January 10, 2013

Understanding "Expected Losses"

This is Part 5 in 5 part series on Experience Rating changes. See Part 1: The Experience Rating Process: Significant Changes Are Imminent; Part 2 A Basic Review of Claim Losses, the Building Blocks of Experience Rating; Part 3 Primary and Excess Losses: Big Changes Beginning in 2013, and Part 4 Dealing with Reserves: When Do Losses Really Count?

We finish this series of blog posts with a brief discussion of "Expected Losses" and "Expected Loss Rates."

The entire experience rating process is driven by "expected losses," the total losses insurance actuaries expect you to suffer. But what exactly are "expected losses" and where do they come from?

Expected losses are contained in the premium rates you pay for each classification of worker. Expected primary loss rates and expected excess loss rates (called the "D ratio") are a percentage of the total rate.

For example:
Class rate - $5.00
Expected losses - about 50% of the rate - $2.50
Expected primary losses about 20% of total losses - $0.50

These percentages do vary somewhat, but will be close to the above estimates.

Thus, the calculation for expected losses for $500,000 in payroll for the above class would be:

Manual premium = $500,000 times $5.00 divided by 100 = $25,000
Expected losses = $25,000 times 50% = $12,500
Expected primary losses = $12,500 times 20% = $2,500

Note that even with half a million dollars in payroll, the expected primary losses are only $2,500. This amount would be exceeded by relatively small losses or one big loss.

One final note: under the new rating plan in PY 13, expected primary losses will increase by about 50%. Using the above example, the new rating plan raises primary rates as follows:

Expected primary losses = $12,500 times 30% = $3,750

In other words, primary losses will go up as the split point goes up, but not fast enough to help employers with significant losses.

Expected losses and expected loss rates have significance in workers comp program performance measurement. Here's why. A good way to measure how well a company manages workers comp is to track how much it spends in losses per hundred dollars of payroll. Then, one can compare that number with the expected loss rate, which is a rate per hundred dollars of payroll. If losses per hundred are running higher than expected losses per hundred, one can readily see that a problem exists, which can be immediately addressed.

After 20 years of stability, the experience rating process is about to undergo significant changes. Educated employers will track these changes and make any needed adjustments to their workers comp cost control programs.

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About this Entry

This page contains a single entry by Tom Lynch published on January 10, 2013 12:01 PM.

Cavalcade of Risk at Insurance Coverage Law in Massachusetts Blog was the previous entry in this blog.

Annals of the Aging Workforce: An Old Man Takes His Lump(s) is the next entry in this blog.

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