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Experience Rating Current Challenges

This presentation by Tony DiDonato from NCCI, Inc. at the 2003 CAS Seminar on Ratemaking delves into the intricacies of Experience Rating (ER) in insurance. It covers ER basics, off-balance factors, ERA adjustment, and performance testing results for NCCI states. The presentation explores the impact of unanticipated frequency and severity changes on ER, sensitivity to total losses and primary/excess split, and historical analysis of off-balance factors. It also discusses manual loss ratios, standard premium levels, and the theoretical off-balance in various scenarios. The presentation concludes with insights on ERA changes aimed at enhancing employer reporting of small medical claims and Plan performance.

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Experience Rating Current Challenges

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  1. Experience Rating Current Challenges Presented by Tony DiDonato, NCCI, Inc. 2003 CAS Seminar on Ratemaking San Antonio, Texas March 28, 2003 WCP-2

  2. NCCI Perspective - Outline I. ER Basics II. Off-Balance in NCCI States III. ERA – Experience Rating Adjustment IV. Performance Testing Results for NCCI States

  3. NCCI Plan - ER Basics The formula: Ap + Ae(W) + Ee(1-W) +B E + B Actual / Expected • Some Qualifications: • Premium thresholds • Actual Losses limited • Mods limited • ERA A = Actual E = Expected p = primary e = excess B = Ballast W = Weight

  4. 1.00 0.989 0.99 0.98 0.964 0.97 0.954 0.96 0.95 Off-Balance 0.941 0.937 0.94 0.931 0.926 0.924 0.924 0.923 0.93 0.92 0.91 0.90 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002p Year Countrywide* Off-Balance Factors * NCCI states

  5. Unanticipated Frequency and Severity: How is Off-Balance Impacted? Theoretical Off-balance <-- Total Unanticipated % Change in Severity --> 0% -20% -12% -4% 4% 12% 20% 0.939 -20% 0.900 0.916 0.931 0.947 0.963 0.978 0.964 -12% 0.920 0.938 0.955 0.972 0.989 1.006 0.988 -4% 0.940 0.960 0.978 0.997 1.016 1.034 % Change in Frequency Total Unanticipated 0% 0.951 0.970 0.990 1.000 1.010 1.029 1.049 1.012 4% 0.961 0.981 1.002 1.022 1.043 1.063 1.036 12% 0.981 1.003 1.025 1.047 1.069 1.091 1.061 20% 1.001 1.025 1.049 1.073 1.096 1.119 Theoretical off-balance increases by about 0.002 - 0.003 for every percentage point of unanticipated severity change. Theoretical off-balance increases by about 0.0025 - 0.0035 for every percentage point of unanticipated frequency change.

  6. 0% -20% -5% -1% 1% 5% 20% Sensitivity of Off-Balance to: Total Losses vs. Primary/Excess Split Theoretical Off-balance <-- Total Unanticipated Percentage Change in D-ratio --> 0.939 -20% 0.843 0.915 0.934 0.944 0.963 1.035 0.985 -5% 0.871 0.956 0.979 0.990 1.013 1.098 Total Unanticipated 0.997 -1% 0.878 0.967 0.991 1.003 1.027 1.116 Total Losses % Change in 0% 0.880 0.970 0.994 1.000 1.006 1.030 1.120 1.003 1% 0.882 0.973 0.997 1.009 1.033 1.124 1.015 5% 0.890 0.984 1.009 1.022 1.047 1.141 1.061 20% 0.917 1.025 1.054 1.068 1.097 1.205 Theoretical off-balance increases by about 0.002 - 0.004 for every percentage point of unanticipated losses. Theoretical off-balance increases by about 0.005 - 0.007 for every unanticipated additive percentage point in the D-ratio.

  7. D-ratio Changes Over Time • The primary change is due to severity trend • Since severity generally increases over time, the d-ratio generally decreases • ERA allows for a trended split point which would tend to stabilize the d-ratio, but trend has not yet been used on the split point

  8. Primary Actual Primary Expected Difference Between Experience Total Actual / / Total Actual / Total Expected Actual D-ratio Average Rating Years Total Expected (Actual D-ratio) (Expected D-ratio) Expected D-ratio Mod 1996 0.84 0.30 0.28 0.02 0.96 1997 0.85 0.30 0.29 0.02 0.95 1998 0.87 0.30 0.30 0.00 0.95 1999 0.84 0.27 0.28 (0.01) 0.94 2000 0.88 0.26 0.28 (0.02) 0.94 2001 0.89 0.25 0.28 (0.02) 0.95 Total Losses and Primary/Excess Split: Forecast vs. Actual Results Intrastate Risks – NCCI States

  9. Experience Rating Plan Off-Balance– Historical Analysis • Countrywide (NCCI states) Off-Balance has increased in each of the last three years. • Total actual losses that were less than total expected losses is the major reason for the relatively low Off-Balances from 1996-1999. • While the split between claim frequency and severity did not drive the low Off-Balances, it did dampen the Off-Balance increases in the last three years. • Unanticipated claim frequency has slightly more of an impact than does unanticipated severity on Mods.

