the incredible shrinking residual market session: wcp/pa-37 presented by: tom daley, acas, maaa,...

THE INCREDIBLE SHRINKING

RESIDUAL MARKETSession: WCP/PA-37

Presented by:

Tom Daley, ACAS, MAAA, NCCI

John Winkleman, Jr., FCAS, AIPSO

Richard Amundson, FCAS, MN DOC

© 2000 National Council on Compensation Insurance, Inc.

WORKERS COMPENSATION

Presented By: Tom Daley


OUTLINE

• Historical Perspective

• How did it get so large?

• Impact on the marketplace

• What caused the shrinkage?

• Ratemaking implications

• How will we keep it from growing again?

®


RESIDUAL MARKET ESTIMATED ULTIMATE PREMIUMSAS OF 9/30/1999

* Excludes Maine Residual Market Pool

2.112.60

2.84

3.493.96

4.394.80

4.09

3.08

1.96

1.000.57

0.33 0.27

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Premium ($Billions)

19

86

19

87

19

88

*

19

89

*

19

90

*

19

91

*

19

92

*

19

93

19

94

19

95

19

96

19

97

19

98

19

99

Policy Year


HOW DID IT GROW SO LARGE?

• Inadequate rates

• Poor underwriting results

• Overly generous benefits

• Lack of cost containment

• Excessive fraud

®


RESIDUAL MARKET UNDERWRITING GAIN/LOSSAS OF 9/30/1999

* Excluding Maine** Excluding Maine and New Mexico# Excluding New Mexico

-1372

-1802 -1880-2064

-1693

-1252

-660

-191

66101

8

-34 -47 -50

-2500.0

-2000.0

-1500.0

-1000.0

-500.0

0.0

500.0

Underwriting Gain\Loss ($Millions)

1986

1987

1988

*

1989

*

1990

**

1991

**

1992

**

1993

#

1994

1995

1996

1997

1998

1999

Policy Year


IMPACT ON THE MARKETPLACE

• Carriers stop writing WC

• AR plans grow

• Rates increase

• Employers costs rise

• Movement towards self-insurance


WHAT CAUSED THE SHRINKAGE?

• Residual Market pricing programs

• Reform at all levels

• New state funds

• Residual Market reform

• Increased competition/capacity


WHAT CAUSED THE SHRINKAGE

Residual Market pricing programs:

• Produced additional premium

• ARAP, Differentials, Surcharges

• Removal of premium discounts

Other programs:

• Take-out credit program

• Safety incentive programs


WHAT CAUSED THE SHRINKAGE?Creation of New State Funds

1992 LA, RI

1993 ME

1994 FL (JUA)

1995 KY, MO

1997 HI



Reform at all levels:

• Employers: Increased safety awareness Embraced RTW programs

• Regulators: Tightened up statutes governing benefits Reduced attorney involvement

• Insurers: Better loss control Improved claims management

Increased penetration of managed care



Residual Market Reform:

• Direct assignment option available

• Servicing Carrier bid process Contributed to reduced underwriting

losses

®


RESIDUAL MARKET COMBINED RATIOSAS OF 9/30/1999

165169 166

159

143

129

114

10598

9599

106

115119

90

110

130

150

170

190

Combined Ratio (%)

1986

1987

1988

*

1989

*

1990

*

1991

*

1992

*

1993

1994

1995

1996

1997

1998

1999

Policy Year

* Excludes Maine Residual Market Pool


NCCI RATEMAKING IN TODAY’S

ASSIGNED RISK MARKET

Two general approaches for overall indication:

1. Use total market data (most states)

2. Use AR data only (a few states)

Residual Market Depopulation Policy Year 93 vs. Policy Year 99

All NCCI States

Premium RangePY 93

Policy Count% ofTotal

PY 99Policy Count

% ofTotal

$0 - $2,499$2,500 -$4,999$5,000 - $9,999$10,000 - $49,999$50,000 - $99,999$100,000 - $499,999

$500,000 and over

271,76856,22936,49136,6975,5583,536

163

66.2%13.7%8.9%8.9%1.4%0.9%

0.0%

87,8729,8254,5522,845

18169

3

83.4%9.3%4.3%2.7%0.2%0.1%

>.01%

Total 410,442 100.0% 105,347 100%


NCCI ASSIGNED RISK RATEMAKING

Biggest challenges facing NCCI:

• Volatility of assigned risk data

• Increasing expense provisions as % of premium

• Maintaining Servicing Carrier capacity

• Affordability vs. subsidies (break-even pricing)


HOW WILL NCCI KEEP RESIDUAL MARKETS SMALL?

• Strive for rate adequacy

• Retain pricing programs in AR market

• Help prevent erosion to reforms

Long term goals:

• Maintain a target goal of underwriting loss to voluntary premium ratio <1.0%

• JUA initiative, with National Administration

PRIVATE PASSENGERRATEMAKING

ASSIGNED RISK

John Winkleman, Jr.

