WCIRB January 1, 2015 Pure Premium Rate Filing

Table of Contents Page 1 30 Part A Pure A:1 Section A Proposed Pure Section B Computation of Indicated Average Pure Premium Rate for 2015 Policies Appendix A Loss Development Methodology Appendix B Trending Methodology Appendix C Projected Loss Adjustment Expense Ratio Appendix D Experience Rating Off Balance Correction Factor Section C Classification Relativities Appendix A Classification Relativity Review Sheets A:A-1 A:A-4 A:B-1 A:B-39 A:B-40 A:B-130 A:B-131 A:B-161 A:B-162 A:B-219 A:B-220 A:B-223 A:C-1 A:C-25 A:C-26 A:C-269 Part B Experience Rating Values B-1 B:5 Section A Computation of Experience Rating Values B:A-1 B:A-23 i

A. Introduction Growth in workers compensation underlying costs has continued to outpace exposure growth since the WCIRB s last pure premium rate filing. 1 As a result, in accordance with the recommendations of the WCIRB Actuarial Committee that were approved by the WCIRB Governing Committee, the WCIRB is proposing new advisory pure premium rates on policies effective on or after January 1, 2015. The proposed January 1, 2015 advisory pure premium rates average $2.86 per $100 of payroll, which is approximately 11.3% higher than the industry average filed pure premium rate of $2.57 2 as of July 1, 2014 and 6.7% higher than the average January 1, 2014 advisory pure premium rate of $2.68. 3 The pure premium rates approved by the California Insurance Commissioner are only advisory in that insurers may, and often do, file and use rates other than those approved by the Insurance Commissioner. Consistent with the 2011 directive from the Insurance Commissioner, the WCIRB s proposed advisory pure premium rates have been benchmarked against the average pure premium rates filed by insurers. As in the last several pure premium rate filings, the WCIRB has provided additional information regarding insurer rates, system costs and the insurance market. Pure premium rates reflect the projected cost of indemnity and medical benefits (losses) paid to and on behalf of injured workers and insurers cost of administering those benefits (loss adjustment expenses) relative to insured payroll. Since 2005, when the reforms of 2002 through 2004 were fully implemented, losses and loss adjustment expenses have grown more quickly than the California economy as represented by insured payroll. Chart 1 on the next page shows that the estimated indemnity claim cost level, even after the enactment of Senate Bill No. 863 (SB 863), is projected to increase by 77% from 2005 to policy year 2015. 4 However, California wage levels are projected to grow by only 33% over the same period. This rate of claim cost growth in excess of the growth in underlying workers compensation exposures has resulted in increases in the indicated average pure premium rates. For example, the indicated average January 1, 2015 advisory pure premium rate of $2.86 is 4.4% higher than the WCIRB s indicated average January 1, 2014 advisory pure premium rate of $2.74 per $100 of payroll. 5 1 The WCIRB s Amended January 1, 2014 Pure Premium Rate Filing was submitted on October 23, 2013. 2 Determined based on insurer rate filings submitted to the California Department of Insurance (CDI). These estimates reflect the most recent payroll weights by insurer and classification (from unit statistical data on policies with effective dates in November 2011 through October 2012). 3 This estimate reflects the most current available set of payroll weights by insurer and classification (from unit statistical data on policies with effective dates in November 2011 through October 2012). The average approved January 1, 2014 advisory pure rate as reflected in the Commissioner s decision (based on earlier exposure weights) was $2.70 per $100 of payroll. 4 This reflects the estimated changes in indemnity claim frequency levels and changes in the WCIRB estimated ultimate indemnity losses, medical losses, and allocated loss adjustment expenses per indemnity claim. 5 This estimate reflects the most current available set of payroll weights by insurer and classification (from unit statistical data on policies with effective dates in November 2011 through October 2012). The indicated average January 1, 2014 advisory pure premium rate as reflected in the WCIRB s Amended January 1, 2014 Pure Premium Rate Filing premium rate was $2.75 per $100 of payroll. 1

200% 180% Chart 1 California Workers Compensation Claims and Wage Level Index Average Wage Level Index (Based on UCLA Data) WCIRB Indemnity Cost Level Index 1.74 1.68 1.77 1.56 160% 1.48 1.41 1.42 140% 1.31 1.33 1.28 1.28 1.22 1.24 1.24 1.20 1.14 1.16 120% 1.12 1.12 1.05 1.0 1.10 100% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Policy Year Accident Year 2015 The advisory pure premium rates proposed in this filing reflect the WCIRB s most current evaluation of the cost and savings impact of SB 863. 6 SB 863 was expected to moderate the differential between loss and payroll trends. However, reform savings are partly dependent on subsequent regulatory action, judicial interpretation and practitioner behavioral patterns that can be difficult to foresee when the reforms are initially evaluated. If SB 863 reforms do not materialize to the extent estimated by the WCIRB, the gap between cost and wage levels will widen and the future indicated pure premium rates will be higher. Conversely, if SB 863 savings exceed estimates, the gap could narrow. The WCIRB s SB 863 Cost Monitoring Plan provides a detailed multi-year plan and schedule for reevaluating the impact of the provisions of SB 863 based on emerging post-sb 863 cost levels. 7 The WCIRB s initial cost monitoring report was published last fall. 8 The WCIRB has begun to refine its SB 863 cost and savings estimates based on emerging post-sb 863 experience. 9 However, at this time which is less than twenty months after the effective date of most SB 863 provisions it is still premature to adjust many of the WCIRB s prospective SB 863 estimates based on emerging post-sb 863 costs. The WCIRB will continue to actively monitor post-sb 863 cost levels and will adjust future pure premium rate indications as appropriate based on the emerging experience. The WCIRB s 2014 comprehensive SB 863 cost monitoring report will be published in November. 6 See WCIRB Evaluation of the Cost Impact of Senate Bill No. 863, WCIRB, updated October 12, 2012, for the WCIRB s initial prospective evaluations of SB 863. See Section B of the WCIRB s Amended January 1, 2014 Pure Premium Rate Filing submitted on October 23, 2013 for an evaluation of the new RBRVS schedule adopted pursuant to SB 863. 7 Senate Bill No. 863 WCIRB Cost Monitoring Plan, WCIRB, March 27, 2013. 8 Senate Bill No. 863 WCIRB Cost Monitoring Report Initial Retrospective Evaluation, WCIRB, October 28, 2013. 9 See Item AC14-08-07 of the August 5, 2014 WCIRB Actuarial Committee meeting for updates to the WCIRB s initial evaluation of SB 863 based post-sb 863 emerging costs. 2

