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THE INCREDIBLE SHRINKING
RESIDUAL MARKETSession: PL-39
Presented by:
Tom Daley, ACAS, MAAA, NCCI
John Winkleman, Jr., FCAS, AIPSO
Richard Amundson, FCAS, MN DOC
© 2000 National Council on Compensation Insurance, Inc.
WORKERS COMPENSATION
Presented By: Tom Daley
© 2000 National Council on Compensation Insurance, Inc.
OUTLINE
• Historical Perspective
• How did it get so large?
• Impact of a large residual market
• What caused the shrinkage?
• Ratemaking implications today
• How will we keep it from growing again?
®
© 2000 National Council on Compensation Insurance, Inc.
RESIDUAL MARKET ESTIMATED ULTIMATE PREMIUMSAS OF 9/30/2000
* Excludes Maine Residual Market Pool
2.11
2.602.84
3.49
3.964.39
4.80
4.09
3.08
1.96
1.000.57
0.33 0.27 0.30
0.0
1.0
2.0
3.0
4.0
5.0
6.0
Premium ($Billions)
19
86
19
87
19
88
*
19
89
*
19
90
*
19
91
*
19
92
*
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
Policy Year
© 2000 National Council on Compensation Insurance, Inc.
HOW DID IT GROW SO LARGE?
• Inadequate rates
• Overly generous benefits
• Lack of cost containment
• Poor underwriting results
®
© 2000 National Council on Compensation Insurance, Inc.
RESIDUAL MARKET UNDERWRITING GAIN/LOSSAS OF 9/30/2000
* Excluding Maine** Excluding Maine and New Mexico# Excluding New Mexico
-1354
-1760 -1848-2018
-1596
-1140
-558
-139
103126
23
-21 -40 -45
-2500.0
-2000.0
-1500.0
-1000.0
-500.0
0.0
500.0
Underwriting Gain\Loss ($Millions)
1986
1987
1988
*
1989
*
1990
**
1991
**
1992
**
1993
#
1994
1995
1996
1997
1998
1999
Policy Year
© 2000 National Council on Compensation Insurance, Inc.
IMPACT OF A LARGE RESIDUAL MARKET
• Carriers stop writing WC
• AR plans grow larger and larger
• Rates increase (both markets)
• Employers costs rise
• Movement towards self-insurance
© 2000 National Council on Compensation Insurance, Inc.
WHAT CAUSED THE SHRINKAGE?
• Reform at all levels of stakeholder
• Residual Market pricing programs
• New state funds
• Increased competition/capacity
© 2000 National Council on Compensation Insurance, Inc.
NCCI RATEMAKING IN TODAY’S
ASSIGNED RISK MARKET
The NCCI approach for overall indication:
1. Use total market data (most states)
2. Use AR data to establish differential
over voluntary market
®
© 2000 National Council on Compensation Insurance, Inc.
RESIDUAL MARKET COMBINED RATIOSAS OF 9/30/2000
164 168 165158
141
126
112104
97 9498
104112
117127
90
110
130
150
170
190
Combined Ratio (%)
19
86
19
87
19
88
*
19
89
*
19
90
*
19
91
*
19
92
*
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
Policy Year
* Excludes Maine Residual Market Pool
Residual Market Policy Size
Large (PY93) Vs. Small (PY2000)
All NCCI States
Premium RangePY 93
Policy Count% ofTotal
PY 2000Policy Count
% ofTotal
$0 - $2,499$2,500 -$4,999$5,000 - $9,999$10,000 - $49,999$50,000 - $99,999$100,000 - $499,999
$500,000 and over
271,76856,22936,49136,697
5,5583,536
163
66.2%13.7%
8.9%8.9%1.4%0.9%
0.0%
75,6848,1614,2383,611
398230
6
82.0%8.8%4.6%4.0%0.4%0.3%
>.01%
Total 410,442 100.0% 92,330 100%
© 2000 National Council on Compensation Insurance, Inc.
NCCI ASSIGNED RISK RATEMAKING
Biggest challenges facing NCCI:
• Volatility of assigned risk data due to low volume
• Increasing expense provisions as % of premium
• Maintaining Servicing Carrier capacity
• Affordability vs. subsidies (break-even pricing)
© 2000 National Council on Compensation Insurance, Inc.
HOW DOES ONE KEEP RESIDUAL MARKETS SMALL?
• Strive for rate adequacy
• Retain pricing programs in AR market
• Help prevent erosion to reforms
• Maintain a target goal of underwriting loss to voluntary premium ratio <1.0%
• Examine alternative Residual Market Structures
PRIVATE PASSENGERRATEMAKING
ASSIGNED RISK
John Winkleman, Jr.
