January 1, 2013 Pure Premium Rate Filing Actuarial and C & R Committee Recommendations

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1 W o r k e r s C o m p e n s a t i o n I n s u r a n c e R a t i n g B u r e a u o f C a l i f o r n i a January 1, 2013 Pure Premium Rate Filing Actuarial and C & R Committee Recommendations Governing Committee Meeting August 15, Summary of Presentation Summary of 1/1/2013 Advisory Pure Premium Rate Indication Actuarial Committee Recommended Methodology C & R Committee Recommended Changes to Commissioner Regulations 2 1

2 Recommended Average Advisory Pure Premium Rate Indicated Average Pure Premium (PP) Rate: $2.68 per $ % above industry average filed PP rate as of 7/1/12 ($2.38) Based on March 31, 2012 loss and loss adjustment expense (LAE) experience Several methodology enhancements Significant deterioration from 7/1/12 filing ($2.43 per $100) Updated Classification Relativities No Impact of Pending Legislation is Reflected June 30, 2012 Experience to be Reviewed in September 3 Evaluation of Pending Legislation - Tentative Timetable Week of 8/20 WCIRB Submits 1/1/2013 Filing No provision for pending legislation Advise that proposed advisory pure premium rates subject to amendment if legislation is adopted by Legislature Week of 8/20 WCIRB Staff Preliminary Evaluation Review cost estimates provided by proponents Evaluate provisions that can be quantified based on reasonably objective criteria Emphasize preliminary nature of evaluation 9/5 Joint Claims Working Group/Actuarial Committee Meeting to Evaluate Legislation (if enacted) 9/12 Governing Committee Meeting to Consider Actuarial Committee Recommendations Week of 9/17 Submit Amendments to Proposed Advisory Pure Premium Rates (if Appropriate) 4 2

3 Recommended Average Advisory Pure Premium Rate Deterioration from 7/1/2012 Filing 10.3% Deterioration from WCIRB 7/1/12 Indication ($2.68 / $2.43) Additional Experience/Updated Economic Forecasts - Approx. 3% from increased loss development - Approx. 1% from extending trending period to PY Approx. 0.6% from reduced wage forecasts and indemnity on-level adjustments - Approx. 0.6% from reduced higher frequency forecast Methodology Changes - Approx. 2% from enhanced medical loss development tail - Approx. 4% from revised trending projection - Approx. -1% from revised ULAE projection methodology 5 Updates to Average Pure Premium Rate Benchmarks Based on Updated Payroll Weights $4.00 $3.00 $2.00 Industry Average Filed Pure Premium Rates as of 1/1/2012 WCIRB 7/1/2012 Indicated Average Advisory Premium Pure Rate $2.51 $2.41 $2.43 $2.25 Approved 7/1/12012 Average Advisory Pure Premium Rate $2.49 $2.41 $1.00 $0.00 Based on PY 2009 Payroll Weights Based on PY 2010 Payroll Weights Based on PY 2009 Payroll Weights Based on PY 2010 Payroll Weights Based on PY 2009 Payroll Weights Based on PY 2010 Payroll Weights For purposes of this summary, policy year 2009 consists of policies incepting between December 2008 and November 2009 and policy year 2010 consists of policies incepting between December 2009 and November

4 Average Rate Measures Per $100 of Payroll Rate per $100 of payroll $3.00 $2.68 $2.38 $2.43 $2.00 $1.00 Indicated Average 1/1/2013 Pure Premium Rate Based on Actuarial Committee Recommendations Industry Average Filed Pure Premium Rate as of 7/1/2012 Indicated Average 7/1/2012 Pure Premium Rate 7 Recent Key Cost Drivers 10% Deterioration in Indicated Pure Premium Rate from 7/1/2012 Filing Continued loss development deterioration Indemnity claim frequency remaining high Increased forecast of future loss inflation ALAE costs increasing Wage growth forecasts less than previous forecasts 8 4

5 Deterioration in WCIRB Projected Loss Ratios % /1/2012 Filing (based on 3/31/2011 Experience) 7/1/2012 Filing (based on 12/31/2011 Experience) * 1/1/2013 Filing (based on 3/31/2012 Experience)* Accident Year *Some of the increased loss development is due to modification to the loss development methodology used for projecting older time period development. 9 Estimated Change in Indemnity Claim Frequency % Change As of March 31, Accident Year 3 months 10 5

6 WCIRB Projected Average Annual Loss Trend % Change 8.0 1/1/2012 Filing 7/1/2012 Filing 1/1/2013 Filing Indemnity Medical Includes the combined impact of projected frequency and severity growth. 11 Paid ALAE Ratios per Claim $ Paid ALAE per Reported Indemnity Claim As of March 31, 2012 Incremental Paid ALAE to On-level Incremental Paid Loss As of March 31, 2012 Accident Year 12 6

