Session # P2 & P3 November 14, 2006, 10:00 am Estimating the Workers Compensation Tail

1. Session # P2 & P3November 14, 2006, 10:00 amEstimating the Workers Compensation Tail Richard E. Sherman, FCAS, MAAA Gordon F. Diss, ACAS, MAAA

2. SAIF Corp. (Oregon State Fund) • Extensive data for 160,000 permanent disability claims. • Accident years 1926-2005. • 80 years of development experience. • Medical & indemnity payments separated. • Separate data by injury type.

3. Workers Compensation Medical Permanent Disability (MPD)

4. Dead on Arrival (DOA) Data Diagonals Only Area (DOA) Standard Triangle

5. Mueller Incremental Tail Method • Using the incremental data, calculate decay factors. • Incremental to incremental ratios. • Use various smoothing techniques if data is volatile. • Square the cumulative triangle. • Increment the squared triangle. • Apply decay factors.

6. WC: Two Different Worlds

7. Workers Compensation Medical Permanent Disability (MPD) Paid Loss Development Factors

8. SAIF’s Actual PLDFs – 1.0

9. We assume a brontosaurus tail.

10. PLDFs – 1.0 Out to DY 58

11. Washington State Fund PLDFs – 1.0

12. MPD payments: Stegosaurus tail.

13. COMMON INTUITIVE ASSUMPTIONS INVESTIGATING THE CIA

14. CIA # 1 MPD paid loss development factors decrease monotonically

16. Mortality Model vs. SAIF’s Actual • 9% rate of future medical cost escalation assumed. • Mortality rates of general population assumed. • Model fit well out to development year (DY) 40. • Model noticeably underestimated actual development beyond DY 40.

18. OPPOSITE INFLUENCES FORCE OF MORTALITY VERSUS FORCE OF MEDICAL COST ESCALATION

19. The Need to Separate We must separately analyze: • The effects of mortality on the remaining number of open claims; and 2) The effects of medical cost escalation on claim severities. This cannot be done with the standard paid loss development method.

20. OPEN COUNTS PROJECTED USING MORTALITY FACTORS AVERAGE PAYMENTS PROJECTED USING MEDICAL ESCALATION RATES

21. A) Incremental Paid Losses ($000’s) AY 12 24 36 48 60 72 1997 2,823 15,936 9,182 4,282 2,064 1,411 1998 2,638 14,250 9,096 2,936 3,214 1999 3,331 15,806 9,735 4,309 2000 3,170 18,602 12,462 2001 3,143 20,306 2002 4,263 B) Open Counts AY 12 24 36 48 60 72 1997 3621,112 793 490 375 324 1998 338 888 628 431 352 1999 343 840 664 492 2000 268 867 731 2001 276 897 2002 333 C) Incremental Paid per Prior Open AY 24 36 48 60 72 1997 44,022 8,257 5,399 4,212 3,764 1998 42,159 10,244 4,675 7,459 1999 46,021 11,589 6,489 2000 69,411 14,374 2001 73,572 2002 -

22. Estimation of Incremental Payments by Static Mortality ModelMPD Losses for Accident Year 2002

25. CIA # 2 As permanently disabled claimants age, neither utilization nor on-level severity changes.

27. CIA # 3Future MPD paid severities should increase in line with historical changes in the medical component of the Consumer Price Index.

28. Comparison of SAIF’s Historical Rate of Medical Cost Escalation with Changes in the Medical Component of the Consumer Price Index

29. Comparison of SAIF’s Recent Rates of Medical Cost Escalation with Average Changes in the Medical Component of the Consumer Price Index

30. CIA # 4 After stabilization, mortality rates of the disabled are greater than those for the general public.

31. Injured Worker Mortality Rates • For ages < 60, injured worker mortality rates somewhat higher. “Between age 60 and 74, the injured worker mortality rate does not differ appreciably from U.S. Life. The differences in mortality, even if accepted, do not imply significant redundancy or inadequacy of tabular reserves.” Gillam, William R., “Injured Worker Mortality”, CAS Forum, Winter 1991 • “Injured worker mortality after some years comes close to standard mortality, and after some age may actually be lower.” Venter, Schill and Barnett, “Review of Report of Committee on Mortality for Disabled Lives”, CAS Forum, Winter 1991

32. Is it appropriate to Use the Ratio of Incurred to Paid for Most Mature AY? Years of Development AY Triangle of Historical Development Data Tail Region Development Factors Helpful

33. CIA # 5MPD case reserves based on inflating payments until the expected year of death should be adequate.

34. What Causes Expected Value to Exceed Simple Reserve Estimates? • Inflation balloons the cost of scenarios where the claimant lives longer than their life expectancy. • Expected Value Contemplates Possibility of “Worst Case” Situation • Medical Cost Escalation.

