Pricing ACC Work Cover

Tim SpicerStephen JefferyGavin Pearce

Overview

• Work Cover Products and Coverage• Standard employer• Self-employed• Partnership programme (PP)

• Pricing Philosophy

• Top-Down/Bottom-Up

• Stop-Loss + Individual XOL for PP

• Residual Account

Product Coverage and Expenditure

• First 7 days covered by employer/self-employed

• Chart shows standard employers breakdown of $308m ultimate claim expenditure expected from 2003/04 accident year

Medical9.7%

Rehab24.7%

Weekly Comp54.6%

Death1.6%

Non-economic loss4.1%

Bulk billed5.3%

Standard Employer and Self-Employed Levies - 2003/04 accident year

• Rates are per $100 of liable earnings (i.e. % of liable earnings)

• Liable earnings are the lesser of actual earnings and $87,000 (the current maximum annual compensation rate)

• Self-employed has separate income and non-income benefit rates. The non-income rate is applied to the lesser of liable earnings and $15,000 (with the result being at least $32)

Pricing Philosophy

• ACC is non-profit, non-tax-paying, nationalised monopoly provider of accident cover…therefore…

• Pricing philosophy is largely “cost-plus”

• Overall price levels directly linked to the annual liability valuation PPCIs

• Exception to pure “cost-plus” philosophy is that we have a prudential margin (15%) in the rates to guard against adverse claims experience and investment returns

Pricing Process

• Marriage of “Top-Down” (i.e. we develop an overall average levy rate for each account using aggregate data) and “Bottom-Up” (i.e. we build up risk group rates using individual claim data)

• Liable earnings weighted average of risk group rates must regenerate the overall average rate

Overall Average Levy Components

“RiskPremium”

(includesany newbenefits)

Expenses

ReservesAdjustment

Ful l Funded Levy

Risk Premium

For each claim payment type* calculate:

Exposure (projected liable earnings)

Projected Incurred Claim Frequency= Number of Incurred Claims

Payments Per Claim Incurred (PPCIs)

= Payment Run-Off Pattern

with discounting and summation gives

Incurred Claim Cost = Risk Premium

*Entitlement, Social Rehab and Total

Reserve Adjustment

• Targeted funding position for all accident years post-1999 is 115% of liabilities (3 years hence)

• Reserve adjustment in two parts

• Adjustment for all past accident years (1999/00 - 2002/03) - can be negative (i.e. a “refund”) if opening fund position is sufficiently favourable

• Adjustment for new accident year (2003/04) - always positive

• Overall reserve adjustment can be negative

Reserve Adjustment (cont’d)

• Reserve adjustment mechanism is such that it is always aiming for 115% funding in 3 years from start of new accident year

e.g. for 2003/04 year, the reserve adjustment will be aiming for 115% funding by 31 March 2006

• At the end of the 2003/04 year, the 2003/04 liabilities fall into the past accidents “pot”, 2004/05 is the new year, and we will now be aiming for 115% funding by 31 March 2007

Summary of “Top-Down” Process

STD EMPLOYERS

“Risk Premium” = 0.73%Full Funded Rate* =

0.84%

Loss Ratio = 73/84 = 87%

*excludes WSMP loading

SELF-EMPLOYED

“Risk Premium” = 1.28%Full Funded Rate = 1.75%

Loss Ratio = 128/175 = 73%

Recommended Rates

Final rates approved by Cabinet may be different to these !!

Bottom-Up Process

• Each work-related claim is allocated to an ANZSIC-based Classification Unit (“CU”) and accident year

• CUs are collections of workers engaged in the same or very similar business activities

• The Bottom-Up process starts with the allocation of claims, and hence incurred claim costs, to the various CUs (There are currently over 550 CUs)

Incurred Claim Costs

• Each claim in the claim file has two components:

1. Claim payments made to date

2. Claim payments outstanding (zero for closed)

• The PV of all outstanding claim payments across all incurred cases should, theoretically, give the outstanding claims liability from the valuation - want results broken down by accident year

• Only difference is the date to which payments are discounted (for valuation - to 31/03/2002, for pricing - to start of accident year)

Allocating Costs to CUs

• Each open (reported) claim is given an individual case estimate (serious or statistical) equalling PV of outstanding claim payments

• Summing across all such cases from a given accident year gives a result typically less than the valuation result (allowance for IBNR and re-opening)

• To allocate IBNR costs to CUs (and accident year) we “calibrate” the case estimates so that

sum of calibrated case estimates = o/s claims liability

for each accident year

Allocating Costs to CUs (cont’d)

• Final step is to combine all the claim payments made to date with the calibrated case estimates (gives the “lifetime” claim cost) and then summarise costs in CU/accident-year “cells”

• Our risk measure is the “lifetime claims/earnings ratio” so it is now a matter of dividing the lifetime claim costs in each CU/accident-year cell by the corresponding liable earnings in the cell