  10. What Should the Experience Rating Plan Off-Balance Be ? • Manual loss ratios for the smallest premium sizes and for unrated risks are higher than the all-risk average. • If the off-balance is 1.00, then there is no standard premium price differential between experience rated and unrated risks. • Having an off-balance less than 1.00 can partially address the difference. • The indicated standard premium level is still correct even if there is a net off-balance.

  11. Developed Manual Loss Ratios by Policy Manual Premium (State X, Five Recent Policy Years)

  12. Developed Manual Loss Ratios (State X, Five Recent Policy Years) 120% 100% 80% 60% 40% 20% 0% 1995 1996 1997 1998 1999 1995-1999 Intrastate Interstate Unrated

  13. Average % of Manual Premium 10.0% 90.0% 100.0% Manual Loss Ratio 83.6% 55.3% 58.1% Actual Loss / Expected Loss 1.439 0.951 1.000 Mod Needed to Equalize Standard Premium Loss Ratios 1.000 0.661 0.695 Mod if Unrated Risks are Subsidized 1.000 0.951 0.956 Simplified Hypothetical Illustration of Experience Rated vs. Unrated Impact on Off-Balance Unrated Risks Rated Risks

  14. Summary of ERA Changes ERA was designed to increase the incentive for employers to report small med-only claims and to improve the performance of the Plan. This was accomplished by the following three changes to the Plan:  (1)   Using only 30% of med-only claims in the Experience Rating formula (2)   The Weighting Value (W) was increased (3)   The primary/excess split point (currently $5,000) will be adjusted over time The effective date of ERA varies by state. The earliest effective date is 7/1/98, which is applicable in several states.

  15. ERA Impact on Med-Only Losses • Compared changes in the proportion of med-only claims in states adopting ERA vs. states that had not • Changes in the average severity of med-only claims were also reviewed • This review did not reveal a significant impact on the reporting of med-only claims due to ERA

  16. Med-Only Changes in Late 1990s From policy period beginning 11/95 to policy period beginning 11/98 ERA States Non-ERA States * State 1 reflects a 2-yr change

  17. Performance Testing: GERT vs. ERA • 1998 mods were calculated for intrastate risks in the 9 states adopting ERA on 7-1-98 • Initially all rated under GERT, then all re-rated under ERA • ERA showed slightly more accurate results

  18. Performance Testing: GERT vs. ERA

  19. Brief Summary of Quintile Testing • Col (2): The actual losses are unlimited losses from WCSP data, generally at a 2nd report or subsequent. • The rates/loss costs in effect during the appropriate time period were used as a proxy for expected losses. The column (2) ratios have been normalized to 1.00 to minimize differences between the actual and expected losses related to development, expenses, etc. • Col (3) shows the deviation of each quintile group from the overall total. • Col (4) reflects the normalization from Col (2), but after application of the Mod (in the denominator) the results were NOT re-normalized. This has no impact on the result in Col (5). The mean value shown is an intermediate step in the calculation and has no particular meaning. • Col (5) shows the deviation of each quintile group from the overall total. • The test statistics shown at the bottom of each analysis are key. A statistic less than 1.00 is expected from an Experience Rating Plan. Lower values of the statistic indicate better performance.

  20. Performance Testing: GERT Actual / Modified Expected Loss Correlation = 0.654453

  21. Performance Testing: ERA Correlation = 0.543165

  22. Countrywide* Quintile Testing Results • Includes Interstate and Intrastate Risks • Policy periods 7/1/97–6/30/98 and 7/1/98–6/30/99 were reviewed • Two quintile groupings were tested: • quintile groups which equalized risk count • quintile groups which equalized expected losses * NCCI states

  23. Countrywide* Quintile Testing Results ALL RISK SIZES Policy Effective Period 7/1/97 - 6/30/98 * NCCI states

  24. Countrywide* Quintile Testing Results ALL RISK SIZES Policy Effective Period 7/1/98 - 6/30/99 * NCCI states

  25. Individual State Quintiles ALL RISK SIZES Policy Effective Period 7/1/97 - 6/30/98 Correlation = 0.620352

  26. Individual State Quintiles ALL RISK SIZES Policy Effective Period 7/1/98 - 6/30/99 Correlation = 0.502986

  27. Quintiles by Risk Count Test Results by Size of Risk * The risk count underlying each policy period and range is uniformly distributed among quintile stratum.

  28. Quintiles by Expected Losses Test Results by Size of Risk * The expected loss volume underlying each policy period and range is uniformly distributed among quintile stratum.

  29. Performance Testing: Next Steps • Currently reviewing the 30% factor for Med-only claims under ERA • Reviewing treatment of small risks • Alternative performance measures are being reviewed • Continued monitoring of ER Plan and performance

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