CHAPTER 2: RATING MANUALS
U. S. WORKERS COMPENSATION RATING MANUAL EXAMPLE
Workers compensation insurance is required for most U.S. employers5
The end result of the workers compensation ratemaking analysis is a rate manual, showing the manual premium for each risk. The premium actually collected by the insurer is referred to as net premium, and it incorporates the manual rates, premium discounts, individual risk rating modifications (e.g., schedule rating, experience rating), and expense constants.
to indemnify employees who are injured on the job. Because employee welfare is so important, workers compensation is a heavily regulated line of business in every U.S. state. As part of the regulation, insurers are required to submit statistical information on worker’s compensation losses and premium in significant detail. The National Council on Compensation Insurance (NCCI) is a U.S. organization that collects workers compensation data from insurers and aggregates the data for ratemaking purposes. The NCCI is the licensed rating and statistical organization for most states, but several states have independent bureaus or operate as
monopolistic plans. The NCCI provides workers compensation insurers with loss cost estimates, which is the portion of the rates that covers the expected future losses and loss adjustment expenses for a policy.
Workers compensation insurers must calculate their own rates by adjusting the NCCI loss costs to account for their underwriting expenses and any perceived difference in loss potential.
WGIC writes workers compensation insurance for small companies with 50 employees or less. It relies heavily on NCCI for the overall loss costs as well as for many of the rating tables, but is able to determine the expense provision needed to profitably write the business.
The following is a simple premium calculation example for a U.S. workers compensation policy.
Class Rate
The purpose of the classification system is to group employers with similar operations that have a similar exposure to loss based on the job duties performed by the employees. There are over 400 different classes recognized by the NCCI for which they collect data. Table 2.23 shows the class rates applicable for a specific operation (in this case, retirement living centers) that Wicked Good writes. These class rates are based on the NCCI class rates, adjusted for WGIC’s expenses and perceived differences in loss potential.
2.23 Class Rates
Class
Rate per
$100 of Payroll
8810-Clerical 0.49
8825-Food Service Employees 2.77
8824-Health Care Employees 3.99
8826-All Other Employees 3.79
5 Workers compensation eligibility requirements vary by state.
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The process of calculating a premium begins with determining which classes best describe the activities of the company seeking insurance. Then, with data obtained for the prospective insured, Wicked Good estimates the amount of exposure ($100s of payroll) expected for each class during the policy period. The premium for the class is determined by applying the rate per $100 of payroll from Table 2.23 to the estimated payroll for each class. These results are aggregated across all classes for which the prospective insured has exposures, and the resulting premium is called the manual premium.
Rating and Underwriting Characteristics
Experience Rating
Under manual rating, all insureds are grouped according to their business operation or classification. The manual rates are averages reflecting the usual conditions found in each class. Although each class
contains similar risks, each risk within a class is different to some extent. Experience rating is designed to reflect these differences in loss potential.
Experience rating generally only applies for larger policies, which inherently are believed to have more stable loss experience. In fact, NCCI designates minimum aggregate manual premium for a company to be eligible for experience rating. Additionally, regulators mandate that experience rating be used if the employer meets the industry eligibility requirements.
When experience rating is used, the insurer compares the policy’s prior loss experience to the expected statewide average for the same classes. The manual premium will be adjusted upward if the actual losses for the company are higher than expected and downward if the actual losses are lower than expected. The adjustment is referred to as the experience modification. More detail on experience rating is contained in Chapter 15.
Since WGIC only insures small companies, experience rating is not applicable to its insureds.
Schedule Rating
As described earlier for medical malpractice, schedule rating specifies a range of credits and debits that an underwriter can apply to modify the manual premium. While some schedule rating schemes are very objective, WGIC has a set of potential credits and debits that require the underwriter to apply judgment in the underwriting process. The underwriter uses judgment based on professional experience and internal guidelines to select a value between the maximum and minimum for each attribute. The following table shows the range of schedule credits and debits that Wicked Good’s underwriters can apply:
2.24 Schedule Rating
Range of Modification Premises Classification
Peculiarities
Medical Facilities
Safety Devices
Employees — Selection, Training, Supervision
Management — Safety Organization
+/-10% +/-10% +/-5% -5% - 0% +/-10% +/-5%
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The overall maximum credit or debit that an underwriter can apply to a single policy is 25%. The policy must have an annual manual premium of at least $1,000 to qualify for schedule rating.
Premium Credits
Wicked Good offers various additional premium credits to its insureds for other factors that may reduce the risk of a workers compensation claim or limit the cost of a claim once an injury has occurred.
2.25 Premium Credits
Factor Credit
Pre-employment Drug Screening 5%
Employee Assistance Program 10%
Return-to-Work Program 5%
These credits are not subject to any overall maximum credit.
Expenses
Expense Constant
Insurers may add a fixed fee to all policies to cover expenses common to all workers compensation policies. This fee, often referred to as an expense constant, does not vary by policy size and covers expenses that are not included in the manual rate.
Wicked Good’s expense constant is $150 per policy.
Premium Discount
The manual rate includes an allowance for administrative expenses that vary with the size of the policy.
