California Workers Compensation Insurance Pure Premium Rates and Claims Cost Benchmark Effective January 1, 2014

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1 October 24, 2013 Ms. Christina Carrol, CPCU Attorney California Department of Insurance Legal Division, Government Law Bureau 300 Capitol Mall, 17th Floor Sacramento, CA RE: California Workers Compensation Insurance Pure Premium Rates and Claims Cost Benchmark Dear Ms. Carrol: The purpose of this letter is to comment on the California Workers Compensation Insurance Rating Bureau (WCIRB) pure premium rate and claims cost benchmark filing for policies effective January 1, 2014 through December 31, 2014 (the Filing). I am a member of the WCIRB Actuarial Committee representing the Public Members of the Governing Committee. This supersedes the projections in my prior letter, dated 10/17/13. The projections in this letter are different than those in the prior letter because they reflect both the impact of RBRVS as well as other information discussed at the 10/21/13 WCIRB Actuarial Committee meeting. The following chart compares the WCIRB and Bickmore projections. Table 1 Range of Pure Premium Indications WCIRB 1 Bickmore Range Recommended Low Best Est. High Loss to Industry Avg. Filed Pure Premium Indemnity Medical Total Loss Adj. Expense/Loss ULAE 2 6.8% 5.7% 5.7% 6.0% ALAE % 17.6% 17.6% 16.5% MCCP 2 7.5% 7.5% 7.5% 8.1% Impact Reforms on LAE -10.4% -10.4% -10.4% -10.4% Total 26.6% 27.5% 27.5% 27.4% Additional Impact of SB 863 Added Bickmore Savings 0.00% -7.6% -5.0% -2.5% RBRVS 1.80% -0.6% 0.0% 3.9% Total 1.80% -8.2% -5.0% 1.3% Change in Off-Balance Factor 1-0.6% -0.6% -0.6% -0.6% Difference from Industry Average Filed Pure Premium 3 8.8% -1.1% 7.1% 27.5% Average Pure Premium Rate WCIRB 1/1/14 Pure Premium Rate Filing, Page A:B-61 2 WCIRB 1/1/14 Pure Premium Rate Filing, Pages A:B Difference from Industry Avg. Filed Pure Premium= (Total Loss to Pure Premium) x (1 + Total Loss Adj. Expense/Loss) 1.

2 The Bickmore indications for January 1, 2014, reflect several differences in approach and assumptions between the WCIRB and Bickmore. 1. Ultimate Medical and Indemnity Losses Accident Year (AY) 2012 and Prior: The Filing uses these estimates as a basis for projecting policy year (PY) 2014 rates. Consistent with the prior rate filing, the ultimate loss projections are based on the paid loss development method, with adjustments for the impact of the 2002 through 2004 reforms and additional adjustments for the impact of SB 863. The projections are based on losses valued as of 6/30/013. While we believe that the development method and adjustments selected by the WCIRB are reasonable, we are concerned with the degree to which the ultimate loss projections have increased in the past few rate filings. The Executive Summary of the 1/1/14 Filing (Page 4) shows the deterioration of the ultimate loss projections for AYs over the past few filings. Although, there appeared to be an improvement of the ultimate loss projections between the prior filing and the 4/1/13 WCIRB analysis based on data evaluated as of 12/31/12, the deterioration in the most recent six months suggests the upward trend is continuing. The following chart shows the ultimate loss ratios for accident years 2010 through 2012 in the most recent and two prior WCIRB filings, in addition to the 4/1/2013 WCIRB analysis. Medical and indemnity projections are combined. Please note that the 1/1/13 amended filing and prior ultimate loss ratios include MCCP payments in Medical, while MCCP payments are excluded from Medical in the 4/1/13 WCIRB analysis and 1/1/14 filing ultimate loss ratios. Chart 1 Ultimate Loss Ratios (Medical & Indemnity) Presented in WCIRB Rate Filings Over Time Accident Year 1/1/12 Filing 7/1/12 Filing 1/1/13 Amended Filing 4/1/2013 WCIRB Analysis 1/1/14 Filing WCIRB 1/1/12 Rate Filing is based on data valued as of 3/31/11 WCIRB 7/1/12 Rate Filing is based on data valued as of 12/31/11 WCIRB 1/1/13 Amended Rate Filing is based on data valued as of 6/30/12 WCIRB 4/1/13 Analysis is based on data valued as of 12/13/12 WCIRB 1/1/14 Rate Filing is based on data valued as of 6/30/13 2