7 Forecasts of Changes in California Average Annual Salary Level % Change /1/2012 Filing (based on June 2011 UCLA Forecast) 7/1/2012 Filing (based on March 2012 UCLA Forecast) 1/1/2013 Filing (based on June 2012 UCLA Forecast) Year 13 Longer-Term Cost Drivers Medical Severities Up 48% Since 2005 Utilization of medical services Liens Medicare set-asides Pharmaceutical costs Medical Cost Containment Medical-legal costs Indemnity Severities Up 40% Since 2005 Permanent disability rating creep Ogilvie & Almaraz/Guzman decisions Increases in temporary disability duration ALAE Severities Up Almost 100% Since 2005 Liens Issues around permanent disability 14 7

8 Summary of Presentation Summary of 1/1/2013 Advisory Pure Premium Rate Indication Actuarial Committee Recommended Methodology 15 Actuarial Committee Recommended Methodology Objective Estimate losses and LAE on 2013 policies Compare to pure premium at industry average filed pure premium rate level as of July 1, 2012 Actuarial Committee Recommendations Similar methodologies as in 7/1/2012 Pure Premium Rate Filing - Medical loss development tail adjusted for inflation - Revised trending methodology to also reflect loss ratio trend - Use of paid ULAE data 16 8

9 Basis of Computation Historical Data Premium, losses, and LAE Aggregated by year of accident (through 2011) Valued as of March 31, 2012 Represents 100% of statewide experience Adjustments to Historical Data Develop losses to ultimate Adjust to common on-level cost level Trend to applicable policy period LAE projection 17 Loss Development Projections Key Diagnostics Reviewed Claim settlement rate decline has stopped Quarterly accident year 2011 loss development lower through 12/31/2011 Alternative Methodologies Reviewed Narrow range of paid projections Incurred projections higher but differences narrowed if adjustments made for insurer mix WCIRB Study of Long-term Medical Loss Development Significant very late development continuing Lack of inflation adjustment on later year development significant (attendant care, prosthetics, pharmaceuticals) Recommend 6% annual medical inflation factor Actuarial Committee Recommended Methodology Continue to use reform-adjusted paid method Adjust medical loss development tail (2% impact) 18 9

10 WCIRB Projected Ultimate Accident Year Medical Loss Payouts by Year 30% % of Ultimate Medical Losses Paid 20% 19% 15% 16% 10% 10% 12% 9% 12% 5% 2% 0% Year 1 Year 2 Year 3 Yr. 4-5 Yr Yr Yr Yr Yr 25+ Adjustments to Common On-Level Basis Losses Adjustments to 2013 benefit levels and wage levels Ogilvie and Almaraz/Guzman impacts appear to be emerging consistent with amounts estimated No impact reflected for pending legislation Premiums Adjust to industry average filed pure premium rate level as of July 1, 2012 Adjust to policy year 2013 wage level Include adjustment to correct for recession impact on audit premiums 20 10

11 Trend Projection Projection to Policy Year and 2011 frequencies above prior years levels 2010 and 2011 average severities relatively flat 2012 WCIRB Claim Frequency Study Frequency increase partly attributable to recession - more cumulative injury claims - more late-reported claims - decline in proportion of medical-only claims - more smaller non-cumulative injury claims Growth in smaller indemnity claims significantly dampened average claim severity 21 Trend Projection Actuarial Committee Recommended Methodology Separate Frequency and Severity Projection Methodology - Has not performed well the last several years - Frequency and severity interrelated - Current projected combined loss trend appears low relative to recent loss ratio growth Combined fitted on-level loss trend - Fits post-reform data well - Recently outperforms separate frequency/severity projection - Does not reflect that frequency and severity are impacted by different phenomena - Does not fully reflect recent signs of moderation in loss trend Actuarial Committee recommends averaging the two methods 22 11

