Actuarial assumptions for WC

Workers compensation Actuarial assumptions for insurers in Australia are a complex and critical part of their business. Unlike other forms of insurance, the premiums are heavily regulated and the claims are “long-tail,” meaning they can take many years to resolve. This makes the work of actuaries in this field particularly important for ensuring the financial health of the insurer and the stability of the overall scheme.

Each Australian state and territory has its own workers’ compensation scheme, each with a unique set of rules and regulations. As a result, actuaries must tailor their assumptions to the specific jurisdiction, whether it’s a privately underwritten scheme or a public one.

1. Claims Frequency and Severity

These two assumptions are the foundation of any ultimate calculation. Claims frequency refers to the number of new claims an insurer expects to receive, while claims severity is the average cost per claim. Actuaries must consider a variety of factors to project these numbers accurately:

• Industry and occupation: The risk of injury varies dramatically across different industries. A construction worker, for example, has a higher risk of a serious injury than a desk worker. Actuaries use historical data, categorized by industry.
• Economic conditions: Economic cycles can influence both claims frequency and severity. In a downturn, for instance, a greater proportion of employees may be reluctant to return to work, potentially extending the duration of claims and increasing their cost.
• Legislative and scheme changes: Changes to a state’s WC laws can have a significant impact. For example, a change to the cap on medical expenses or the duration of weekly benefits can directly alter the average cost of a claim.

2. Claims Development and Inflation

Workers’ compensation is a “long-tail” class of business, with claims potentially remaining open for years or even decades. Actuaries must project how these claims will “develop” over time.

• Payment patterns: Actuaries model how quickly payments will be made over a claim’s life. This is crucial for managing cash flow and determining the correct amount of reserves to hold.
• Medical and wage inflation: The cost of weekly benefits and medical care will increase over time due to inflation. Actuaries must use assumptions about wage growth and specific medical cost inflation to project these future expenses.
• Superimposed inflation: This is a crucial and often volatile assumption. It represents the increase in claims costs beyond general economic inflation. It can be driven by a variety of factors, such as more expensive medical treatments, increased legal costs, or a tendency for claims to be resolved with higher settlements.

Aggregate-level reserving is more commonly used than granular-level reserving. The Chain Ladder Method and its variants are the most frequently employed techniques, followed by Bornhuetter-Ferguson (BF) , Payment-Based Methods and other granular methods .

3. Economic and Financial Assumptions

The financial health of a WC scheme is highly dependent on its ability to earn returns on the reserves it holds for future claims.

• Discount rate: This is the rate of return an insurer expects to earn on its investments. It is used to “discount” future liabilities to their present value. A higher discount rate will reduce the calculated cost of future claims, while a lower rate will increase it. The discount rate is often based on the yields of government bonds.
• Risk margins:  A “risk margin” is added to the central estimate of the liability to account for the uncertainty in the assumptions. This ensures a certain probability (e.g., 75%) that the reserves will be sufficient to cover all future claims.

4. Claim Characteristics and Employer Factors

Finally, actuaries must also consider the specific characteristics of the claims and the employers themselves.

• Injury type and severity: Different types of injuries, from minor sprains to catastrophic injuries, have vastly different costs. Actuaries must model the distribution of these injury types.
• Employer’s claims history: In many Australian schemes, a medium-to-large employer’s individual claims history is used to adjust their premium. A strong safety record and good return-to-work programs can lead to lower premiums. Actuaries must incorporate a “claims experience rating” into their models.

Lump sum settlements: In many schemes, claims can be settled with a lump sum payment. The prevalence and cost of these settlements are an important assumption for actuaries.In summary, the actuarial assumptions for an Australian workers’ compensation insurer are a delicate balance of historical data, economic forecasts, and expert judgment. They must accurately reflect the specific risks of each industry while also accounting for the dynamic nature of claims and the regulatory environment.