3 Over the past few years the WCIRB has made a considerable effort to refine its loss projection methods. The Filing includes 12 different loss projection methods for AY 2012 and prior (WCIRB 1/1/14 Rate Filing, Part A, Section B, Appendices A and B). It is our conclusion that recently the incurred loss development method (latest year, unadjusted) has been more stable than the paid methods and thus should be given weight in the selected pure premium rates. This conclusion is based on the display of ultimate loss projections of several methods over time (WCIRB Actuarial Committee Meeting Agenda August 1, 2013, Item IV-C). As a result, we have weighted together the results of this incurred method with the paid method selected by the WCIRB. Our best estimate reflects 50% weight to the incurred method. We are particularly concerned that the ultimate loss projections using the paid development method increased substantially between the 3/31/13 and 6/30/13 valuation. We believe that part of what appears to be a deterioration in results is actually just an acceleration in the rate in which claims are closed. We believe this acceleration distorts the results as of 6/30/13, so we gave 50% weight to the paid development method using losses valued as of 3/13/13 rather than 6/30/13. The following table highlights the acceleration in the rate at which claims have closed over the past year. Chart 2 Ratio of Incremental Closed Indemnity Claims to Prior Open Indemnity Claims 30.0% 25.0% 20.0% 15.0% 10.0% 27.1% 24.2% 24.5% 23.5% 22.6% 20.6% Prior 12 Months Latest 12 Months 21.4% 20.8% 18.7% 18.3% 5.0% 0.0% Accident Year Months of Development WCIRB Actuarial Committee meeting 10/21/13, Page III-A-6 (page 13). Our low scenario is based on the WCIRB projections, and our high scenario assumes that the best estimate projected ultimate loss ratios for 2011 and 2012 are understated. 3

4 2. Trend Method: The WCIRB July 1, 2014 Filing uses the most recent two full accident years (2011 & 2012) as the base from which to project future claim frequency and average claim size. We have based the best estimate and high projections on an exponential fit, using accident years 2005 through 2012 as the base period. We chose this method for two reasons. First, it utilizes multiple years, not just the two most recent years. Given the increases in loss ratios between valuation dates, we feel it is appropriate to include projections from more mature years in the trending process since the projections for those years are less likely to move significantly. Second, it involves trending pure premium directly rather than separately trending frequency and claim size. Over the past several years the overall pure premium ratio trend has been much more consistent than either the claim frequency or ultimate severity trend. In their 1/1/13 filing, the WCIRB gave 50% weight to exponential trend and 50% to frequency/severity trend. For the 1/1/14 filing, the WCIRB is giving 100% weight to frequency/severity trends. We continue to believe that the exponential trend is the most appropriate and accurate. The data fits an exponential curve very well, with R-square of 0.98 and 0.94 for medical and indemnity benefits, respectively. The projections using an exponential fit are displayed on the following chart. Please note that the pure premium medical ratios for 2010 and prior have been adjusted to remove MCCP payments. Chart 3 On-Level Medical & Indemnity to Industry Average Filed Pure Premium Ratio Bickmore Best Estimate Medical Indemnity /1/15 Accident Year Based on 50% weight to Incurred Development (Latest Year, Unadjusted, as of 3/31/13) and 50% weight to Paid Development method selected by WCIRB. 4