12 Indemnity Loss Trend Projected On-level Indemnity Loss to Industry Average Filed Pure Premium Ratio % Latest Year Reform-Adjusted Development Method Projection Based on the Average of Trended 2010 and 2011 Ratios with Application of Separate Frequency and Severity Trends Projection Based on the Application of a Fitted Exponential Loss Ratio Trend Based on the 2005 to 2011 Ratios Projection Based on the Average of the Projection Based +2.6% on Application of a Fitted Exponential Loss Ratio Trend and the Projection Based on the Application of Separate Frequency and Severity Trends. +8.0% +5.4% % % Average Annual Growth Rate to 2011 = +3.8% * +0.7% represents the annualized growth rate from 1/1/2011 to 1/1/2014 based on separate frequency and severity trends applied to the average of the two latest years. ** +3.5% represents the annualized growth rate from 1/1/2011 to 1/1/2014 after applying a fitted exponential loss ratio trend based on the 2005 to 2011 ratios. *** +2.1% represents the average of the annualized growth rates based on application of a fitted exponential loss ratio trend and on separate applications based on frequency and severity trends /1/2014 Accident Year % ** % *** % * 23 Medical Loss Trend Projected On-level Medical Loss to Industry Average Filed Pure Premium Ratio % Latest Year Reform-Adjusted Development Method Projection Based on the Average of Trended 2010 and 2011 Ratios with Application of Separate Frequency and Severity Trends Projection Based on the Application of a Fitted Exponential Loss Ratio Trend Based on the 2005 to 2011 Ratios Projection Based on the Average of the Projection Based on Application of a Fitted Exponential Loss Ratio Trend and the Projection Based on the Application of Separate Frequency and Severity Trends. +9.0% % % % Average Annual Growth Rate to 2011 = +7.4% * +4.6% represents the annualized growth rate from 1/1/2011 to 1/1/2014 based on separate frequency and severity trends applied to the average of the two latest years. **+7.3% represents the annualized growth rate from 1/1/2011 to 1/1/2014 after applying a fitted exponential loss ratio trend based on the 2005 to 2011 ratios ***+6.0% represents the average of the annualized growth rates based on application of a fitted exponential loss ratio trend and on separate applications based on frequency and severity trends /1/2014 Accident Year +3.5% % ** +6.0% *** % * 24 12

13 Ratios of ULAE to Loss: State Fund, California & National Insurers % Incurred ULAE to Incurred Loss Calendar Year California private insurers are insurers with more than 80% of their workers compensation writings in California. 25 Ratios of Paid ULAE to Loss: State Fund, California & National Insurers % Paid ULAE to Paid Loss Calendar Year California private insurers are insurers with more than 80% of their workers compensation writings in California

14 Projections of ALAE & ULAE to Loss Policy Year 2013 ALAE Projection ALAE Projection Method Trended Ultimate ALAE Per Indemnity Claim Statewide ALAE Ratio Private Insurer ALAE Ratio Private Insurer & State Fund ALAE Ratio Combined at Current Weights Tempered 50% 15.4% 16.5% 16.2% Policy Year 2013 ULAE Projection ULAE Projection Method Projection Based on Calendar Year Incurred ULAE (7/1/2012 Filing Methodology Projection Based on Calendar Year Paid ULAE (Actuarial Committee 1/1/13 Recommendation) Statewide ULAE Ratio Private Insurer ULAE Ratio Private Insurer & State Fund ULAE Ratio Combined at Current Weights Tempered 50% 13.0% 6.9% 9.1% 9.7% 6.1% 7.5% 27 LAE Projection under Alternative Methods for Adjusting State Fund Experience* 30% 25.1% 23.4% 25.3% 24.4% 23.7% 20% 10% Statewide Based on Paid ULAE Private Insurers Based on Incurred ULAE - 7/1/12 Decision Methodology Tempered State Fund Incurred ULAE - 7/1/12 Filing Method Tempered State Fund Paid ULAE & Private Insurers Incurred ULAE Tempered State Fund Paid ULAE - Act. Comm. Recommendation * Alternative projections for ULAE are based on average of open indemnity claim-based projection and paid loss based-projection. Alternative projections for ALAE are based on growth in ultimate ALAE per ultimate indemnity claim projection

15 Computation of Indicated 1/1/2013 Change Indicated Average Change in Pure Premium Rates for 2013 Policy Year Indemnity to industry average filed pure premium ratio Medical to industry average filed pure premium ratio Total loss to industry average filed pure premium ratio Projected LAE factor Projected loss & LAE to industry average filed pure premium ratio Indicated Policy Year 2013 Pure Premium Rate Level Change from Industry Average Filed Pure +12.6% Premium Rate as of July 1, Summary of Presentation Summary of 1/1/2013 Advisory Pure Premium Rate Indication Actuarial Committee Recommended Methodology C & R Committee Recommended Changes to Commissioner Regulations 30 15

16 Recommended Changes to USRP Wage Limitations & Standard Classification Changes Wage Limitations and Thresholds Adjust Executive Officers/Partners/Individual Employers wage maximum from $104,000 to $106,600 and wage minimum from $40,300 to $41,600 Increase in maximum also applies to athletic teams and entertainment classifications Adjust per-cab minimum from $29,200 to $29,800 Standard Classification Changes Combine the two dam construction classifications Incorporate pertinent information from Ruling & Interpretation compendium into USRP 31 Recommended Changes to USRP Dual Wage Thresholds Require physical audits on policies below $10,000 if high wage class to be assigned, except on renewal policies audited in the last 2 years (effective 1/1/2014) Continue multi-year study of dual wage thresholds No changes to threshold in four years Inflation sources support increases Governing Committee deferred 2012 changes pending comprehensive review of dual wage system 32 16

