NCCI.Circular

Reading: National Council on Compensation Insurance, Retrospective Rating Plan Manual for Workers Compensation and Employers Liability Insurance Circular. Filing Memorandum, Exhibits 1 — 7, 13.

Synopsis: This is the first of two articles on the NCCI Retrospective Rating Circular reading. It covers the first part of the circular which is an overview of the NCCI approach to retrospective rating. The second part of the NCCI Circular reading is available at NCCI.InformationalExhibits.

Study Tips

Although this article is lengthy, none of the calculations are particularly hard - they're just involved. Make sure you return to this article to work the examples from time to time to keep the calculations fresh in your mind.

Estimated study time: 8 Hours (not including subsequent review time)

BattleTable

This is a newer reading and due to the CAS no longer publishing past exams there are no prior exam questions available. At BattleActs we feel the main things you need to know (in rough order of importance) are:

• How to calculate the Basic Premium Factor
• How to calculate the Expected Number of Claims
• How to calculate the Policy Excess Ratio
• The general structure of the NCCI retrospective rating plan, including evaluation points, losses covered and the options of loss limitation and retrospective development for premium stabilization.

reference	part (a)	part (b)	part (c)	part (d)
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In Plain English!

Overview

Alice: "The National Council on Compensation Insurance (NCCI) has a strict copyright policy on the materials they provide in the CAS study kit. What follows here is our interpretation of these materials for the purposes of helping you learn the content of NCCI Circular CIF-2018-28 to get you through the CAS exam. As such, we'll provide any figures you require but they may not match those available in the latest study kit or NCCI manual. Nor is there any guarantee this material exhaustively covers the circular. Lastly, please remember this material is for exam purposes only — you shouldn't use these wiki articles for work purposes!"

This is the first of two articles which constitute the NCCI Circular reading; part 2 is available here.

The NCCI Circular describes the NCCI approach to retrospective rating. It uses a newer methodology which improves the accuracy of the insurance charge. In particular, due to recent increases in computational power, the NCCI now offers real-time calculation of factors which negates the need for copious numbers of lookup tables. Since you can't (yet) access the real-time look-up in the exam, the NCCI also has a table of countrywide factors that is available in the study kit.

One of the important things to note is the terminology in the NCCI Circular is slightly different from what you've so far encountered in the Fisher readings. Here's a summary of the main changes you should pay close attention to:

Fisher	NCCI Circular
Insurance Charge	Aggregate Excess Loss Factor (AELF)
Insurance Savings	Aggregate Minimum Loss Factor
Net Insurance Charge	Net Aggregate Loss Factor

The NCCI revised its retrospective rating methodology primarily to revamp the tables used in their rating algorithm. The revision uses more recent data, removes some approximations that were used and increased the accuracy and fairness (equity) of the insurance charges both within a state and countrywide. Rather than producing many tables for the various state/hazard group combinations, the NCCI has developed an online application which allows you to produce Aggregate Loss Factors (ALFs) on Demand. The ALFs on demand are produced after entering estimated claim count and severity distributions for the state/hazard group in question and can even handle interstate risks across multiple hazard groups.

In recognition that not everyone has permanent internet access, and that insurers may need time to implement the necessary IT/system changes, the NCCI provides the Table of Aggregate Loss Factors which replaces the previous tables of insurance charges. The table of aggregate loss factors is a countrywide alternative to the ALFs on demand.

Question: What are some of the benefits of using the table of aggregate loss factors over the previous table of net insurance charges?

Solution:

• The table of aggregate loss factors shares the methodology improvements of the ALFs on demand so are more accurate.
• It automatically accounts for claim size inflation over time .
• Removes the need for updates to hazard group differentials and the expected loss group ranges.
• More recent data is used to generate these tables. The previous Table of Insurance Charges has been unchanged since its inception in the 1990's.

Question: What is a disadvantage of using the table of aggregate loss factors?

