806 KAR 13:120. Workers' compensation small deductible policies.

 

      RELATES TO: KRS 304.13-057, 304.13-400-304.13-420

      STATUTORY AUTHORITY: KRS 304.2-110, 304.13-410

      NECESSITY, FUNCTION, AND CONFORMITY: KRS 304.2-110 provides that the Executive Director of Insurance may make reasonable administrative regulations necessary for or as an aid to the effectuation of any provision of the Kentucky Insurance Code. KRS 304.13-410 provides that premium reductions for deductible workers' compensation insurance policies shall be calculated by the insurer in accordance with administrative regulations promulgated by the Executive Director of Insurance. This administrative regulation establishes the method of calculating premium reductions for workers' compensation insurance policies with deductibles.

 

      Section 1. All insurers authorized to write workers' compensation insurance in Kentucky, when establishing the premium for a workers' compensation insurance policy with a deductible ranging from $100 to $10,000 shall use only the following deductibles: $100, $200, $300, $400, $500, $1,000, $1,500, $2,500, $5,000, $7,500, $10,000.

 

      Section 2. Application of this Administrative Regulation. (1) General.

      (a) This administrative regulation applies to all insurers and licensed advisory organizations introducing or revising workers' compensation insurance deductible discounts for policies with deductibles of $100 to $10,000 or their application in Kentucky.

      (b) A licensed advisory organization filing shall be self- contained and fully documented and shall not simply adopt the deductible plan or factors of another filing. An insurer may file a self-contained and fully documented deductible discount plan or it may choose to adopt the filed deductible plan and discounts of a licensed advisory organization or another insurer.

      (2) Form of the deductible. The deductible discounts shall be determined by the multiplication of the deductible discount factors by the manual premiums. Separate deductible discounts for each deductible option shall be applicable for each hazard group defined in Appendix A.

      (3) Experience and retrospective rating. Experience rating modifications shall be based on net losses and premiums, that is, losses net of deductibles and manual premiums less the deductible discount. The parameters of the experience rating plan shall also be adjusted to account for the deductible.

      (4) Premium discount programs. For insurers that have a premium discount program based on the standard premium of a policy, the deductible discounts shall be applied prior to the application of premium discounts. The deductible discount shall be calculated by multiplying the discount factor by the manual premium. Premium discounts then are calculated based on the standard premium, after deductibles.

 

      Section 3. Methodology. (1) General. The deductible discount recognizes the reduction in losses (claim costs) borne by the insurer as a result of the insured's selection of a deductible. The most critical factor in the calculation is the loss elimination ratio ("LER"), which estimates the percentage of losses eliminated as a result of the deductible. Typically, two (2) types of adjustments are required to calculate the deductible discount from the LER:

      (a) Recognition of factors which imply additional costs or savings associated with the deductible. These include credit risks that the insured will not repay the insurer for the deductible amount, changes in insurer cash flow, and higher levels of risk and possible antiselection. These types of factors are treated in this administrative regulation as adjustments to the otherwise indicated LER.

      (b) Recognition that many insurer operating expenses are not reduced by the introduction of deductibles. This consideration is treated in this administrative regulation through the deductible discount formula.

      (2) Formula.

      (a) The formula for pricing of deductibles in Kentucky shall be as follows:

where:

      p(x) - is the discount factor for a deductible of "x";

      a - is loss adjustment expenses as a percentage of standard premiums after premium discounts (based on the insurer's filings);

      c - is a factor to account for credit risk;

      d(x) - is the LER, which is defined as the percentage of losses eliminated by the deductible;

      e - is the general expenses as a percentage of standard premium after premium discounts (based on the insurer's filings);

      E - is the losses excluding loss adjustment expense as a percentage of standard premiums after premium discounts;

      i - is a factor to account for the differences in investment income earned by the insurer between policies with deductible and those without a deductible;

      k - is a factor to account for interest on the loan due to prepayment of losses below the deductible;

      r - is a factor to account for the increased risk associated with deductible policies; and

      s - is a factor to account for adverse selection.