B. Rate Information The proposed January 1, 2015 advisory pure premium rates average $2.86 per $100 of payroll, which is 11.3% higher than the industry average filed pure premium rate of $2.57 as of July 1, 2014. In the Amended January 1, 2014 Pure Premium Rate Filing, the WCIRB s average indicated pure premium rate was $2.74 per $100 of payroll (updated from $2.75 that was indicated in the Amended January 1, 2014 Pure Premium Rate Filing by applying the most current available set of payroll weights by insurer and classification). The Insurance Commissioner approved an average advisory pure premium rate as of January 1, 2014 of $2.68 per $100 of payroll (updated from $2.70 in the Decision on the January 1, 2014 Pure Premium Rate Filing, based on the most current available set of payroll weights by insurer and classification). 10 Chart 2 shows (1) the average proposed January 1, 2015 advisory pure premium rate, (2) the industry average filed pure premium rate as of July 1, 2014, (3), the industry average filed manual rate as of July 1, 2014, 11 and (4) the industry average charged rate for the first quarter of 2014, after the application of most insurer rating plan adjustments. 12 The methodologies used to compute the industry average filed and charged rates shown in Chart 2 are described in Exhibit 1 of this. Chart 2 Proposed Advisory and Industry Average Rates per $100 of Payroll $4.00 $3.80 $3.00 $2.86 $2.57 $2.95 $2.00 $1.00 $0.00 Average Proposed Advisory PP Rate 1/1/15 Industry Average Filed PP Rate 7/1/14 Industry Average Filed Manual Rate 7/1/14 Industry Average Charged Rate First Quarter of 2014 Sources: WCIRB January 1, 2014 Pure Premium Rate Filing, insurer rate filings submitted to the CDI, and insurer data submitted in first quarter of 2014 WCIRB data calls. Exhibit 2 shows the advisory pure premium rates proposed by the WCIRB to be effective January 1, 2015 for each standard classification, the corresponding industry average filed pure premium rate as of July 1, 2014, and the difference between these two pure premium rates. 10 The Insurance Commissioner s Decision on the WCIRB s Amended January 1, 2014 Pure Premium Rate Filing was based on the WCIRB s actuarial indication, with the exception that the determination of the approved average pure premium rate excluded the State Compensation Insurance Fund s loss adjustment expense experience and reflected an assumed 2.5% reduction in medical treatment levels resulting from the independent medical review provisions of SB 863. 11 The industry average filed manual rate as of July 1, 2014 of $3.80 per $100 of payroll is $0.20 (+5.6%) higher than the industry average filed manual rate as of July 1, 2013 of $3.60 (based on the most current available set of payroll weights by classification and insurer). 12 This computation is based on reported premium at the insurer rate level, which includes the impact of all insurer rating plan adjustments except for the application of deductible credits, retrospective rating plan adjustments, and terrorism charges. 3

C. System Cost Drivers The indicated average January 1, 2015 pure premium rate of $2.86 per $100 of payroll represents an increase of $0.12, or 4.4%, from the indicated average January 1, 2014 pure premium rate reflected in the WCIRB s Amended January 1, 2014 Pure Premium Rate Filing. The increase is attributable to a number of factors: Medical Loss Development. Medical loss development has continued to deteriorate, thereby increasing WCIRB estimates of ultimate historical accident year loss ratios and the resultant future year medical cost projections. Chart 3 shows the deterioration in the WCIRB s projected historical accident year loss ratios from those evaluated as of June 30, 2013 that were reflected in the January 1, 2014 Pure Premium Rate Filing. 13 Chart 3 Deterioration in WCIRB Projected Ultimate Medical Loss Ratio 65.0 60.0 1/1/2014 Filing (based on June 30, 2013 experience) 1/1/2015 Filing (based on March 31, 2014 experience) 58.5 55.0 53.2 53.5 50.0 45.0 48.2 47.3 40.0 2011 2012 2013 Accident Year Source: WCIRB projections based on reported medical loss development patterns. Increasing Claim Frequency. For many years, indemnity claim frequency had declined. This decades-long decrease in indemnity claim frequency, which averaged approximately 3% to 4% per year, is attributable to multiple factors including long-term shifts from heavy manufacturing to a more service-based economy, increased mechanization within industries and enhanced employer-sponsored safety efforts. However, in 2010, there was a sharp increase in claim frequency that was partly attributable to a spike in cumulative injury claims in the immediate postrecession environment. 14 Rather than returning to the long-term pattern of decline, indemnity claim frequency in 2011 remained high and in 2012, 2013 and the first quarter of 2014 claim frequency increased at an average rate of approximately 4% per year. In late 2013, the WCIRB conducted an analysis of indemnity claim frequency changes since 2010. 15 The WCIRB found that the drivers of the 2012 13 The estimates in Chart 3 are based on the WCIRB s January 1, 2014 Pure Premium Rate Filing loss development methodology and do not reflect the adjustments to long-term medical loss development projections reflected in this filing. 14 See Analysis of Changes in Indemnity Claim Frequency, WCIRB, August 2012 for a full analysis of the 2010 indemnity claim frequency increase. 15 Analysis of Changes in Indemnity Claim Frequency 2013 Report, WCIRB, December 2013. 4

