©Towers Perrin

Reserving in a Changing Environment

Reserving for Workers Compensation Liabilities for Self-Insured Entities During Plant Closures, Downsizing & Layoffs

September 13, 2004

Presented by: Atul Malhotra, FCAS, MAAA

2©Towers Perrin

Introduction

Corporations today are undergoing staff reorganizations frequently to respond to the rapidly changing external environment

These staff reorganizations can have an adverse impact on the corporation’s workers compensation (WC) costs

Reviewed the issues and potential impact of plant closures, downsizing and layoffs on the WC costs of self-insured entities

The general methodology described here can also be adapted to reserving for WC liabilities for insurance companies

Methods vs. Models – our approach to adapt traditional reserving methodologies to address the related issues

3©Towers Perrin

Introduction (Cont’d)

Data from Bureau of Labor Statistics – number of nationwide mass layoff events were steady from 1996 through 2000, jumped up in 2001 and 2002, have been gradually declining since

A mass layoff event occurs when at least 50 initial unemployment claims are filed against an establishment during a consecutive 5-week period

Mass Layoff Events by Year

-

10,000

20,000

30,000

1996 1997 1998 1999 2000 2001 2002 2003 2004

4©Towers Perrin

Impact of Staff Reorganizations

Internal Factors

“Downsizing” announcement tactics

Employee loyalty

Union relations

Level of severance benefits

Psychology of surviving employees

Skill level of downsized employees and the opportunity and ability to learn new skills

Overall impact dependent upon a number of internal and external factors including:

5©Towers Perrin

Impact of Staff Reorganizations (cont’d)

External Factors

Economic environment in the local area

Local unemployment rates

Socioeconomic issues that can vary by geographic areas

6©Towers Perrin

Impact of Staff Reorganizations (cont’d)

Claim Frequency may increase

Claim severity may increases

Litigation rate may increase

Change in claim reporting rates

Change in claim settlement rates

Based on a combination of the above factors, we observed an increase in WC costs from anywhere between 0% to 100%

Some of the impacts observed are similar to the impacts observed during recessionary periods

Most of the impact is limited to most recent two to three accident years

It is impossible to completely delineate the impact of plant closures from other impacts.

7©Towers Perrin

Claim Frequency

WC benefits can partially substitute for loss of income The differential between full pay and WC benefits is absent Difficult to lay off employees with open WC claims WC benefits usually larger and paid over a longer period of time Additional surgeries/procedures may be scheduled Deterioration of relations between management and employees Lower compliance with appropriate safety behaviors Lower motivation to comply with appropriate safety behaviors

The factors that may cause increased claim filings from laid-off employees are as follows:

8©Towers Perrin

Claim Severity

Shift medical costs for chronic injuries or ailments to WC system

Absence of rehabilitation and return-to-work programs

Distribution of surviving employees

Distribution by type of claim

Some chronic injuries concealed for a longer period of time may be revealed at the time of layoff

Increase in disability duration due to the increased time to find re-employment

Attorney involvement – class action suits, employment practices liability

Moral hazard issues

More frequent and larger lump sum settlements

The reason for the increase in claim severity may be the following:

9©Towers Perrin

Increase in Costs

Increased average duration of temporary total disability cases

Increased medical costs due to increased utilization of medical services

Higher permanent partial disability ratings

Increased claims for occupational disease or cumulative injury cases

Other indemnity benefits

More frequent and larger lump sum settlements

Some of the literature we reviewed on the impact of recessions on WC costs cited the following reasons for the increase in costs:

10©Towers Perrin

Diagnosing the Impact

Reported Claim Counts By Accident Year

-

200

400

600

800

1,000

1,200

12 24 36 48 60

Evaluation Month

11 12 13 14 15

11©Towers Perrin

Diagnosing the Impact

Reported Claim Severity By Accident Year

-

5,000

10,000

15,000

20,000

25,000

12 24 36 48 60

Evaluation Month

11 12 13 14 15

12©Towers Perrin

Diagnosing the Impact

Ratio of Lost Time Claim Counts to Medical Only Claim Counts By Accident Year

0.00

0.20

0.40

0.60

0.80

1.00

12 24 36 48 60Evaluation Month

11

12

13

14

15

13©Towers Perrin

Diagnosing the Impact

Paid ALAE to Paid Loss Ratio By Accident Year

-

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

12 24 36 48 60

Evaluation Month

11 12 13 14 15

14©Towers Perrin

Diagnosing the Impact

Paid Pure Premium per $100 of Payroll

0.0

2.0

4.0

6.0

8.0

10.0

12.0

1998 1999 2000 2001 2002

Fiscal Accident Year

Pai

d L

oss

& A

LA

EPure

Pre

miu

m P

er $

Hundre

d P

ayro

ll

At 3 months At 6 months At 9 months At 12 months At 15 monthsAt 18 months At 21 months At 24 months

15©Towers Perrin

Discussion of Methodology

The non-systemic nature of staff reorganizations can distort the results of standard reserving methodologies

Standard methodologies may over react or under react to the changing conditions

Non-standard methodologies such as the Berquist-Sherman and other similar methods may not be appropriate as the underlying exposure/propensity to loss changes as a result of these staff reorganizations

Claims mix changes

Employee distribution by type of occupation may change

Other factors – employee psychology, employee management relations, etc.

If sufficient data is available, try to segment the loss development data

16©Towers Perrin

Discussion of Methodology (cont’d)

Frequency /Severity Approach:

Back to the basics – adopting a claim frequency severity approach to calculating ultimate loss and reserves

Calculate ultimate claim severity by type of claim

Review claims mix by type of claim

Develop ultimate claim counts using development or Bornhuetter-Ferguson (B-F) approach

Advantages of the frequency/severity approach in a staff reduction scenario:

Avoids the non-systemic distortions caused in the latest diagonals

Allows for explicit adjustment for changes in exposure and type of loss

Allows for the calculation of cost impact for WC costs as result of staff reorganizations

Estimates of ultimate loss form the frequency/severity method can be used as initial expected losses for the B-F techniques

17©Towers Perrin

Discussion of Methodology (Cont’d)

Modified Loss Development Pattern for use in the B-F Methodologies:

Modify historical loss emergence patterns by adjusting for the emergence of the additional plant closure impact

Input from the claim adjusting personnel and the company risk manager essential

Use the modified loss emergence pattern and initial expected loss from the adjusted frequency/severity method to develop estimates based on B-F methods

ALAE Modeling:

Develop empirical model

Model accident year paid ALAE to paid loss ratio using data on variables such as litigation rate of claims and indemnity to med-only claim ratios

18©Towers Perrin

Conclusion

Actuary should consider the impact of plant closures and layoffs when calculating WC liabilities for self-insured entities

Loss estimates produced from the adjusted methods vary based on the assumptions and adjustments made

Loss development methods without any adjustments too responsive

B-F methods without any adjustments slow to respond to the changing conditions

The adjustments made to the B-F method make it more responsive

Using the frequency/severity approach allows the actuary to explore the changes in the underlying propensity to loss and incorporate the changes into the reserving methodology

Most importantly, we should look for the impact and try to understand the changes and communicate these changes to the management