36. CIA # 6 For a given development period, Worker’s Compensation tail factors should be constant for all accident years

37. Testing CIA # 6 with an Illustrative Model • 35 successive AYs that are identical except: • Applicable mortality table varies by CY. • Used projected Social Security mortality table for future mortality rates. • Each AY starts with 5,000 permanent disability cases. All assumptions fit SAIF’s historical patterns.

38. Indicated WC MPD Tail Factors End of Development Year AY 10 20 30 40 50 60 70 80 1970 2.570 2.177 1.773 1.438 1.210 1.075 1.015 1.0012 1975 2.628 2.223 1.805 1.456 1.220 1.080 1.016 1.0013 1980 2.701 2.279 1.842 1.477 1.231 1.085 1.018 1.0014 1985 2.774 2.336 1.879 1.499 1.242 1.090 1.020 1.0016 1990 2.848 2.393 1.918 1.521 1.253 1.095 1.021 1.0017 1995 2.921 2.451 1.957 1.543 1.265 1.101 1.023 1.0019 2000 2.990 2.505 1.993 1.563 1.275 1.105 1.023 1.0021

39. Number of Open Claims for Representative Accident Years at Five Year Intervals of Development End of Development Year AY 10 20 30 40 50 60 70 80 1970 196 119 71 33 12 3.5 0.5 0.02 1975 197 120 73 34 13 3.7 0.6 0.03 1980 200 123 76 36 14 3.9 0.6 0.03 1985 202 126 79 38 14 4.2 0.7 0.04 1990 204 128 81 39 15 4.4 0.7 0.04 1995 206 130 83 41 16 4.7 0.8 0.05 2000 207 132 86 42 17 5.0 0.9 0.06

40. CIA # 7 For a given development period, WC age-to-age paid loss development factors should be constant for all accident years

41. Trends in Five Year Paid Loss Development Factors Development Years AY 15/10 20/15 25/20 30/25 35/30 40/35 45/40 50/45 55/50 1970 1.082 1.091 1.103 1.113 1.114 1.107 1.097 1.084 1.069 1975 1.083 1.092 1.105 1.115 1.116 1.110 1.099 1.086 1.071 1980 1.084 1.094 1.107 1.118 1.119 1.114 1.103 1.089 1.073 1985 1.084 1.095 1.109 1.120 1.123 1.117 1.106 1.092 1.076 1990 1.085 1.096 1.111 1.123 1.126 1.120 1.109 1.094 1.078 1995 1.086 1.097 1.113 1.126 1.129 1.123 1.112 1.097 1.081 2000 1.087 1.098 1.114 1.128 1.132 1.126 1.115 1.100 1.083

42. CIA # 8Paid tail factors will not change much when the retention changes.

43. CIA # 9 Monte Carlo simulation of MPD losses will reasonably estimate the variability of MPD reserves.

44. Markov Chain Model • Typical Monte Carlo simulation involves utilization of size of loss distribution based on incurred amounts, all of which are well below their expected value. • Better to model year-by-year payments for individual claimants using a Markov chain approach.

45. CONCLUSIONS • Data prior to traditional triangle can be used effectively. • All 9 CIAs do not apply to MPD paid and reserves. • MPD PLDFs increase for many mature DYs. • MPD paid tails and incremental PLDFs trend upward as mortality rates decline. • Utilization and severity tend to increase as permanently disabled claimants become elderly. • Common methods significantly underestimate the expected value of MPD case reserves. • Common methods understate MPD reserve variability. • Predictive model produces more realistic estimates.

46. Average On-Level Incremental Paid