frequency increase differed from the drivers of the 2010 increase. While the 2010 increase was very broad-based, largely driven by economic factors, and mostly affected smaller claims, the 2012 frequency change was largely focused in the Los Angeles regions and affected relatively larger permanent disability claims, most particularly those involving multiple body parts or cumulative injury. Chart 4 shows indemnity claim frequency changes by accident year. Chart 5 shows the frequency changes over the last several years by region. 10.0% Chart 4 WCIRB Estimated Change in Indemnity Claim Frequency 6.9% 3.2% 4.9% 4.6% 0.0% -10.0% -3.0% -6.4% -2.3% -3.9% -1.9% -0.9% -13.9% -20.0% -17.0% 02-03 03-04 04-05 05-06 06-07 07-08 08-09 09-10 10-11 11-12 12-13 13-14 3 mos. Accident Year Source: WCIRB projections based on reported indemnity claim count information. Indemnity Claims per $1 Million Payroll 0.50 0.40 0.30 0.20 0.10 0.00 Chart 5 Indemnity Claim Frequency by Region -3% Bay Area +2% Central California +19% Los Angeles County +14% Remainder of LA Basin Accident Year 2009 Accident Year 2010 Accident Year 2011 Accident Year 2012 +9% San Diego County +4% All Other Regions +9% All Regions Source: WCIRB unit statistical data at first report level. Frequency is per $1 million insured payroll at a 2010 wage level. Region information is based on the employer zip code reported on the California policy. While the SB 863 permanent disability benefit increases were expected to impact claim frequency, the increases experienced in the last several years are well in excess of the levels projected. The WCIRB is continuing its analysis of these frequency patterns to assess the extent 5

to which the higher frequency levels over the last several years are attributable to a greater than anticipated reaction to the higher SB 863 benefit levels. Greater Recognition of Changing Long-Term Medical Development. For a number of years, the year-to-year paid losses emerging on older accident years has been in excess of WCIRB projections. Earlier this year, the WCIRB conducted a study of this long-term medical loss development. 16 The study showed there was a fundamental shift in medical payment patterns in the mid-1990 s following the 1996 Minniear decision. 17 Chart 6 shows the dramatic shift in medical payment development between 36 months and 96 months in the mid-1990s. While paid medical losses in the pre-minniear period increased by less than 30% from 36 months to 96 months, the ratio changed dramatically in the mid-1990 and now medical paid losses develop by more than 80% for the same period. Chart 6 also shows that this fundamental shift that occurred in California was not shown in the composite data compiled by the National Council on Compensation Insurance (NCCI) for other states. Chart 6 - Paid Medical Development From 36 to 96 Months California vs. Countrywide 2.000 California Countrywide * 1.800 1.600 1.400 1.200 1.000 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 Calendar Year * NCCI countrywide pattern is from NCCI Annual Statistical Bulletins (latest year) and excludes California and several other states. The WCIRB study showed that using recent paid development on older pre-minniear accident years to project future development of post-minniear accident years significantly understated medical development. The study recommended an enhancement to project long-term loss development that has been adopted for use in this filing. SB 863 Impact on Frictional Costs. SB 863 was intended to significantly reduce frictional costs while increasing permanent disability benefits for injured workers. The WCIRB s initial prospective analyses of SB 863, as reflected in the Amended January 1, 2013 and January 1, 2014 Pure Premium Rate Filings, indicated that once the estimated impact of the resource-based relative value scale (RBRVS) medical fee schedule is reflected, the increased costs arising from SB 863 were estimated to be slightly less than the cost savings resulting from the SB 863 reforms. 18 16 See Item AC14-03-03 of the June 11, 2014 WCIRB Actuarial Committee meeting for a complete discussion of this analysis. 17 Minniear v. Mount San Antonio Community College District (1996) 61 Cal. Comp. Cases 1055 (Appeals Board en banc opinion). 18 See WCIRB Evaluation of the Cost Impact of Senate Bill No. 863, WCIRB, updated October 12, 2012 for the WCIRB s initial evaluation of SB 863. See Section B of the WCIRB s Amended January 1, 2014 Pure Premium Rate Filing submitted on October 23, 2013 for an evaluation of the new RBRVS schedule adopted pursuant to SB 863. 6

A key measure of frictional costs in the system is loss adjustment expenses (LAE). LAE are costs paid by insurers in investigating, administering, defending and settling workers compensation claims. These expenses include the costs associated with handling claims that can be directly allocated to a particular claim (allocated loss adjustment expenses or ALAE), as well as costs associated with handling claims that cannot be directly allocated to a particular claim (unallocated loss adjustment expenses or ULAE). Chart 7 shows the average paid ALAE per reported indemnity claim by accident year for private insurers. Chart 8 shows the average calendar year incurred ULAE as a ratio to indemnity claims open at the beginning of the calendar year for private insurers. $1,500 Chart 7 Paid ALAE Per Indemnity Claim at 15 Months Private Insurers $1,000 $796 $847 $944 $1,036 $1,131 $1,147 $1,141 $1,212 $500 $0 2006 2007 2008 2009 2010 2011 2012 2013 Accident Year $2,000 Chart 8 Paid ULAE Per Open Indemnity Claim Private Insurers $1,676 $1,683 $1,698 $1,762 $1,500 $1,000 $500 2010 2011 2012 2013 Calendar Year As shown in Charts 7 and 8, both ALAE and ULAE severities show significant increases in 2013 the initial year of post-sb 863 experience. As shown in Chart 9, these increases vary dramatically from the WCIRB s severity growth projected in the Amended January 1, 2013 Pure Premium Rate Filing that reflected the projected frictional cost reductions arising from SB 863 in addition to estimated regular inflation in ALAE and ULAE costs. 7