 

      (b) Loss adjustment expenses include allocated and unallocated expenses. General expenses include all expenses incurred other than loss adjustment expense, commissions, and other expenses that vary directly with the premium. Losses are expected losses for a policy with no deductible. The manual premium shall be used to calculate loss and expense ratios.

      (c) Loss elimination ratio. The loss elimination ratio shall be determined by the size of loss distribution. To determine the size of loss distribution function it is necessary to analyze historical data. The analysis shall determine a mathematical function or a discrete empirical distribution table.

      1. Source of data. The data used in the analysis shall be relevant and appropriate. The ideal data for analysis is recent Kentucky-based number of claims and dollars of loss for medical and indemnity combined, by size of loss and hazard group on a per occurrence basis. The current National Council on Compensation Insurance Unit Statistical Plan incorporated by reference and available from the Kentucky Office of Insurance, 215 West Main Street, Frankfort, Kentucky 40601-1847, 8 a.m. to 4:30 p.m. (ET), weekdays, may be used subject to the following adjustment:

      a. The per claimant size of loss distribution shall be adjusted by scaling the x axis by a factor of five (5) percent to ten (10) percent. That is, if s(x) is the probability density function of the per claimant size of loss distribution and f(x) is the probability density function of the per occurrence size of loss distribution, and the adjustment factor is selected as ten (10) percent, then f(x) equals s(x/1.1).

      b. An alternative to this shall be to estimate mathematically the per occurrence size of loss distribution using a simulation method or by taking convolutions of the size of loss distribution. In either case, key inputs shall be the size of claims distribution and the distribution of the number of claimants per occurrence. Methodology shall be fully documented in the filing.

      c. If a filer has data that is more suitable for the determination of deductible discounts than National Council on Compensation Insurance Unit Statistical Plan data, its use shall be encouraged.

      (d) Trending.

      1. The size of loss distribution or data shall be trended to the effective period of the deductible factors. The trend factor shall be consistent with the historical data and with the most recent rate filing. The trend period shall reflect the average accident date of the underlying data and the average accident date of those policies issued during the effective period of the deductible factors.

      2. While trends may affect the shape of the size of loss distribution, these adjustments are difficult to codify and are probably not significant in the short term. Thus, filers may use the assumption that the effect of the trend is uniform for claims of all sizes. Alternative assumptions may be used if thoroughly documented and supported in the filing.

      (e) Loss development. Loss development for losses below $10,000 has a significantly shorter "tail" than for total losses. The assumption that no development takes place on this layer of loss after three (3) to five (5) years may be used in the calculation of the LER. Thus, the size of loss distributions below $10,000 shall be taken as:

Where g(x) is the distribution function determined from the size of loss data reported as of three (3) to five (5) years and LDF is the loss development factor to ultimate for all claims. Alternative assumptions may be used if thoroughly documented and supported in the filing.

      (3) Investment income and increased risk.

      (a) It is expected that loss payments by the insurer on losses from policies with deductibles shall be made later than those from policies without deductibles, since the insured is responsible for losses below the deductible which would be paid first. Losses above a deductible are also more volatile than losses from the first dollar of loss. The increased volatility increases the risk borne by the insurer.

      (b) The adjustment for investment income works in a direction opposite that of the adjustment for increased risk. It shall be assumed that these items completely offset each other. If the filer wishes to include an explicit factor for one (1) of these items, the filer shall also include an explicit factor for the other, and the filing document shall support the use of these factors.

      (4) Loan on the prepayment of losses.

      (a) The provision in KRS 304.13-400(3)(a) that every dollar of loss that is eliminated by the deductible shall first be paid by an insurer and then be reimbursed by the insured amounts to a loan, the effects of which may be recognized in the filing. This factor shall be equal to the amount or proportion of dollars that are eliminated by the deductible times a reasonable interest rate to account for the loss in investment income.

      (b) This rate shall reflect the investment earned during the period of the loan. Insurers shall reflect repayment of losses three (3) months after the claim. Thus, the factor "k" shall be determined by the following formula:

Where y is the yield on ninety (90) day United States treasury bills.

