Imagine you’re three months away from your workers’ compensation renewal when you open your email to find an unexpected non-renewal notice due to losses. How can this be? After all, your current year’s loss ratio stands at a seemingly healthy 35%. That should be profitable, right?
The reality is a bit more complex. The true cost of claims for a specific policy period often remains uncertain for several years. To estimate the final values of claims, loss development factors come into play. Here are some common questions that can help clarify this important topic.
When are loss development factors used?
While the initial example illustrates the impact of loss development factors on a loss ratio (the percentage of losses compared to premiums paid) for guaranteed cost renewals, these factors also play a crucial role in determining the parameters of a loss-sensitive workers’ compensation program.
Expected losses (or loss picks) for a given year are based on the developed loss rate (the rate of developed losses per $100 payroll) derived from prior years’ loss experience. These expected losses influence both the fixed costs of the policy and the collateral requirements.
Incurred retrospective workers’ compensation programs include agreed-upon loss development factors that adjust incurred claim values at each retrospective adjustment.
Who determines the values of loss development factors?
Loss development factors are established by tracking changes in actual claim values over time. Independent organizations like IRMI publish these factors based on data from NCCI and state rating bureaus, among other sources. Additionally, carrier actuaries may develop their own rates based on the overall experience of their book or specific niches.
Loss development factors can be national or state-specific:
- National loss development factors apply uniformly to all claims in a policy year, regardless of the states involved.
- State-specific loss development factors should be used if your operations are confined to one state. For businesses operating in multiple states, a blended rate can be calculated for the relevant states.
Is the same factor applied to each policy year?
No, the factor typically decreases as policy years mature and claims reach their final values.
If claims include reserve allocations, why do we need to develop the incurred value?
There are several reasons why development factors are applied even to claims with open reserves:
- Workers’ compensation claims often have a long tail, meaning not all costs can be accurately estimated upfront. For instance, unforeseen medical complications or legal issues can lead to additional expenses.
- Reserves do not account for incurred but not reported (IBNR) claims.
- Closed claims can reopen, potentially leading to further costs.
Am I bound to the development factors used by my insurance carrier?
The developed incurred loss value and loss rate from your carrier serve as a starting point for your broker’s negotiations. While it’s possible that your carrier’s development rates are lower than those published by third parties like IRMI, your broker should prepare their own loss pick before renewal negotiations. This preparation allows them to make a well-informed argument if the carrier’s loss pick is higher.
There is generally less flexibility with loss development factors in incurred retrospective programs, as these are typically actuarially developed by the carrier and applied across their entire book of business. However, these factors should be transparent to you in the program parameters from the outset.
Understanding these nuances can empower you to navigate the complexities of workers’ compensation and better prepare for your renewal discussions.