10% 5% Chart 9 2013 Post-SB 863 Severity Changes Projected Vs. Actual 6.2% Projected Actual (Current Estimate) 3.8% 0% -5% -10% -7.8% -15% ALAE -12.3% ULAE The WCIRB s initial report monitoring the cost impact of SB 863 was published last fall. 19 The WCIRB has begun to refine its SB 863 cost estimates based on additional emerging post-sb 863 experience. 20 The reduction in the volume of liens filed after the January 1, 2013 effective date of SB 863 is greater than initially projected. As a result, the WCIRB has increased its projected SB 863 savings estimates arising from the SB 863 lien provisions by approximately $200 million. However, the projected savings resulting in frictional costs arising from the SB 863 provisions related to independent medical review (IMR) are not materializing. The WCIRB s estimated frictional cost savings related to IMR were predicated on replacing higher cost medical treatment dispute resolution mechanisms such as medical liens and the qualified medical evaluator (QME) and expedited hearing processes with lower cost IMRs. However, Division of Workers Compensation (DWC) data on IMR suggests the volume of IMRs is two to four times higher than that contemplated in the initial cost estimates. Also, while at a reduced volume, medical treatment on a lien basis is still occurring. Finally, while qualified medical evaluations are generally not being conducted on medical necessity issues, many claims, partially in response to the Dubon decision, 21 are having expedited hearings on utilization review issues. For all these reasons, the WCIRB s updated cost projections reflected in the proposed January 1, 2015 pure premium rates do not reflect the estimated frictional cost savings of approximately $200 million resulting from the IMR provisions of SB 863 that were reflected in earlier WCIRB evaluations of SB 863. 19 Senate Bill No. 863 WCIRB Cost Monitoring Report Initial Retrospective Evaluation, WCIRB, October 28, 2013. 20 See Item AC14-08-07 of the August 5, 2014 WCIRB Actuarial Committee meeting for updates to the WCIRB s SB 863 cost evaluation based post-sb 863 emerging costs. 21 Dubon v. World Restoration, Inc., 79 Cal. Comp Cases 566. 8

Reduced Economic Forecasts of Future Wage Inflation. Since workers compensation rates are expressed as a percentage of payroll, wage inflation generates additional premium to help offset claim cost inflation. UCLA forecast wage growth continues to be modest as the California economy continues its recovery from the Great Recession of the last decade. Chart 10 shows the changes in UCLA average wage forecasts for 2013, 2014 and 2015 since the time of the Amended January 1, 2014 Pure Premium Rate Filing. Chart 10 Forecasts of Changes in California Average Annual Wage Level 4.0% 3.0% 1/1/2014 Filing (based on June 2013 UCLA Forecast) 1/1/2015 Filing (based on June 2014 UCLA Forecast) 2.7% 2.7% 2.6% 2.4% 2.0% 1.5% 1.0% 0.4% 0.0% 2013 2014 2015 Year Experience Rating Off-Balance. Experience rating is designed to be premium-neutral in that the total statewide pure premium, after application of experience rating, should be the same as if there were no experience rating. However, the collective experience of large employers, to which experience rating assigns greater weight, has been better than average, and the collective experience of small employers, many of which are not experience rated, has been worse than average. As a result, if no adjustment was made, the statewide average experience modification would be below 100%, and the pure premium rates would be insufficient to provide for losses and loss adjustment expenses after application of experience rating. Every year, the WCIRB computes the indicated experience rating off-balance factor to be applied to the pure premium rates based on the latest available information on historical experience modifications. As the statewide average experience modification has declined modestly in 2014, the indicated off-balance for policy year 2015 has increased by 0.6% to1.030. 9

D. Supplemental Insurance Market Information After a long period of decline and with the significant increases in underlying cost drivers since 2005, the industry average charged rates began to increase in 2010. As shown in Chart 11, the industry average charged rate of $2.95 for policies incepting in the first quarter of 2014 is 40% above the 2009 low ($2.10), but remains 53% below the high prior to the reforms of 2002 through 2004 ($6.29). $8.00 Chart 11 Industry Average Charged Rate Per $100 of Payroll $6.29 $6.00 $5.49 $4.36 $4.00 $2.85 $2.30 $2.15 $2.10 $2.25 $2.32 $2.39 $2.57 $2.84 $2.95 $2.00 $0.00 7/03-12/03 7/04-12/04 7/05-12/05 7/06-12/06 7/07-12/07 2008 2009 2010 2011 1/12-6/12 Policy Period 7/12-12/12 2013 1/14-3/14 Source: Insurer unit statistical reports and WCIRB data calls. Chart 12 on the following page shows the combined ratio of WCIRB projected losses, loss adjustment expenses, and other insurer expenses to earned premium by accident year. 22 As shown in Chart 12, rising claim costs, combined with relatively flat industry average charged rates, led to increasing accident year combined ratios through accident year 2010. Over the last several years, higher insurer charged rates, modest claim cost trends, and lower insurer expense ratios resulted in an improved insurer combined loss and expense ratio. However, accident year 2013 s combined ratio of 116% remains well above the national average for workers compensation of 99% 23 and the long-term historical norm. 22 These combined ratios reflect WCIRB estimates of ultimate losses and loss adjustment expenses by accident year relative to calendar year earned premiums. Insurers also report calendar year combined ratios, which reflect their paid losses and loss adjustment expenses and changes in reserves reported during a calendar year relative to calendar year earned premium. These two measures of combined ratios may differ. Also, these are combined underwriting results and, as such, do not reflect profits, federal income taxes, or investment income returns. 23 Countrywide estimate is from the NCCI May 8, 2014 State of the Line Presentation and reflects only private insurer data. 10