AIPSO

RATEMAKING METHODOLOGY

BASED ON SIZE OF PREMIUM

TOTAL PREMIUM < $1.0M

BASED ON COMPARISON TO NON- STD MARKET

TOTAL PREMIUM > $1.0M

BASED ON PROSPECTIVE RATING

New YorkPPNF Liability

0

200

400

600

800

1000

1200

12/8

212

/83

12/8

412

/85

12/8

612

/87

12/8

812

/89

12/9

012

/91

12/9

212

/93

12/9

412

/95

12/9

612

/97

12/9

812

/99

12 Months Ending

12

Mo

nth

s A

ss

ign

ed

sT

ho

us

an

ds

CountrywidePPNF Liability

0

1

2

3

4

12/8212/83

12/8412/85

12/8612/87

12/8812/89

12/9012/91

12/9212/93

12/9412/95

12/9612/97

12/9812/99

12 Months Ending

12

Mo

nth

s A

ss

ign

ed

sM

illio

ns

Countrywide OTPP Liability

0

100

200

300

400

12/8

212

/83

12/8

412

/85

12/8

612

/87

12/8

812

/89

12/9

012

/91

12/9

212

/93

12/9

412

/95

12/9

612

/97

12/9

812

/99

12 Months Ending

12

Mo

nth

s A

ss

ign

ed

sT

ho

us

an

ds

Residual Market Pricing

Richard Amundson

CAS Ratemaking Seminar

March 9, 2000

San Diego

A Paradox

• An assigned risk plan (ARP) whose rates are suppressed may have stable loss ratios even in the face of inflation.

• An ARP whose rates increase based on its own experience may fail to improve its loss ratios.

An Actuarial Explanation

• With rates constant, influx of better risks improves ARP’s book of business, offsetting inflation. When rates increase, departure of good risks hurts book, offsetting improvement due to higher rates.

• If ARP bases prices on its own experience, use of a contingency factor adds to price of each policy like a profit margin. Best business leaves, driving prices of remaining policies to unaffordable levels.

A Second Paradox

• The voluntary market charges for the same coverages as ARP but in addition charges for profit because of its risk.

• ARP has no charge for risk. With no contingency factor, ARP has a rate advantage. It can pick up market share, improve its book, and destroy the voluntary market.

• Maybe ARP should use a contingency factor.

What is the truth?

Will break-even pricing cause ARP to grow or cause it to shrink? Does ARP need a contingency factor or not?

The Scales Fall From Our Eyes

Both these scenarios can happen: ARP may grow or ARP may shrink. Break-even pricing is inherently unstable. To achieve goals normally desired, ARP should base rates on voluntary market rates, not on its own experience.

A Model of Residual Market Pricing Some assumptions

• ARP sets prices to break even based on its own experience.

• ARP’s profit or loss is allocated to the voluntary market.

• Insurance is mandatory; 2 choices: voluntary or ARP.

• An insured buys from market with lowest price.• Expenses are proportional to loss and will be

ignored.

An Instructive Example

• Insurer needs $100 surplus for $200 yr-end loss.• Insurer earns 5% risk-free on invested assets.• Insurer needs a 15% return on equity.

Extreme case 1: ARP has 0 percent market share.• Insurer collects $200 in premium, invests it & the

$100 of surplus.• Insurer earns $15 during the year.• Year-end: insurer pays $200, has $100 plus $15

from investments.

Extreme case 2: ARP has 100 percent market share.

Insurer has no voluntary premium, but retains responsibility for ARP’s losses. Insurer still needs $100 in surplus: all the risks that surplus protects against are still around and still borne by insurer. Insurer has same risk as in case 1, same investment as in case 1, so needs same return. ARP must charge full $200 in order to generate same return.

Regardless of ARP market share, the full $100 surplus is needed and the full $200 premium is needed.

FIGURE 1

MARKET RATES IN EQUILIBRIUM

PREMIUM y

y = x

R

y = ax

x EXPECTED

R’ R LOSS

R = ARP price

ax = voluntary market price

A Natural Limit: Assigned Risk Must Charge Strictly More Than Market Average

L = average expected loss per policyR = ARP price per policyV = voluntary market average pricen = total number of insuredsm = number of ARP insuredsnL = total premium neededmR = premium collected by ARP(n-m)V = premium collected by voluntary market

Insurer pricing problem: find premium, V, which attracts customers ( V < R ) and which leaves an adequate reward for risk ( mR+(n-m)V nL ).

R > V (nL-mR) / (n-m) nR-mR > nL-mR nR > nL R > L

If R L, there is no solution to pricing problem.

The Elusive Search For EquilibriumIf R > L, what happens when ARP reviews rates?