      (5) Adverse selection. In some lines of insurance there has been evidence of antiselection with respect to deductibles, that is, those that choose to purchase insurance with a deductible tend to have losses that exceed those losses which are expected. LERs may be reduced for adverse selection by up to five (5) percent, unless a greater reduction is clearly supported by facts such as loss ratios by deductible and class which clearly show that the deductible discounts are consistently, across classes and time, high. For the initial filing, data from other states with deductibles may be used to support the selection of the factor.

      (6) Credit risk. This factor is intended to account for losses below the deductible paid by insurers and not reimbursed by insureds due to bankruptcy. If the percentage of businesses that become bankrupt annually in Kentucky is expected to be "z," then the load should assume that z% of the amount "on loan" shall not be reimbursed. This shall be calculated as follows:

Factors between 0 and 2.5% may be used.

 

      Section 4. Effect on Rate Making. (1) Data. Rate-making data from the National Council on Compensation Insurance Unit Statistical plan shall be modified to include a field indicating the deductible on the policy. Financial data calls shall also segregate data by deductible.

      (2) Gross versus net data. KRS 304.13-057 requires that net data be used in rate making. However, adjustments to net data shall be made in the rate-making process to account for the presence of deductibles. That is, losses shall be loaded by the LER (adjusted for antiselection) to a gross basis prior to the rate- making process. The LER and antiselection factor shall be the same as in the current approved filing.

      (3) Methodology. Rate-making methods shall be modified to account for the presence of deductibles. For example, there shall be an adjustment in classification rate making for differences in the distribution of exposures by deductible among classes. Also, there shall be an adjustment in the trending procedure for the presence of a shift in the distribution by deductible.

 

      Section 5. Interrogatories to be Answered in Rate Filings. Every rate filing for a workers' compensation insurance deductible shall include a completed interrogatories form as set forth in Appendix B to this administrative regulation. (19 Ky.R. 1982; Am. 2260; eff. 5-10-93.)

 

APPENDIX A

TABLE OF CLASSIFICATIONS BY HAZARD GROUP

Code

No.

Hazard

Group

Code

No.

Hazard

Group

Code

No.

Hazard

Group

0005

II

1438

III

2065

II

0008

II

1452

III

2070

III

0016

II

1463

III

2081

II

0034

II

1470

III

2089

II

0035

II

1472

III

2095

II

0036

II

1624

III

2101

II

0037

II

1642

III

2105

II

0042

III

1654

III

2110

II

0050

II

1655

III

2111

II

0079

II

1699

III

2112

II

0083

II

1701

III

2114

II

0106

III

1710

III

2121

II

0113

II

1741

IV

2130

II

0169

II

1747

III

2131

II

0170

II

1748

III

2143

II

0251

II

1803

IV

2150

II

0400

II

1852

III

2156

II

0401

III

1853

II

2157

II

0908

II

1860

II

2172

I

0909

II

1924

II

2174

I

0912

II

1925

III

2177

I

0913

I

2001

II

2211

III

0917

II

2002

II

2220

II

1005

III

2003

III

2286

II

1164

IV

2014

III

2288

II

1165

III

2016

II

2300

I

1219

IV

2021

II

2302

II

1320

III

2030

III

2305

II

1322

III

2039

II

2361

I

1430

III

2041

I

2362

II

2380

I

2747

I

3082

III

2386

I

2759

II

3085

III

2388

II

2790

II

3091

II

2402

III

2802

II

3110

II

2413

II

2812

II

3111

II

2416

II

2826

II

3113

II

2417

II

2835

I

3114

II

2501

II

2836

I

3118

II

2503

II

2841

II

3119

I

2534

II

2881

II

3122

II

2570

III

2883

II

3126

II

2576

I

2913

II

3131

I

2578

II

2915

III

3132

III

2585

II

2916

II

3145

I

2586

II

2923

II

3146

II

2587

II

2942

I

3169

II

2589

II

2960

II

3175

II

2600

II

3004

III

3179

II

2623

II

3018

II

3180

II

2651

II