Chart 12 WCIRB Projected Ultimate Accident Year Combined Loss and Expense Ratios as of March 31, 2014 200% 150% 100% 50% 175% 20% 151% 21% 18% 18% 120% 16% 15% 134% 115% 89% Losses LAE Other Expenses 144% 147% 146% 122% 22% 23% 23% 127% 20% 24% 24% 20% 116% 98% 33% 19% 84% 18% 19% 25% 23% 15% 73% 60% 16% 12% 58% 16% 14% 14% 9% 10% 12% 57% 37% 34% 45% 64% 83% 98% 100% 90% 82% 74% 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011* 2012* 2013* Accident Year Source: WCIRB projections based on insurer aggregate financial data submissions to the WCIRB. * For accident years 2011-2013, MCCP costs are included in LAE rather than loss. For all other accident years, MCCP costs are included in loss. As shown in Chart 13, increasing loss and expense ratios have led to reduced profitability (return on net worth). The estimated return on net worth for calendar year 2012 for California workers compensation insurance, as reflected in the National Association of Insurance Commissioners (NAIC) most recent report on profitability, 24 is 3.9%. This is well below the 13.4% Fortune Magazine all-industry average return shown in the NAIC report. The long-term 15-year average return on net worth for California workers compensation as published by the NAIC is 3.8% as compared to 13.2% for the Fortune Magazine all-industry average. Chart 13 NAIC Estimates of Average Return on Net Worth 30% Fortune Magazine - All Industry California Workers' Compensation 20% 13.4% 15.2% 14.6% 14.9% 15.4% 15.2% 10.4%10.2% 12.6%13.9% 13.1%10.5% 12.7% 14.3% 13.4% 10% 12.6% 14.2% 16.4% 12.1% 0% 1.0% 3.1% 7.0% 4.6% 5.2% 7.4% 3.9% -10% -6.7% -5.3% -7.3% 15-Year Arithmetic Average Return California Workers Compensation 3.8% -11.5% Fortune Magazine All Industry 13.2% -20% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: NAIC Report on Profitability in 2013 Calendar Year 24 Report on Profitability by Line and State in 2012, NAIC, 2013. 11

E. Summary of Pure Premium Rate Filing Information Proposed Advisory Pure (Part A) The proposed January 1, 2015 advisory pure premium rates and the methodologies used to compute those pure premium rates are presented in Part A of this filing. Computation of Average Proposed January 1, 2015 Pure Premium Rate The average proposed January 1, 2015 pure premium rate of $2.86 per $100 of payroll is based on a comparison of the losses and loss adjustment expenses (LAE) projected to be incurred on policies incepting in 2015 to the premium that would be generated on those policies using the industry average filed pure premium rates as of July 1, 2014. The proposed pure premium rates for policies incepting in 2015 are based on an evaluation of the loss, LAE, and premium experience of calendar-accident years 1984 through 2013, valued as of March 31, 2014. Beginning with policies incepting on or after July 1, 2010, the California Workers Compensation Uniform Statistical Reporting Plan 1995 requires that the cost of medical cost containment programs (MCCP) be reported as ALAE rather than as medical loss. As a result, portions of accident year 2010 and accident year 2011 reported MCCP costs are included in medical loss and portions are included in ALAE. In this filing, the medical loss information for the 2011 through 2013 accident years and the projected medical on-level loss ratio underlying the indicated average pure premium rate exclude any provision for MCCP costs. Similarly, projected LAE amounts include the cost of MCCP, which was projected as a separate component of ALAE. The average proposed pure premium rate for policies incepting in 2015 reflects a wide range of actuarial and economic projections based on methodologies recommended by the WCIRB. The principal methodologies and projections used by the WCIRB in calculating the average proposed pure premium rate as detailed in Part A, Section B of this filing are summarized below. 1. Loss Development Methodology. The proposed policy year 2015 pure premium rates are intended to reflect the estimated final, or ultimate, cost of losses and LAE on all accidents that arise on policies incepting in 2015. However, since workers compensation claims that are incurred in a particular year will be paid out over many years, the losses reported for each historical accident year are adjusted, or developed, to reflect the ultimate cost of all accidents that occurred during that year. This process is known as loss development. Consistent with recent WCIRB pure premium rate filings and corresponding CDI decisions, the WCIRB is again recommending projecting the statewide losses paid for each accident year as of March 31, 2014 through 195 months based on historical development patterns of losses paid as the claims mature. However, as discussed in reference to Chart 6 above, the 1996 Minniear decision fundamentally altered the pattern of workers compensation medical delivery in California and medical paid development continues to emerge at a dramatically slower rate than during the pre-minniear period. As a result, using current year development of pre-minniear accident years to project future development of post-minniear accident years significantly understates the development of those years. To correct for this fundamental shift in payment patterns, the WCIRB has recommended using incurred loss development, which is much less affected by the payment pattern shift, to project medical loss development beyond 195 months. 25 In prior pure premium rate filings, paid development patterns have been adjusted to reflect the impact of the 2002 through 2004 reforms. However, the WCIRB s most recent analysis of these reforms conducted earlier this year showed that these adjustments are no longer improving the accuracy of 25 See Item AC14-03-03 of the June 11, 2014 WCIRB Actuarial Committee meeting for a complete discussion of this analysis. 12