17 Recommended Changes to USRP 2011 Study of Dual Wage Thresholds Year Current 2011 Dual Wage Classification Established Threshold Recommendation /5542, Sheet Metal Work 1986 $25 $ /5187, Plumbing 1986 $24 $ /5482, Painting 1986 $24 $ /5140, Electrical Wiring 1986 $28 $ /5432, Carpentry 1986 $26 $ /5633, Steel Framing 1986 $26 $29 33 Recommended Changes to USRP 2012 Study of Dual Wage Thresholds Year Current 2012 Dual Wage Classification Established Threshold Recommendation /5028, Masonry 1992 $24 $ /5205, Concrete or Cement Work 1992 $24 $ /5470, Glazers 1992 $26 $ /5447, Wallboard Application 1992 $26 $ /5553, Roofing 1992 $23 $

18 Recommended Changes to USRP Study of Dual Wage Thresholds 2013 Plan Year Current Dual Wage Classification Established Threshold /5485, Plastering or Stucco Work 1992 $ /6220, Excavation 1992 $ /6308 Sewer Construction 1992 $ /6316, Water/Gas Mains or Connections Construction 1992 $ /5186 Automatic Sprinkler 1995 $27 35 Recommended Changes to USRP Dual Wage Thresholds Threshold Considerations Distribution of Reported Payroll between High and Low Wage Classifications Statistical Credibility of the Low Wage and High Wage Classifications Concentration of Wages Near the Threshold Loss Cost Differential per $100 of Payroll between Employers Paying Wages Above & Below Threshold 36 18

19 Study of Dual Wage Thresholds Description of Wage Level Survey In November and December Contacted the Trade Associations Related to the Dual Wage Classifications A Random Selection of Employers Representing Approximately 34% of the Payroll under Review Staff Visited the Selected Policyholders to Obtain Employee Wages Information for October 17 21, 2011 A Sample of 1,727 Policyholders, 24,161 Employees Survey Wages Were Rounded to the Nearest Dollar For Each Surveyed Policyholder, a USR Payroll and Loss History for the Dual Wage Classifications was Obtained for Two Years (2009 and 2008) of Experience 37 Study of Dual Wage Thresholds 5027/5028, Masonry Dual Classifications Created in 1992 Original Threshold $17 Current Threshold $24 42% of 2009 USR Payroll in Low Wage Classification (41% in 1994) Current Pure Premium Rate Relativity 165% (181% in 1997) Both Dual Classifications Fully Credible with 4 Years Experience 38 19

20 5027/5028 Masonry Evaluation of Current Threshold Based on Wage Study 53% of Surveyed Wages Below the Dual Wage Threshold 11% of Surveyed Employees within $1 of Threshold Surveyed Loss to Payroll Differential of 122% /5028 Masonry Number of Surveyed Employees by Hourly Wage Level 40 20

21 5027/5028 Masonry Loss Costs Differential per $100 of Payroll Survey Data: 122% /5028 Masonry Loss Costs Differential per $100 of Payroll Alternative $27 Threshold: 171% 42 21

22 5027/5028, Masonry $27 Alternative Threshold Remains Statistically Credible in Both the Low Wage and High Wage Classifications Changes the Survey Wage Distribution from 53%/47% to 64%/36% (however PY 2009 USR split 42%/58%) Reduces the Concentration in Wages within $1 of the Threshold from 11% to 7% Improves the Loss Differential per $100 of Payroll from 122% to 171% Recommend Increasing Threshold to $27 43 Recommended Changes to ERP Annual Update of Experience Rating Values Expected loss rates, D-ratios and eligibility threshold Changes to Credibility Values No substantive changes since 2010 Based on most current available data Increases credibility slightly for most employers Changes due to new credibility generally smaller than typical change due to other factors 44 22

23 Recommended Changes to ERP Indicated Distribution of Changes in X-Mods Percent of Employers Percentage Point Change in Modification Changes with Recommended 2013 Credibilities Typical Year-to-Year Change < -20 Points -20 to -11 Points -10 to -4 Points -3 to +3 Points +4 to +10 Points +11 to +20 Points > +20 Points 45 W o r k e r s C o m p e n s a t i o n I n s u r a n c e R a t i n g B u r e a u o f C a l i f o r n i a January 1, 2013 Pure Premium Rate Filing Actuarial and C & R Committee Recommendations Governing Committee Meeting August 15,