• For each CU we can now produce a claims/earnings (“c/e”) ratio history

Forming Levy Risk Groups

• Many CUs have too little claims experience from which to develop a reliable rate - we pool the 550+ CUs together into 130 credible sized risk groups

• By examining the c/e ratio histories, we formed the “Pricing Hierarchy”

• Each Levy Risk Group (130 for 2003/04) should have CUs from the same industry and with a similar c/e ratio history (i.e. same industry and similar risk level)

• Hierarchical structure adopted is similar to British Columbia scheme but based on ANZSIC rather than North American industry classification

Example c/e history and projection Farmers - LRG 120 (9 CUs pooled)

Claims/Earnings Ratio History and Projected Risk and FF Levy Rates

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

96/97 97/98 98/99 99/00 00/01 01/02 02/03 03/04

EM c/e his t S E cre dible c/e his t P P c/e his t (e s t) EM R IS K R ATE S E RIS K R ATE EM F F RATE S E F F RATE

Setting risk premiums for risk groups using the Hierarchy

PRICING HIERARCHYBased on ANZSIC

INDUSTRY DIVISION A B C D E F G H I J K L M N O P Q

INDUSTRY RISK GROUP A10 A20 A30 A40 A50

LEVY RISK GROUP 110 122 130 120 145 140 150 170

CLASSIFICATION UNIT 2130 2200 3030

ACCO UNT

. . . . . . . . . . . . . . . . . . . . . . . .

Credibility Adjustment

• The 130 risk rates thus far were found by working down the Hierarchy

• Work back up the hierarchy using credibility weighting until you strike a fully credible base

• Full credibility is either E = $400m in earnings or N = 250 entitlement claims (per annum)

• Partial credibility weight (Z) is:

Z = MAX{ sqrt(E/400m), sqrt(N/250) }

Full Funded Rates (1)

• From the 130 credibility adjusted risk rates form a set of claim cost relativities (and normalise so that earnings weighted average relativity is 100%) for both employers and self-employed

• As ACC management elected to risk rate all expenses the full funded rate (net of WSM) is found by applying the relativity to the 0.84% average rate

• Next step is to apply the risk group WSM loading (so that after WSM discounts the total levy received is unchanged) - this gives us the “A” rates.

Full Funded Rates (2)

• The self-employed rate is split into an income and non-income rate (based on historic expenditure on these two classes of benefits)

• Both employer and self-employed rates are further subjected to

1. A minimum invoice loading (giving “B” rates)

2. A 25% increase cap loading (giving “C” rates)

• The costs of providing these “commercial” constraints are shared by ALL other workers and NOT contained just within their risk group

Partnership Programmes

• These are risk sharing arrangements available to employers of sufficient size after a successful Workplace Safety Evaluation

• Full Self Cover (FSC) and Partnership Discount Plan (PDP)

• FSC employers manage claims for the first 4-5 years after which claims revert to ACC for a charge based on actual claims - up-front levy is for admin only

• PDP employers manage claims for first 2-3 years with reversion to ACC at no extra cost - std employer levy is discounted for costs in first 2-3 years

Stop Loss and Individual XOL

• All FSC employers must purchase Stop Loss cover (150% and 200% options). Individual XOL is optional ($250K, $500K, $750K and $1M)

• Stop Loss losses for FSC employers include the liability reversion at the end of 4-5 years of claim management

• Stop Loss and XOL levy rates vary by standard levy that would otherwise have been payable

• PDP employers have optional Stop Loss (150% and 200% options) but no XOL options

Pricing FSC Stop Loss / XOL

• Assume a Compound Poisson aggregate claims distribution for each of 3 risk bands

• Individual claim sizes based on most recent 6 years of individual claim size data (empirical distribution) calibrated to 2003/04 level

• “Tail” of empirical claim size distribution modelled using a Pareto density for “smoothness”

• We built a SAS program to do the zillions of simulations required to get smooth rate curves

• Final rates were capped at 25% with those below the cap sharing the loss from capping

Residual Account Levies

• The Residual Account is for pre-July 1999 work claims and pre-July 1992 non-work claims by workers

• The Residual Account has a significant unfunded liability (only 36% funded as at 30 June 2002)

• Residual levies are set so that the account is 115% funded by 31 March 2014 (i.e. assets equal 115% of liabilities at that time)

Aggregate Residual Levy Rate

• As for other accounts a “Top-Down/Bottom-Up” approach is used

• Aggregate rate (0.31%) is found by projecting earnings, claim payments, liabilities, expenses and investment earnings out to 2014 and “goal-seeking” the flat % of earnings that will achieve 115% funding by 2014

• Split aggregate rate into a work (0.21%) and non-work component (0.10%) - pro-rata to outstanding claims liability for work and non-work accidents

Risk Group Residual Levies

• A similar process is followed here as for the standard cover pricing:

1. Form risk based groups

2. Allocate outstanding work-related claims liability across risk groups

3. Calculate a work-related o/s c/e ratio relativity

4. Apply relativity to aggregate work rate and add flat non-work rate to give risk group rate