AIPSO
RATEMAKING METHODOLOGY
BASED ON SIZE OF PREMIUM
TOTAL PREMIUM < $1.0M
BASED ON COMPARISON TO NON- STD MARKET
TOTAL PREMIUM > $1.0M
BASED ON PROSPECTIVE RATING
New YorkPPNF Liability
0
200
400
600
800
1000
1200
12 Months Ending
12 M
onth
s As
sign
eds
Thou
sand
s
CountrywidePPNF Liability
0
1
2
3
4
12 Months Ending
12 M
onth
s As
sign
eds
Mill
ions
Countrywide OTPP Liability
0
100
200
300
400
12 Months Ending
12
Mo
nth
s A
ss
ign
ed
s
Th
ou
sa
nd
s
Residual Market Pricing
Richard Amundson, FCAS
Actuarial Director
MN Department of Commerce
A Model of Residual Market Pricing Some assumptions
• Assigned Risk Plan (ARP) sets prices to break even based on its own experience.
• ARP’s profit or loss is allocated to the voluntary market.
• Insurance is mandatory; 2 choices: voluntary or ARP.
• An insured buys from market with lowest price.
• Expenses are proportional to loss and will be ignored.
An Instructive Example
• Insurer needs $100 surplus for $200 yr-end loss.
• Insurer earns 5% risk-free on invested assets.
• Insurer needs a 15% return on equity.
Extreme case 1: ARP has 0 percent market share.
• Insurer collects $200 in premium, invests it & the $100 of surplus.
• Insurer earns $15 during the year.
• Year-end: insurer pays $200, has $100 plus $15 from investments.
Extreme case 2: ARP has 100% market share.
• Insurer has no voluntary premium, but retains responsibility for ARP’s losses.
• Insurer still needs $100 of surplus: all the risk is still around and the insurer still bears it all.
• Insurer has same risk as in case 1, same investment as in case 1, so needs same return. ARP must charge full $200 in order to generate same return.
Regardless of ARP market share, insurer needs the full $100 surplus and the full $200 prem.
FIGURE 1
MARKET RATES IN EQUILIBRIUM
PREMIUM y
y = x
R
y = ax
x EXPECTED
R’ R LOSS
R = ARP price
ax = voluntary market price
The Elusive Search For Equilibrium
What happens when ARP reviews rates?
• ARP overcharged insureds with expected losses between R’ and R and undercharged insureds with expected losses > R. Net effect is undercharge, but analysis will not necessarily indicate rate increase.
• ARP doesn’t include profit in its analysis. ARP may charge enough to pay claims: analysis on non-profit basis may show need for rate reduction. Whether analysis will show need for increase or decrease is function of distribution of expected losses.
• Only sure way to remain in equilibrium is to ignore indications.
Figure 2Market Rates With ARP Pricing To
Break Even PREMIUM
y
29.19 y = x
28.18
27.62
y = 27.62
y = ax
x EXPECTED 28 29 LOSS
27.62 = ARP price
ax = voluntary market price
If consensus is in favor of keeping and controlling residual market, break-even pricing is poor tool.
Assuming that ARP will exist, that it should not be too burdensome on voluntary market and that it should not have wild swings in market share, then there is a reasonable solution to rate problem:
Base ARP rates on industrywide experience, consistently higher than what a typical insurer would need to charge in voluntary market.
How To Set ARP Rates
Guidelines:
Bigger the voluntary market the better.
Residual market should not be unaffordable.
Expected assessment of residual mkt losses on voluntary mkt insureds not excessive.
Rate changes should not be abrupt.
Setting Specific Goals
Possible goals for residual market:
Market share under 1%. Rates under 150% of voluntary. Expected assessment under 0.5%. Annual rate changes < 10% (relative to
voluntary market) during catch-up period.
Using Goals To Set Prices
Residual market can set prices as multiple of voluntary market and measure success directly from goals.
Example of Specific Goals
Yes, to prevent future problems from arising. The best time to repair the roof is when it isn’t raining.
Market-based pricing gives ARP a built-in stabilizer, a governor to keep the system from breaking down.
Should ARP move away from break-even pricing even if already running
smoothly?
Remember the Maine
If you don’t think the system can break down:
State ofRemember theMaine
If you don’t think the system can break down:
If you take one idea home with you, let it be this:
The burden that ARP puts on the voluntary market is not simply ARP’s bottom-line losses.
The burden is reduced return on surplus, even if ARP’s return is positive.
Recap: one last look at ARP’s burden
Put yourself in the shoes of the voluntary market where you have $1 million each of premium and surplus,
and ARP has $500 million of premium & no surplus.
If ARP expects a bottom-line gain of 1% of premium, would you like the right to the gain if it also obligates you to pay in case of a loss?
If you say yes, I have some advice for you on behalf of Governor Ventura and the Minnesota guaranty fund:
Recap: one last look at ARP’s burden
An Illustration
Stay out of Minnesota!