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Reserving in a Changing Environment
Reserving for Workers Compensation Liabilities for Self-Insured Entities During Plant Closures, Downsizing & Layoffs
September 13, 2004
Presented by: Atul Malhotra, FCAS, MAAA
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Introduction
Corporations today are undergoing staff reorganizations frequently to respond to the rapidly changing external environment
These staff reorganizations can have an adverse impact on the corporation’s workers compensation (WC) costs
Reviewed the issues and potential impact of plant closures, downsizing and layoffs on the WC costs of self-insured entities
The general methodology described here can also be adapted to reserving for WC liabilities for insurance companies
Methods vs. Models – our approach to adapt traditional reserving methodologies to address the related issues
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Introduction (Cont’d)
Data from Bureau of Labor Statistics – number of nationwide mass layoff events were steady from 1996 through 2000, jumped up in 2001 and 2002, have been gradually declining since
A mass layoff event occurs when at least 50 initial unemployment claims are filed against an establishment during a consecutive 5-week period
Mass Layoff Events by Year
-
10,000
20,000
30,000
1996 1997 1998 1999 2000 2001 2002 2003 2004
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Impact of Staff Reorganizations
Internal Factors
“Downsizing” announcement tactics
Employee loyalty
Union relations
Level of severance benefits
Psychology of surviving employees
Skill level of downsized employees and the opportunity and ability to learn new skills
Overall impact dependent upon a number of internal and external factors including:
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Impact of Staff Reorganizations (cont’d)
External Factors
Economic environment in the local area
Local unemployment rates
Socioeconomic issues that can vary by geographic areas
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Impact of Staff Reorganizations (cont’d)
Claim Frequency may increase
Claim severity may increases
Litigation rate may increase
Change in claim reporting rates
Change in claim settlement rates
Based on a combination of the above factors, we observed an increase in WC costs from anywhere between 0% to 100%
Some of the impacts observed are similar to the impacts observed during recessionary periods
Most of the impact is limited to most recent two to three accident years
It is impossible to completely delineate the impact of plant closures from other impacts.
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Claim Frequency
WC benefits can partially substitute for loss of income The differential between full pay and WC benefits is absent Difficult to lay off employees with open WC claims WC benefits usually larger and paid over a longer period of time Additional surgeries/procedures may be scheduled Deterioration of relations between management and employees Lower compliance with appropriate safety behaviors Lower motivation to comply with appropriate safety behaviors
The factors that may cause increased claim filings from laid-off employees are as follows:
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Claim Severity
Shift medical costs for chronic injuries or ailments to WC system
Absence of rehabilitation and return-to-work programs
Distribution of surviving employees
Distribution by type of claim
Some chronic injuries concealed for a longer period of time may be revealed at the time of layoff
Increase in disability duration due to the increased time to find re-employment
Attorney involvement – class action suits, employment practices liability
Moral hazard issues
More frequent and larger lump sum settlements
The reason for the increase in claim severity may be the following:
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Increase in Costs
Increased average duration of temporary total disability cases
Increased medical costs due to increased utilization of medical services
Higher permanent partial disability ratings
Increased claims for occupational disease or cumulative injury cases
Other indemnity benefits
More frequent and larger lump sum settlements
Some of the literature we reviewed on the impact of recessions on WC costs cited the following reasons for the increase in costs:
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Diagnosing the Impact
Reported Claim Counts By Accident Year
-
200
400
600
800
1,000
1,200
12 24 36 48 60
Evaluation Month
11 12 13 14 15
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Diagnosing the Impact
Reported Claim Severity By Accident Year
-
5,000
10,000
15,000
20,000
25,000
12 24 36 48 60
Evaluation Month
11 12 13 14 15
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Diagnosing the Impact
Ratio of Lost Time Claim Counts to Medical Only Claim Counts By Accident Year
0.00
0.20
0.40
0.60
0.80
1.00
12 24 36 48 60Evaluation Month
11
12
13
14
15
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Diagnosing the Impact
Paid ALAE to Paid Loss Ratio By Accident Year
-
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40
0.45
12 24 36 48 60
Evaluation Month
11 12 13 14 15
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Diagnosing the Impact
Paid Pure Premium per $100 of Payroll
0.0
2.0
4.0
6.0
8.0
10.0
12.0
1998 1999 2000 2001 2002
Fiscal Accident Year
Pai
d L
oss
& A
LA
EPure
Pre
miu
m P
er $
Hundre
d P
ayro
ll
At 3 months At 6 months At 9 months At 12 months At 15 monthsAt 18 months At 21 months At 24 months
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Discussion of Methodology
The non-systemic nature of staff reorganizations can distort the results of standard reserving methodologies
Standard methodologies may over react or under react to the changing conditions
Non-standard methodologies such as the Berquist-Sherman and other similar methods may not be appropriate as the underlying exposure/propensity to loss changes as a result of these staff reorganizations
Claims mix changes
Employee distribution by type of occupation may change
Other factors – employee psychology, employee management relations, etc.
If sufficient data is available, try to segment the loss development data
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Discussion of Methodology (cont’d)
Frequency /Severity Approach:
Back to the basics – adopting a claim frequency severity approach to calculating ultimate loss and reserves
Calculate ultimate claim severity by type of claim
Review claims mix by type of claim
Develop ultimate claim counts using development or Bornhuetter-Ferguson (B-F) approach
Advantages of the frequency/severity approach in a staff reduction scenario:
Avoids the non-systemic distortions caused in the latest diagonals
Allows for explicit adjustment for changes in exposure and type of loss
Allows for the calculation of cost impact for WC costs as result of staff reorganizations
Estimates of ultimate loss form the frequency/severity method can be used as initial expected losses for the B-F techniques
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Discussion of Methodology (Cont’d)
Modified Loss Development Pattern for use in the B-F Methodologies:
Modify historical loss emergence patterns by adjusting for the emergence of the additional plant closure impact
Input from the claim adjusting personnel and the company risk manager essential
Use the modified loss emergence pattern and initial expected loss from the adjusted frequency/severity method to develop estimates based on B-F methods
ALAE Modeling:
Develop empirical model
Model accident year paid ALAE to paid loss ratio using data on variables such as litigation rate of claims and indemnity to med-only claim ratios
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Conclusion
Actuary should consider the impact of plant closures and layoffs when calculating WC liabilities for self-insured entities
Loss estimates produced from the adjusted methods vary based on the assumptions and adjustments made
Loss development methods without any adjustments too responsive
B-F methods without any adjustments slow to respond to the changing conditions
The adjustments made to the B-F method make it more responsive
Using the frequency/severity approach allows the actuary to explore the changes in the underlying propensity to loss and incorporate the changes into the reserving methodology
Most importantly, we should look for the impact and try to understand the changes and communicate these changes to the management