5 3. Claims Severity: The projected change in the ultimate medical and indemnity severities per indemnity claim show similar patterns; severity increases were quite high in the years immediately following major reforms ( ) and have dropped significantly in the past few years ( ). We feel it is important to analyze the severity trends. However, the severity changes have not been predictable from year to year, and they appear to be inversely correlated with changes in frequency. As a result, we do not feel that projecting policy year 2014 costs based on frequency/severity changes is the best approach in this Filing. The following charts show the severity trends by year, as well as the current WCIRB selections for medical and indemnity benefits. The fact that the trends are so different from versus makes it very difficult to project trend factors for 2013 and beyond. Again, the medical severities for 2010 and prior have been adjusted to remove MCCP payments. Chart 4 On-Level Medical Severity Annual % Change Only Includes Indemnity Claims 14.0% 12.0% 10.0% 11.6% 9.4% 10.6% Avg =9.3% 8.0% 6.0% 4.0% 2.0% 0.0% 2.0% WCIRB 1/1/14= 5.0% 5.7% 2.5% Avg. 2010,2012=1.5% 0.3% Accident Year The Medical Severities for 2006 through 2010 have been adjusted to remove MCCP payments WCIRB Rate Filing 1/1/14, page A:B-55. 5

6 Chart 5 On-Level Indemnity Severity Annual % Change Only Includes Indemnity Claims 12.0% 10.0% 8.0% 6.0% 4.0% 3.6% 5.3% 6.0% Avg =4.5% 3.1% WCIRB 1/1/14 = 2.5% 2.0% 0.0% 2.0% 4.0% 0.3% 0.3% % Avg = 0.3% Accident Year WCIRB Rate Filing 1/1/14, page A:B Claim Frequency: The claim frequency trends are also inconsistent by year. As with the severity trends, we feel it is very important to study these trends. However, we do not feel that frequency trend should be used to project policy year 2014 results, because over the past few years the claim frequency has been difficult to predict. 5. Loss Adjustment Expense (LAE): There are three differences between our projected LAE ratios and those of the WCIRB. First, we have reflected differences in our projections of losses, and this affects the denominator of the LAE ratio. Second, our best estimate ULAE and ALAE projections are based on private carrier experience excluding the State Compensation Insurance Fund (SCIF), whereas the WCIRB does give some weight to SCIF experience. Lastly, the WCIRB has projected continued decreases in claim frequency subsequent to 2013, whereas we have projected slight increases. As a result we project a higher volume of indemnity claims in 2014, and that is why our ALAE projections are higher than those of the WCIRB. 6. Impact of SB 863 ( Added Bickmore Savings ): Excluding RBRVS, neither Bickmore nor the WCIRB has changed our estimates of the impact of SB 863 since last year. We provided the State with a detailed description of our projections related to the reforms in a letter dated 10/10/12, which is also part of the public record. In that letter we estimated the ultimate savings from the reform to be 7.6%, excluding RBRVS. The WCIRB projected savings excluding RBRVS are 2.7% (WCIRB Evaluation of the Cost Impact of Senate Bill 863, dated 10/12/12). The 2.7% savings is already reflected in the WCIRB projections of loss pure premiums and loss adjustment expense. However, we have added an additional 5% of savings to reflect that our projected savings are 7.6% and not 2.7%. 6

7 7. RBRVS: The WCIRB has projected that the impact of RBRVS on policy year pure premium 2014 will be 1.8%. RBRVS rates change annually in accordance with the Medicare Economic Index (MEI), and it is this inflation projected through 2017 that is the primary basis for the WCIRB s projection. Our best estimate is that there is no impact of RBRVS, because we believe that the inflation associated with MEI is similar to what is already in the projections. To research the inflation that is already implied in the WCIRB and Bickmore projections, we utilized work from the Workers Compensation Research Institute (WCRI). The WCRI has published estimated price indices which are specific to California workers compensation and which control for changes in utilization ( WCRI Medical Price Index for Workers Compensation, 5 th Edition ). We believe that the medical inflation associated with the WCRI MPI-WC is already reflected in the WCIRB and Bickmore projections. A comparison of the WCRI California MPI-WC and the MEI indicates that the WCRI California MPI-WC has actually been higher than the MEI for 5 of the past 6 years. In other words, even though the California workers compensation fee schedule (OMFS) has changed very little over the past few years, changes in actual payments per service have increased at a rate higher than those of the MEI. As a result, we feel it is reasonable to assume that future changes to RBRVS fees associated with MEI would be similar to payment changes that would have occurred under the OMFS, and so our best estimate assumes that no adjustment is necessary for RBRVS. Chart 6 Comparison of Price Changes Medicare Economic Index (in RBRVS) vs. WCRI California MPI-WC 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 4.0% 1.9% WCRI California MPI WC 1.6% 1.8% 0.9% 0.9% 0.9% 1.0% 1.2% MEI (in RBRVS) 0.8% 0.6% 0.4% Year WCRI Medical Price Index for Workers Compensation, 5 th Edition, page 106 Medicare ( Payment/SustainableGRatesConFact/Downloads/sgr2014p.pdf), Table 6 We agree with the WCIRB that there are many factors associated with RBRVS that simply cannot be quantified but could have a major impact on costs. These include potential changes to the ground rules, utilization, access to care, and fee discounts. 7