• ARP overcharged insureds with expected losses between R’ and R and undercharged insureds with expected losses > R. Net effect is undercharge, but analysis will not necessarily indicate rate increase.

• ARP doesn’t include profit in its analysis. ARP may charge enough to pay claims: analysis on non-profit basis may show need for rate reduction. Whether analysis will show need for increase or decrease is function of distribution of expected losses.

• Only sure way to remain in equilibrium is to ignore indications.

Table 1

(1) (2) (3) (4) (5) (6)

If ARP writes all risks with losses greater than x ------------------------------------------------------------------------------

x P[X = x] voluntary ARP rate voluntary 1: ARP gains xmarket rate ( for all ) market rate -1: ARP loses x

for x for x + 1 0: equilibrium--- ------------- ------------- ----------- ------------- --------------------20 0.10 30.71 23.81 32.25 121 0.10 25.98 24.29 27.21 122 0.10 25.03 24.76 26.16 123 0.10 25.02 25.24 26.11 024 0.10 25.40 25.71 26.46 025 0.10 25.97 26.19 27.01 026 0.10 26.65 26.67 27.67 027 0.10 27.39 27.14 28.40 128 0.10 28.18 27.62 29.19 129 0.10 29.00

--------24.5 = average expected loss = E[X]

Figure 2Market Rates With ARP Pricing To Break Even

PREMIUM y

29.19 y = x

28.18

27.62

y = 27.62

y = ax

x EXPECTED 28 29 LOSS

27.62 = ARP price

ax = voluntary market price

Table 2

(1) (2) (3) (4) (5) (6)



for x for x + 1 0: equilibrium--- ------------- ------------- ----------- ------------- --------------------20 0.0028 429.57 23.35 451.05 121 0.0095 115.79 23.38 121.30 122 0.0316 47.96 23.46 50.14 123 0.1053 29.86 23.65 31.16 124 0.3508 25.23 24.21 26.28 125 0.3508 25.23 25.14 26.24 126 0.1053 26.06 26.04 27.07 127 0.0316 27.02 26.89 28.02 128 0.0095 28.01 27.62 29.00 129 0.0028 29.00

--------24.5 = average expected loss = E[X]

Table 3

(1) (2) (3) (4) (5) (6)



for x for x + 1 0: equilibrium--- ------------- ------------- ----------- ------------- --------------------1 0.0646 3.71 3.74 7.42 02 0.1769 2.76 4.17 4.13 -13 0.2424 3.32 4.79 4.43 -14 0.2214 4.16 5.52 5.20 -15 0.1516 5.08 6.32 6.10 -16 0.0831 6.04 7.16 7.05 -17 0.0379 7.02 8.02 8.02 -18 0.0149 8.01 8.85 9.01 09 0.0051 9.00 9.52 10.00 0

10 0.0021 10.00-------- 3.74 = average expected loss = E[X]

Table 4

(1) (2) (3) (4) (5) (6)



for x for x + 1 0: equilibrium--- ------------- ------------- ----------- ------------- --------------------1 0.5400 1.12 2.71 2.23 -12 0.2484 2.07 3.66 3.11 -13 0.1143 3.05 4.61 4.07 -14 0.0526 4.03 5.56 5.04 -15 0.0242 5.02 6.49 6.02 -16 0.0111 6.01 7.40 7.01 -17 0.0051 7.01 8.26 8.01 -18 0.0024 8.00 9.01 9.00 -19 0.0011 9.00 9.52 10.00 0

10 0.0009 10.00 -------- 1.85 = average expected loss = E[X]

How To Set ARP Rates

If consensus is in favor of keeping and controlling residual market, break-even pricing is poor tool.

Assuming that ARP will exist, that it should not be too burdensome on voluntary market and that it should not have wild swings in market share, then there is a reasonable solution to rate problem:

Base ARP rates on industrywide experience, consistently higher than what a typical insurer would need to charge in voluntary market.

Setting Specific Goals

Guidelines:

Bigger the voluntary market the better.

Residual market should not be unaffordable.

Expected assessment of residual mkt losses on voluntary mkt insureds not excessive.

Rate changes should not be abrupt.

Possible goals for residual market:

Market share under 1%. Rates under 150% of voluntary. Expected assessment under 0.5%. Annual rate changes < 10% (relative to voluntary

market) during catch-up period.

Using Goals To Set Prices

Residual market can set prices as multiple of voluntary market and measure success directly from goals.

Example of Specific Goals

Final Thoughts

Residual markets don’t usually get into trouble from basing rates on their own experience, but rather from suppressing rates and ignoring the effects.

Basing ARP rates directly on ARP experience may seem the obvious solution to such a problem, but it is an unreliable solution. A better solution is to base the rates on the overall market experience, at a level consistently above the rest of the market.

the incredible shrinking residual market session: wcp/pa-37 presented by: tom daley, acas, maaa,...

Documents

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