credible base • Full credibility is either E = $400m in earnings or N = 250 entitlement claims (per annum) • Partial credibility weight (Z) is: Z = MAX{ sqrt(E/400m), sqrt(N/250) }

Full Funded Rates (1) • From the 130 credibility adjusted risk rates form a set of claim cost relativities (and normalise so that earnings weighted average relativity is 100%) for both employers and self-employed • As ACC management elected to risk rate all expenses the full funded rate (net of WSM) is found by applying the relativity to the 0.84% average rate • Next step is to apply the risk group WSM loading (so that after WSM discounts the total levy received is unchanged) - this gives us the “A” rates.

Full Funded Rates (2) • The self-employed rate is split into an income and non-income rate (based on historic expenditure on these two classes of benefits) • Both employer and self-employed rates are further subjected to 1. A minimum invoice loading (giving “B” rates) 2. A 25% increase cap loading (giving “C” rates) • The costs of providing these “commercial” constraints are shared by ALL other workers and NOT contained just within their risk group

Partnership Programmes • These are risk sharing arrangements available to employers of sufficient size after a successful Workplace Safety Evaluation • Full Self Cover (FSC) and Partnership Discount Plan (PDP) • FSC employers manage claims for the first 4-5 years after which claims revert to ACC for a charge based on actual claims - up-front levy is for admin only • PDP employers manage claims for first 2-3 years with reversion to ACC at no extra cost - std employer levy is discounted for costs in first 2-3 years

Stop Loss and Individual XOL • All FSC employers must purchase Stop Loss cover (150% and 200% options). Individual XOL is optional ($250K, $500K, $750K and $1M) • Stop Loss losses for FSC employers include the liability reversion at the end of 4-5 years of claim management • Stop Loss and XOL levy rates vary by standard levy that would otherwise have been payable • PDP employers have optional Stop Loss (150% and 200% options) but no XOL options

Pricing FSC Stop Loss / XOL • Assume a Compound Poisson aggregate claims distribution for each of 3 risk bands • Individual claim sizes based on most recent 6 years of individual claim size data (empirical distribution) calibrated to 2003/04 level • “Tail” of empirical claim size distribution modelled using a Pareto density for “smoothness” • We built a SAS program to do the zillions of simulations required to get smooth rate curves • Final rates were capped at 25% with those below the cap sharing the loss from capping

Residual Account Levies • The Residual Account is for pre-July 1999 work claims and pre-July 1992 non-work claims by workers • The Residual Account has a significant unfunded liability (only 36% funded as at 30 June 2002) • Residual levies are set so that the account is 115% funded by 31 March 2014 (i.e. assets equal 115% of liabilities at that time)

Aggregate Residual Levy Rate • As for other accounts a “Top-Down/Bottom-Up” approach is used • Aggregate rate (0.31%) is found by projecting earnings, claim payments, liabilities, expenses and investment earnings out to 2014 and “goal-seeking” the flat % of earnings that will achieve 115% funding by 2014 • Split aggregate rate into a work (0.21%) and non-work component (0.10%) - pro-rata to outstanding claims liability for work and non-work accidents

Risk Group Residual Levies • A similar process is followed here as for the standard cover pricing: 1. Form risk based groups 2. Allocate outstanding work-related claims liability across risk groups 3. Calculate a work-related o/s c/e ratio relativity 4. Apply relativity to aggregate work rate and add flat non-work rate to give risk group rate

Pricing ACC Work Cover