8 Other Comments In addition to providing an analysis of the proposed Filing, the following are general comments related to the WCIRB or California workers compensation which we believe are important to consider. 1. Rate Changes: Given that the WCIRB rates are compared to average industry filed pure premium rates, and the industry rates change between each filing, it can be confusing to figure out the underlying changes to rates. The following chart compares the rates in the current and prior Filings. Table 2 Pure Premium Rate Comparison: Prior and Current Filings Industry Group 1/1/13 Filing (Amended) 1/1/14 Filing Change 3 Avg. Insurer Filed Pure % Premium 1 WCIRB Recommended Rate 1 Actuarial Committee % Governing Committee % Bickmore Rates Low % Middle/Best Estimate % High % 1 1/1/14 based on WCIRB Amended rate filing, page 1. 1/1/13 Based on 1/1/14 CDI Decision, page Filed rates in Amended 1/1/13 Filing value November 9, /1/13 Filing rates valued as of 7/1/12. 1/1/14 Filing rates valued as of 7/1/13. Comparison of 1/1/14 Filing vs. 1/1/13 Filing (Amended) 2. Affordable Care Act (ACA): Given the potential interplay between healthcare and workers compensation, we believe it is important to be aware of major healthcare changes when projecting workers compensation costs. Since key aspects of the ACA are due to take effect on 1/1/14, we believe it is critical to think about ways this might impact workers compensation. The following is a listing of issues we think are worth monitoring: a. Frequency of Hospital Billings Decreases: The study The Impact of Health Care Reform on Workers Compensation, Evidence from Massachusetts (RAND, 2012) found that healthcare reform coincided with a decreased volume of workers compensation hospital billings. The idea is that this may be due to cost shifting from workers compensation to healthcare. Based on this it would be interesting to monitor both the frequency and dollars associated with hospital billings. b. Availability of Primary Care Physicians: There has been much discussion regarding whether the ACA will result in a shortage of primary care physicians. Such a shortage could lead to increased negotiated rates for primary care doctors and longer wait times. As a result, we think it would be good to monitor charged rates for primary care physicians as well as the lag between injury and first treatment. It should be noted that under RBRVS primary care physicians will likely have higher workers compensation fees then they had in the past, and this should work to increase the availability of primary care physicians in the workers compensation system. 8

9 c. Comorbidities: It s possible that some of the comorbidities associated with workers compensation claims, like diabetes, will be decreased as more people have healthcare. This could be because people get these conditions treated through healthcare rather than through workers compensation, or people might become generally healthier, and so the prevalence of these comorbidities decreases. d. Generics: It is our understanding that over time the ACA is supposed to make generics available quicker. Therefore it will be important to monitor the mix of generics vs. nongenerics. e. Taxes: The ACA is supposed to introduce some increased taxes on certain medical equipment. We recommend monitoring to see if this increases costs in the workers compensation system. 3. Retrospective Impact of SB 863: Insurers will likely benefit from retroactive cost decreases associated with SB 863. This is because the primary provisions of SB 863 that were projected to increase costs are only implemented on a prospective basis. For example, the changes to permanent disability only affect injuries occurring after 1/1/13. In contrast, some of the provisions expected to lead to costs decreases affected injuries prior to 1/1/13. For example, the changes related to liens and IMR will affect open claims. Insurers are quick to point out when reforms retroactively increase costs, because those costs were not anticipated in the insurance premium. However, it should be pointed out that in the case of SB 863 insurers are benefiting from the retrospective provisions in the reform. 9