the projection and, as a result, have been eliminated. 26 SB 863 increased indemnity benefits effective January 1, 2013 and January 1, 2014 and included a number of structural reforms to the workers compensation benefit delivery system. Many of these provisions impact benefits incurred on all open claims regardless of the date of injury. Additionally, accident year development factors for 2012 and prior years that emerged after January 1, 2013 reflect a mix of payments made under the pre-sb 863 environment and the post-sb 863 environment and can be distorted. In 2013, the WCIRB analyzed the potential impact of SB 863 on indemnity and medical paid loss development patterns and developed a number of adjustments to correct for the impact of the Bill on paid loss patterns. 27 The WCIRB continues to believe these reform adjustments are appropriate and the recommended adjustments to loss development to reflect the impact of SB 863 are discussed in Part A, Section B, Appendix A. 28 The SB 863 reform adjustments reflected in this filing have been adjusted based on the most current available information on emerging post-sb 863 costs including cost information related to liens and IMR. 29 For informational purposes, the WCIRB has computed a series of alternative January 1, 2015 pure premium rate projections over a wide range of alternative loss development methodologies (see Exhibit 3). The resultant indicated average January 1, 2015 pure premium rates range from $2.63 to $2.92 per $100 of payroll. The assumptions underlying these alternative loss development methodologies as well as the methodology recommended by the WCIRB are discussed in detail in Part A, Section B, Appendix A. The proposed January 1, 2015 pure premium rates are based on statewide loss and loss adjustment experience evaluated as of March 31, 2014. In late 2013, the DWC adopted a new physician fee schedule based on RBRVS used by Medicare effective January 1, 2014. As shown in Chart 14, in the first quarter of 2014, medical payments were significantly less than in recent calendar quarters, which may, in part, be a result of physicians and insurer bill review vendors modifying their billing and payment systems to reflect the new schedule. These potential delays in payments in the first quarter may cause an increase in paid medical development in the second quarter. The WCIRB will be reviewing accident year experience valued as of June 30, 2014 once it is received and, if appropriate, will amend the pure premium rates proposed in this filing. 26 See Item AC14-08-06 of the August 5, 2014 WCIRB Actuarial Committee meeting for an evaluation of the continued appropriateness of the 2002 through 2004 reform adjustments to the loss development projections. 27 Impact of Senate Bill No. 863 on Loss Development Patterns, WCIRB, August 13, 2013. 28 See Item AC14-08-06 of the August 5, 2014 WCIRB Actuarial Committee meeting for an evaluation of the continued appropriateness of the SB 863 reform adjustments to the loss development projections. 29 See Item AC14-08-07 of the August 5, 2014 WCIRB Actuarial Committee meeting for an updated evaluation of SB 863 based on the most current available emerging post-sb 863 information. 13

Chart 14 Total Medical Payments By Calendar Quarter ($ s in millions) $1,500 $1,400 $1,300 $1,200 $1,168 $1,163 $1,283 $1,233 $1,295 $1,290 $1,279 $1,176 $1,100 $1,114 $1,000 1 Q12 2 Q12 3 Q12 4 Q12 1 Q13 2 Q13 3 Q13 4 Q13 1 Q14 Calendar Quarter-Year 2. Trending Methodology. The pure premium rates effective January 1, 2015 are intended to reflect the cost of losses and LAE incurred on all accidents that arise on policies incepting in 2015. As a result, ultimate cost (loss) information on historical accident years is adjusted, or trended, to reflect the ultimate cost of claims covered by policies incepting in 2015. First, losses are adjusted to a current, or on-level, basis by adjusting for wage inflation, statutory benefit changes and reforms, and fee schedule changes. The on-level adjustments to reflect the impact of SB 863 have been adjusted from those reflected in the January 1, 2014 pure premium rate filing to reflect the most current post-sb 863 information available. 30 In particular, the estimated impact of the SB 863 reforms related to liens and IMR have been adjusted based on the emerging post-sb 863 experience. As with accident year losses, each historical year s earned premium is adjusted to a current, or on-level, basis by adjusting for wage level changes, rate changes and other factors impacting premiums. The loss ratios shown for historical accident years, once adjusted to an ultimate and on-level basis, are used to project the policy year 2015 loss ratio at the industry average filed pure premium rate level as of July 1, 2014. As in the last several pure premium rate filings, the WCIRB projected future loss trends are based on separate projections of indemnity claim frequency and claim severity. The WCIRB forecasts frequency changes using an econometric model developed based on a longterm, forty-year history of frequency changes in relation to changes in economic and other claimsrelated factors. 31 After a period of steady long-term frequency decline, indemnity claim frequency increased sharply in 2010 and since that time has continued to increase rather than returning to the typical long-term rate of decline. The WCIRB s frequency forecast, however, reflects a balance between long-term and shorter term trends. The frequency forecasts reflected in the WCIRB s projected policy year 2015 pure premium rate range from -0.4% to -0.1% annually for the 2014 through 2016 period. While recent accident year frequency is emerging at levels higher than that in the past, recent accident year claim severities have not increased at rates consistent with historical trends. Charts 15 and 16 show the estimated ultimate severities by accident year for indemnity and medical losses, respectively. 30 See Item AC14-08-07 of the August 5, 2014 WCIRB Actuarial Committee meeting for an updated evaluation of SB 863 based on the most current available emerging post-sb 863 information. 31 Brooks, Ward, California Workers Compensation Benefit Utilization A Study of Changes in Frequency and Severity in Response to Changes in Statutory Workers Compensation Benefit Levels, Proceedings of the Casualty Actuarial Society, Volume LXXXVI, 1999, pp. 80 262. 14