Not all expenses increase uniformly as the premium increases; for example, a company with $200,000 of payroll may not generate twice the administrative expenses for the insurer as a $100,000 payroll insured.
To adjust for this expense savings, workers compensation insurers reduce the premium for large insureds through the use of premium discounts.
Since Wicked Good only writes policies for small companies, it does not offer premium discounts.
Minimum Premium
The workers compensation rating manual specifies that the minimum premium for any policy is $1,500.
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Workers Compensation Rating Algorithm for WGIC
The components of the rating manual can be combined using a single rating algorithm to calculate the final premium for a given policy.
Total Premium = Higher of
[ Class rate x $Payrollfor class /100) where number ofclasses
1
∑
==
N
( i
N
i
i
x (1.0+ Schedule Rating Factor)
x (1.0- Pre-Employment Drug Screening Credit) x (1.0- Employee Assistance Program Credit) x (1.0- Return-to-Work Program Credit) + Expense Constant]
and
Minimum Premium specified in the rating manual ($1,500 in this example).
Also according to the manual, premium is rounded to the nearest penny after each step and to the nearest dollar amount at the end to determine the total premium. Note that experience rating factors and premium discounts do not appear in Wicked Good Company’s rating algorithm because these rating variables do not apply to its book of business.
Workers Compensation Rate Calculation Example for WGIC
A retirement living center has requested a quote. The following are characteristics of the retirement living center:
2.26 Payroll by Class
Class Payroll
8810 – Clerical $35,000
8825 - Food Service Employees $75,000
8824 - Health Care Employees $100,000
8826 - All Other Employees & Salespersons, Drivers $25,000
• The center has trained its entire staff in first aid, and first aid equipment is available throughout the building.
• The center has been inspected by Wicked Good, and the premises are clean and well-maintained.
• The center requires all employees to be drug-tested prior to employment.
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The first step in determining the premium is to compute the aggregate manual premium. The following table shows the computation of the manual premium for each class:
2.27 Manual Premium by Class
Class Payroll Payroll/$100
Rate per $100 of Payroll
Class Manual Premium
8810 Clerical $35,000 $350 0.49 $171.50
8825 - Food Service Employees $75,000 $750 2.77 $2,077.50
8824 - Health Care Employees $100,000 $1,000 3.99 $3,990.00
8826 - All Other Employees $25,000 $250 3.79 $947.50
Total $235,000 $7,186.50
The manual premium for each class is calculated as the payroll divided by $100 multiplied by the applicable rate per $100 of payroll. The total manual premium for the policy is the sum of the manual premium for each class:
$7,186.50 = $171.50 + $2,077.50 + $3,990.00 + $947.50.
The underwriter has determined that the following credits should apply based on the retirement living center’s characteristics:
2.28 Schedule Rating Modifications
Modification Premises Classification
Peculiarities
Medical Facilities
Safety Devices
Employees — Selection, Training, Supervision
Management
—Safety Organization
-10% 0% 0% -2.5% -5% 0%
The total credit (i.e., reduction to manual premium) for schedule rating is 10% + 2.5% + 5% = 17.5%.
The credit takes into account the first aid equipment, staff training, and cleanliness of the premises. The credit is less than the maximum allowable credit of 25%; therefore, the entire 17.5% credit is applied to the manual premium. The schedule rating factor that should be applied to the manual premium is:
0.825 =1.000 - 0.175.
The following other factors apply to the policy:
2.29 Entries from Wicked Good’s Rating Manual Entries from Rating Manual
Pre-employment Drug Screening Credit 5%
Employee Assistance Program Credit 0%
Return-to-Work Program Credit 0%
Expense Constant $150
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The Employee Assistance Program credit and Return-to-Work credit do not apply to the policy because the center does not have those programs. The following is the total premium for the policy:
$5,782 = $7,186.50 x 0.825 x (1.0 - 0.05) x (1.0 - 0) x (1.0 - 0) + $150.
Since $5,782 is greater than the minimum premium per policy of $1,500, the total premium for the policy is $5,782.
SUMMARY
The rating manual is an aid for anyone who needs to understand the process of calculating an insurance premium. For most lines of business, the manual includes the rules, rate pages, rating algorithm, and possibly the underwriting guidelines.
The rules contain items such as key definitions and summaries of what the contract covers, instructions on how to classify risks for premium rating, and information on optional coverages. Rules may also contain underwriting guidelines, or these may be provided separately.
The rate pages generally contain the numerical inputs needed to calculate the premium. These include base rates, rating tables, and fees.
The rating algorithm is the precise mathematical expression of how to calculate the premium using the inputs from the rate pages.
Underwriting guidelines document company-specific rules around risk selection, risk placement, and additional premium adjustments from underwriting characteristics. Underwriting guidelines are typically not part of the rating manual (and therefore not publicly available) unless required by statute.
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KEY CONCEPTS IN CHAPTER 2
1. Basic components of a rate manual a. Rules
b. Rate pages c. Rating algorithm d. Underwriting guidelines
2. Simple rating examples a. Homeowners b. Medical malpractice c. U.S. workers compensation