10 4. Rates by Industry: The average WCIRB January 1, 2014, recommended pure premium of 2.70 is the 6.7% higher than the average insurer filed pure premium of However, the Filing makes it clear that there are substantial differences between the WCIRB and insurance company pure premiums by class (Executive Summary, Pages 19 through 25). The following chart shows that there are also significant differences between the WCIRB recommended pure premium and insurance company filed pure premiums by industry group. The information in this chart is based on weighted averages of a sampling of 198 class codes representing over 90% of California statewide payroll. Table 3 WCIRB vs. Insurer Pure Premium Rates by Industry Group % that WCIRB PP Rates are Industry Group Higher Than/(Lower Than) Industry Filed PP Rates Administrative 6.4% Agriculture 5.8% Arts & Entertainment 5.9% Clerical 5.8% Construction -3.1% Education 17.1% Finance & Insurance 7.4% Health 12.4% Hospitality 20.3% Information 3.6% Manufacturing 9.0% Mining -13.0% Other 13.9% Outside Sales 0.0% Professional Services 1.3% Real Estate -2.1% Retail 13.0% Transportation 2.0% Utilities -4.6% Wholesale 7.7% Total 6.7% Source: Class Rates from WCIRB January 1, 2014, Rate Filing, Executive Summary Pages 19 through 25. Information by industry is based on weighted averages of a sampling of 198 class codes representing over 90% of California statewide payroll Because of differences between insurance company filed and charged rates, it is difficult to conclude from the preceding table whether or not a specific industry is being under or overcharged in the insurance market. However, the results tend to be very consistent within an industry group. For example, insurance company filed rates were higher than those of the WCIRB in 73% of construction classifications. 10

11 5. The Insurance Market: Not only are the WCIRB recommended pure premium rates higher than those filed by insurers, but insurance charged are well below the filed rates. Pure premium rates only reflect loss and loss adjustment expense, and other insurance company expenses can exceed 20% of premium. While some of this expense is offset by investment income, the return on investments has been low over the past few years. As a result one would expect the charged rates to be much higher than the filed pure premiums. However, the Filing indicates that the average industry charged rate is $2.83, which is only 4.8% higher than the WCIRB recommended pure premium rate of $2.70. Given that the insurance industry charged rates are likely not high enough to cover expenses, one would expect the market to be unprofitable. In fact, the WCIRB is showing loss and expense ratios - excluding investment income - of 140% and 120% for accident years 2011 and 2012, respectively. While these ratios are not as high as those in the late 1990s and early 2000s, a period which resulted in several insurance company insolvencies, we feel that the projected loss and expense ratios call for careful monitoring of the financial health of insurance companies writing workers compensation in California. Aside from profitability, another potential financial concern regarding the insurance industry is understatement of liabilities. Every quarter insurance companies provide the WCIRB with updated loss, payroll, and premium information. Included in this information are projected ultimate losses and liabilities on a direct basis. As of June 30, 2013, the total direct insurance company workers compensation liabilities in California were over $41 billion. One way to measure insurance company reserve adequacy is to compare the ultimate loss projections aggregated for all insurers to those estimated by the WCIRB. The following chart shows that the adequacy of insurance company liability projections has varied significantly over the past 16 years. In the following chart, a positive number means that insurance company estimates are less than those of the WCIRB, whereas a negative number means they are higher than those of the WCIRB. Recently, the insurance company estimates have crossed the line between initially being higher than those of the WCIRB ( ) to being lower than those of the WCIRB ( ). 11

12 Chart 6 CA WC Insurance Company Reserve Inadequacy ($Billions) (2.0) (4.0) (2.5) (0.4) (1.5) Evaluation Year Source: WCIRB Summary of June 30, 2013 Insurer Experience, Exhibit 9. It should be noted that the comparison of insurer and WCIRB ultimate costs are on a direct basis. Net insurance company ultimate losses are affected by deductibles, reinsurance, and other issues. Nevertheless, the preceding figures should be a good indication of overall reserve adequacy. Thank you for your consideration of the issues outlined in this document. We will be testifying at the upcoming rate hearing and will be available to discuss these issues in further detail at that time. Respectfully Submitted, Bickmore Mark Priven, Director of Regulatory and Alternative Risk Consulting Fellow, Casualty Actuarial Society Member, American Academy of Actuaries 12

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