$30,000 $20,000 Chart 15 WCIRB Projected Ultimate Indemnity Loss Per Indemnity Claim Based on Experience as of March 31, 2014 $26,106 $26,064 $25,156 $25,972 $26,116 $26,544 $22,539 $20,732 $18,773 $10,000 $0 2005 2006 2007 2008 2009 2010 2011 2012 2013 Accident Year $60,000 Chart 16 WCIRB Projected Ultimate Medical Loss Per Indemnity Claim Based on Experience as of March 31, 2014 (Including Medical Cost Containment Program Costs) $50,000 $40,000 $30,000 $32,013 $36,044 $40,648 $45,229 $48,345 $50,174 $51,865 $51,927 $51,354 $20,000 $10,000 2005 2006 2007 2008 2009 2010 2011 2012 2013 Accident Year The WCIRB s 2012 and 2013 reports on claim frequency show that the recent changes in claim frequency and claim severity could be interrelated. The lower than typical severity growth rates in 2010 and 2011 are partly attributable to an increase in the number of relatively smaller indemnity claims that may have otherwise been medical-only claims in the past. 32 However, the WCIRB s 2013 frequency study suggests that for 2012, the increased frequency was largely driven by an increase in 32 Analysis of Changes in Indemnity Claim Frequency, WCIRB, August 2012. 15

larger permanent disability claims, many involving cumulative injury and multiple body parts. 33 Nevertheless, recent severity changes remain modest and, as a result, the WCIRB believes that some moderation of forecast future claim severity growth is appropriate. The WCIRB is projecting future indemnity and medical claim severity growth based on the approximate average rate of growth between the longer term (post-2005) and shorter term (post-2008) periods. This results in severity growth projections of 1% for indemnity and 4% for medical. (These projections compare to 2.5% for indemnity and 5% for medical in the January 1, 2014 Pure Premium Rate Filing.) In summary, combining these severity growth projections with the frequency projections discussed above produces an implied average combined loss trend rate of 1.6% for indemnity and 4.6% for medical. For informational purposes, the WCIRB has computed a series of alternative January 1, 2015 pure premium rate projections over a wide range of alternative trending methodologies (see Exhibit 4). The resultant indicated average January 1, 2015 pure premium rates based on these alternative trending methods range from $2.74 to $3.12 per $100 of payroll. The assumptions underlying each of these alternative trending methodologies as well as the methodology recommended by the WCIRB are discussed in detail in Part A, Section B, Appendix B. 3. Loss Adjustment Expense Projection Methodology. The California Insurance Code provides that the advisory pure premium rates include the costs associated with LAE. The WCIRB makes separate projections of ALAE and ULAE. As in the last several pure premium rate filings, the WCIRB projected policy year 2015 ULAE based on the relationship of calendar year paid ULAE amounts, which the WCIRB began to collect beginning with the 2010 calendar year, to paid losses and open indemnity claim counts. Most of the provisions of SB 863 became effective January 1, 2013 and as a result are reflected in emerging 2013 LAE costs. However, both 2012 and 2013 are used as the basis of projecting policy year 2015 ULAE and calendar year 2012 ULAE was not impacted by SB 863. As a result, calendar year 2012 ULAE was adjusted to an on-level basis by reflecting the WCIRB s most current estimate of the impact of SB 863 on LAE. In recent pure premium rate filings, given the unusual patterns of State Compensation Insurance Fund (State Fund) ULAE experience and the unique statutory characteristics of State Fund, the weight given to State Fund s ULAE experience was tempered by 50% in the pure premium rate projection. However, given continued anomalies in State Fund s LAE experience and the CDI s expressed concerns with including any State Fund ULAE experience in the approved advisory pure premium rate projection, the WCIRB based the LAE provisions in the 2015 pure premium rate projection solely on the experience of private insurers. The projected policy year 2015 ULAE provision using this methodology is 5.4% of losses. As in prior pure premium rate filings, the ALAE projection was based on a methodology that reflected estimated ultimate ALAE per indemnity claim. The projected policy year 2015 ALAE, excluding MCCP costs and State Fund s ALAE experience and using similar methodologies to adjust for SB 863 as used for ULAE, is 15.0% of losses. The WCIRB separately projected the cost of MCCP using a similar methodology as used for the projection of ALAE excluding MCCP based on the cost of estimated ultimate MCCP per indemnity claim by accident year. The projected policy year 2015 MCCP provision computed on this basis is 7.1% of losses. For informational purposes, the WCIRB has computed a series of indicated policy year 2015 LAE provisions based on a variety of alternative ALAE and ULAE projection methodologies. Estimates of ULAE range from 5.1% to 12.5% of losses as compared to 5.4% reflected in this filing (see Exhibit 33 Analysis of Changes in Indemnity Claim Frequency 2013 Report, WCIRB, December 2013. 16

