Workers Compensation

Workers’ Compensation (WC) ratemaking has distinct characteristics, as it covers both lost wages (Indemnity) and medical expenses (Medical) for work-related injuries.

\text{Total Loss Ratio} = \text{Indemnity Loss Ratio} + \text{Medical Loss Ratio} + \text{ALAE Ratio}

Indemnity Benefits

Indemnity benefits compensate injured workers for lost wages. These costs are driven by wage inflation (which increases the average benefit paid) and legislative changes (which modify benefit caps or coverage rules).

Benefit Level and Trend Adjustments

To project historical indemnity losses to the future level, actuaries combine the impact of legislative changes and wage inflation.

AY	Benefit Change	Wage Trend Impact	Combined Impact	Indemnity Adj Factor
2012	$0.0\%$	$1.0\%$	$1.0\%$	$0.761$
2013	$0.0\%$	$2.0\%$	$2.0\%$	$0.746$
2014	$-30.0\%$	$2.0\%$	$-28.6\%$	$1.045$
2015	$0.0\%$	$1.5\%$	$1.5\%$	$1.029$
2016	$0.0\%$	$0.9\%$	$0.9\%$	$1.020$
Projected	$0.0\%$	$2.0\%$	$2.0\%$	$1.000$

Alternate Representation (On-Level & Trend)

Alternatively, historical losses are adjusted using an On-Level Factor and an annual trend projection:

AY	Avg Benefit Level	On-Level Factor	Hist Loss Trend	Proj Loss Trend	Combined Factor
2012	$1.000$	$0.700$	$1.066$		$0.761$
2013	$1.000$	$0.700$	$1.045$		$0.746$
2014	$0.700$	$1.000$	$1.024$		$1.045$
2015	$0.700$	$1.000$	$1.009$		$1.029$
2016	$0.700$	$1.000$	$1.000$		$1.020$
Projected	$0.700$			$1.020$

Loss Cost Premiums and Payroll On-Levelling

Workers’ compensation exposures are measured in units of payroll (typically per $100 of payroll).

Historical Loss Cost Premium

Historical premiums are restated using future wage levels and experience modifications:

\text{Loss Cost Premium} = \text{Payroll} \times \text{Current Advisory Loss Cost} \times \text{Experience Modification Factor}

To project premiums to the future level, actuaries adjust historical payroll for wage inflation and replace historical experience modifications with expected future values:

AY	Industry Premium	Payroll Chg	Curr Wage Fact	Exp Wage Chg	Fut Wage Fact	Hist Avg Mod	Exp Avg Mod	Proj Premium
2012	$3,900,972,841	$2.5\%$	$1.152$	$6.1\%$	$1.265$	$0.991$	$0.970$	$4,829,585,462
2013	$4,148,612,420	$3.0\%$	$1.118$	$6.1\%$	$1.228$	$0.985$	$0.970$	$5,016,952,524
2014	$4,334,300,493	$3.7\%$	$1.078$	$6.1\%$	$1.184$	$0.981$	$0.970$	$5,075,100,094
2015	$4,659,789,168	$4.2\%$	$1.035$	$6.1\%$	$1.136$	$0.982$	$0.970$	$5,230,963,178
2016	$4,795,461,580	$3.5\%$	$1.000$	$6.1\%$	$1.098$	$0.957$	$0.970$	$5,337,095,962
Total	$21,839,136,502							$25,489,697,222

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Medical Benefits

Medical costs are split between services subject to medical fee schedules and non-regulated charges.

\text{Medical Loss Cost} = \text{Fee Schedule portion} + \text{"Other Medical" portion}

Medical Trend Adjustments

Fee Schedule Changes: Pre-determined maximum reimbursement levels negotiated or set by state regulatory bodies.¹
Other Medical inflation: Adjusted based on the medical component of the Consumer Price Index (CPI).

AY	Fee Schedule Chg	Other Med Chg	Fee Schedule %	Combined Effect	Med Adj Factor
2012	$0\%$	$2.5\%$	$75.0\%$	$0.6\%$	$0.983$
2013	$0\%$	$2.0\%$	$75.0\%$	$0.5\%$	$0.978$
2014	$-20\%$	$4.0\%$	$70.0\%$	$-12.8\%$	$1.122$
2015	$0\%$	$4.1\%$	$70.0\%$	$1.2\%$	$1.108$
2016	$10\%$	$3.9\%$	$70.0\%$	$8.2\%$	$1.024$
Projected	$0\%$	$8.2\%$	$70.0\%$	$2.4\%$

Indication & Loss Cost Multipliers (LCM)

Actuarial rating bureaus (e.g., NCCI) typically calculate and file Advisory Loss Costs. Individual insurers then apply their own Loss Cost Multipliers (LCM) to cover operating expenses, commissions, and target profit.

Insurer Rate Indication Formula

The total indicated rate change for an individual insurer is:

\text{Indicated Rate Change} = \text{Advisory Loss Cost Change} \times \frac{\text{Proposed Deviation}}{\text{Current Deviation}}

Where:

$\text{Deviation (LCM)} = \text{Expense \& Profit Adjustment} \times \text{Operational Adjustment}$
$\text{Expense \& Profit Adjustment} = \frac{1}{\text{Permissible Loss Ratio (PLR)}}$
$\text{Operational Adjustment} = 1 + \text{Expected Loss Cost Difference}$ $Operational Adjustment = 1 + Expected Loss Cost Difference$
- Expected Loss Cost Difference: Reflects the insurer’s expectation of how their loss experience will differ from the industry average (e.g., $-5\%$ due to superior underwriting).

\text{LCM} = \frac{1 + \text{Expected Loss Cost Difference}}{\text{Permissible Loss Ratio}}

*[LCM]: Loss Cost Multiplier *[PLR]: Permissible Loss Ratio

A fee schedule limits the maximum allowable reimbursement for specific medical procedures, helping standardize and control workers’ compensation medical cost inflation. ↩