The Bare Bones of Loss Development Factors
Staffing & Workers' Compensation
You’re three months out from your workers’ compensation renewal, and you open your email to unexpectedly find a non-renewal notice due to losses. How can that be – your current year’s loss ratio is 35%? That’s profitable, right?
The answer is…not necessarily. The ultimate cost of claims for a specific policy period is usually not known for several years. To estimate final values of claims, loss development factors are used. Here are five common questions around the topic at-hand.
1. If claims include reserve allocations, why does the incurred value need to be developed?
- Due to the long tail nature of workers’ compensation claims, all costs cannot ultimately be factored up front. For example, unanticipated medical complications that lead to additional treatment or legal involvement ultimately result in higher costs.
- Reserves do not account for incurred but not reported (IBNR) claims.
- Closed claims (which do not have reserves allocated) can reopen.
2. Who determines the values of loss development factors?
Loss development factors are established by tracking the changes in actual claim values over a period of time. Independent organizations such as IRMI publish factors based on information they receive from NCCI and state rating bureaus, among other sources. Carrier actuaries may develop their own rates based on the experience of their book as a whole or even a specific niche.
National or state specific loss development factors may be used:
- National loss development factors – this single factor is applied to all claims in a policy year regardless of the number of states, or which specific states, are on the policy.
- State specific loss development factors – if you operate in one state, the specific state factor should be used. If you operate in multiple states, but not nationally, a blended rate can be calculated for the select states you operate in.
3. Is the same factor applied to each policy year?
No. The factor decreases as policy years mature and claims ultimately reach their final values.
4. When are loss development factors used?
While the initial example showed the impact of loss development factors on a loss ratio (percentage of losses compared to premium paid) to determine profitability for a guaranteed cost renewal, loss development factors are also impactful in determining the parameters of a loss sensitive workers’ compensation program.
Expected losses (or loss pick) for a given year is based on the developed loss rate (rate of developed losses per $100 payroll) from prior years’ loss experience. Expected losses affect the fixed costs of the policy as well as the collateral requirement.
Incurred retrospective workers’ compensation programs include agreed to loss development factors that are used to adjust the incurred claim values at each calculated retrospective adjustment.
5. Am I tied to the development factors my insurance carrier uses?
Your carrier’s developed incurred loss value and loss rate is a starting point for your broker’s negotiations. While it’s possible your carrier’s development rates are lower than those released by a third party, such as IRMI, your broker should prepare their own loss pick prior to renewal negotiations so they’re prepared to make an educated argument in the event that the carrier’s loss pick is higher.
There’s less flexibility with loss development factors included in an incurred retrospective program as these are typically actuarially developed by the carrier and required to be used across their book of business. However, these factors should be transparent to you in the program parameters up front.
Back to our initial example...
Let’s say you have $140,000 in incurred losses on the most recent policy year at a guaranteed cost premium of $400,000, which calculates to a 35% incurred loss ratio. If the carrier’s actuary applies the current national IRMI loss development factor (1.750) to the losses, the developed losses are projected to be $245,000, which means that the developed loss ratio is actually 61.25%, which exceeds their target 55% profitability level.
Does this mean you won’t receive a renewal quote? No. The cumulative loss experience of the past five years, among other factors, is ultimately taken into consideration. As years mature, the loss development factors decrease, and the actual results will yield the true experience.
For additional questions on loss development, contact a member of the ‘A’ Team.
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