5.1). Estimates of ALAE range from 10.7% to 15.0% of losses as compared to 15.0% reflected in this filing (see Exhibit 5.2). The assumptions underlying each of the alternative LAE projection methodologies as well as the methodologies recommended by the WCIRB are discussed in Part A, Section B, Appendix C. 4. Experience Rating Off-Balance Correction Factor. The WCIRB annually computes the indicated offbalance adjustment to pure premium rates to offset the anticipated lower-than-unity average experience modification. For 2015, the indicated experience rating off-balance correction factor based on the most current available information on issued experience modifications is 1.030. This is 0.6% greater than the 2014 off-balance factor of 1.024. The computation of the indicated 2015 experience rating off-balance correction factor is discussed in Part A, Section B, Appendix D. Computation of Standard Classification Pure The proposed January 1, 2015 pure premium rate for each standard classification is based on the allclassification average proposed January 1, 2015 pure premium rate as computed in Part A, Section B and the 2015 classification relativity for each standard classification. The computation of the 2015 classification relativities is described in Part A, Section C. Proposed Changes to the Experience Rating Values (Part B) The WCIRB is proposing that the rating values that underlie the computation of experience modifications be updated to reflect the most current available experience. As in the January 1, 2014 Pure Premium Rate Filing, in order to reduce year-to-year volatility in a classification s expected loss rates, the proposed 2015 expected loss rates have been limited such that the change in a classification s expected loss rate relativity is no more than 15% from the classification s 2014 expected loss rate relativity. The methodology used to compute proposed 2015 expected loss rates is discussed in Part B, Section A. 17

Exhibit 1 Computation of Proposed and Industry Average Rates A. Computation of Industry Average Filed Manual Rate as of July 1, 2014 1 1. For each of the 120 largest insurers in California, 2 the WCIRB determined the filed manual rate for each standard classification as of July 1, 2014 based on the insurer s rate filing information submitted to the California Department of Insurance (CDI). In instances when an insurer s filed manual rates reflected a deviation from the standard classification system (e.g., by sub-classification, tier or territory), the WCIRB obtained additional information from the insurer as to the volume of business written for each of the deviated classifications. This information was used to compute the insurer s average filed manual rate for the applicable standard classification. 2. For each of the 120 insurers, the payroll reported to the WCIRB on unit statistical reports (USRs) for 2012 policies 3 (reported payroll) for each standard classification (classification) was extended by the insurer s applicable filed manual rate. 4 For each classification, the resulting premium for all 120 insurers was summed and divided by the total reported payroll for the classification for all 120 insurers to produce an industry average filed manual rate for the classification. 3. The total reported payroll for each classification for all insurers was extended by the industry average filed manual rate for the classification. The resulting premium for each classification was summed and divided by the total reported payroll for all classifications for all insurers to produce the industry average filed manual rate. B. Computation of Industry Average Filed Pure Premium Rate as of July 1, 2014 5 1. For each of the 120 largest insurers in California, the WCIRB determined the filed pure premium rate for each classification as of July 1, 2014 by adjusting each insurer s filed manual rate by classification, derived as described in Section A, paragraph 1 above, to remove the applicable underwriting expense loading factor reflected in the insurer s rate filing information. 2. For each of the 120 insurers, the reported payroll for each classification was extended by the insurer s applicable filed pure premium rate. For each classification, the resulting pure premium for all 120 insurers was summed and divided by the total reported payroll for the classification for all 120 insurers to produce an industry average filed pure premium rate for the classification. 3. The total reported payroll for each classification for all insurers was extended by the industry average filed pure premium rate for the classification. The resulting pure premium for each classification was summed and divided by the total reported payroll for all classifications for all insurers to produce the industry average filed pure premium rate. 1 The average filed manual rate varies dramatically across insurers for a variety of reasons, including the mix of classifications written, underwriting practices, and use of rating plan adjustments. For example, an insurer with relatively high manual rates may, as a matter of underwriting practice, apply higher schedule credits than an insurer with lower manual rates. 2 In total, these insurers wrote in excess of 98% of the California workers compensation insurance market in 2013. 3 The most current USRs available were for policies incepting November of 2011 through October of 2012. 4 If an insurer filed deviations from standard classifications, the average filed manual rate for the applicable standard classification, derived as described in Section A, paragraph 1 above, was used instead. 5 An insurer s filed pure premium rates are a function of the set of advisory pure premium rates referenced in its rate filing as well as the manner in which the rate filing was developed. An insurer with an average filed pure premium rate greater than the industry average filed pure premium rate may or may not have higher than average filed manual rates, as the insurer may choose to apply a relatively small expense loading to develop the manual rates filed with the CDI. For example, for the 120 insurers studied, the percentage loadings in insurer rate filings applied to an insurer s pure premium rates to develop manual rates ranged from 17.4% to 90.6%. The average pure premium rate varies dramatically across insurers due to a variety of reasons, including the mix of classifications written, underwriting practices, the manner in which the insurer rate filing was prepared, and use of rating plan adjustments. 18

Exhibit 1 C. Computation of Proposed Average Pure Premium Rate The industry average filed pure premium rate as of July 1, 2014 derived as described in Section B, paragraph 3 above, is adjusted by the Indicated Difference from Industry Average Filed Pure Premium Rate as of July 1, 2014 (line 5 of Part A, Section B, Exhibit 8) to produce the proposed average pure premium rate per $100 of payroll for policies incepting in 2015. D. Computation of Industry Average Charged Rate for the First Quarter of 2014 1. The average advisory pure premium rate for the first quarter of 2014 is estimated by extending the January 1, 2014 advisory pure premium rate for each classification by the reported payroll for the classification for all insurers. 2. The industry average charged rate for the first quarter of 2014 is estimated by multiplying (a) the average advisory pure premium rate for the first quarter of 2014, derived as described in paragraph 1 above, by (b) the average policy year 2014 ratio of premium written at the industry average charged rate level to premium written at the advisory pure premium rate level based on the WCIRB s quarterly calls for experience 6 through March 31, 2014. 6 Premiums reported on the WCIRB s quarterly calls for experience exclude the impact of deductible credits, retrospective rating plan adjustments and terrorism charges. 19