Solution:

• The table of aggregate loss factors is countrywide so doesn't reflect the state and hazard group severity distribution differences. (Alice: "The ALFs on demand do pick this up, so get online!")

Background & Definitions

The NCCI Circular uses the retrospective rating formula we've seen in the Fisher Risk Sharing article, namely [math]R=(B+cL)\cdot T[/math]. Here R is the retrospective premium (subject to min. and max. amounts), B is the basic premium, c is the loss conversion factor, L is the actual incurred loss, and T is the tax multiplier.

As we did in the Fisher articles, you'll use entry ratios (defined as the ratio of the loss limit to the expected losses) to price policies.

The basic premium, B, is a percentage of the standard premium and is calculated by the insurer by multiplying the standard premium by the basic premium factor which we'll show you how to calculate later in this article.

Question: What is included in the basic premium?

Solution:

The basic premium includes the following:

• General insurer admin costs.
• Cost of related loss control services.
• Net aggregate loss factor.

Question: What is NOT included in the basic premium?

Solution:

The basic premium doesn't include:

• Premium taxes (found in the tax multiplier). Or,
• Claims adjustment expenses (found in the loss conversion factor)

Excess Loss Premium

If the insured chooses a loss limitation such as per-claim or per-occurrence limit then the charge for this is added into the retrospective rating formula after the basic premium component. This charge is called the Excess Loss Premium (ELP). This is defined as [math]ELP=\mbox{(Excess Loss Factor)}\cdot\mbox{(Standard Premium)}\cdot\mbox{(Loss Conversion Factor)}[/math].

The NCCI files either excess loss factors (in rate states) or excess loss pure premium factors (in loss cost states). Either may or may not include a provision for allocated loss adjustment expenses (ALAE). To calculate the ELP you must have an excess loss factor so in loss cost states you need to perform a conversion first.

To convert to an excess loss factor (or excess loss and allocated expense factor if ALAE is included), multiply the excess loss pure premium factor (or excess loss and allocated expense pure premium factor) by [math]\mbox{ELR}\cdot(1+\mbox{Loss Adjustment Expense %} + \mbox{Loss Assessment %)}[/math].

The Expected Loss Ratio (ELR) is the ratio of pure losses (no LAE) to premium and is determined by the insurer. The loss adjustment expense percentage and loss assessment percentage are found in the appropriate NCCI state filing. The resulting excess loss factor varies by hazard group and the loss limitation chosen.

If a policy has exposures across several hazard groups then use the product of the policy excess ratio with the expected loss ratio instead. The Policy Excess Ratio is the total expected excess loss divided by the total expected loss.

Tables Included in the Circular

The circular can seem quite daunting in the study kit but that's largely because of the number of table pages given. Exhibit 4 contains Appendix A which has two tables, one for looking up the expected claim count group based on the expected number of claims, and the other for looking up the relevant sub-table based on the excess ratio range. Exhibit 5 contains the huge Appendix B that has tables of aggregate excess loss factors grouped by sub-table and expected claim count group with values ordered by increasing entry ratio from 0 to 10 in steps of 0.01.

Alice: "The study kit currently only includes sub-table 6 yet Appendix B is still 40 pages of tiny print - bring a magnifying glass!"

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Basic Premium Factor Calculation

This is the main calculation for the application of the circular. There are a lot of steps involved but if you memorize them well this should be straight forward points on the exam.

Alice: "The PDF below shows you how to calculate the basic premium factor. You should have this open in another browser tab so you can follow the line by line commentary in this wiki article."

Calculate the NCCI Basic Premium Factor

Alice: "To break this example into manageable pieces we've colour-coded the example as follows: Grey - information provided. Yellow - information you'll calculate on the way. Blue - information you'll look up based on intermediate values. Red - information you'll probably be provided with but may need to calculate. Green - the final answer! You should read the commentary below as you work through the example."

Line by Line Commentary

Alice: "The NCCI Circular is an update to the NCCI Retrospective Rating plan which is no longer on the syllabus. Because of this, the syllabus reading is unclear about the rounding involved. In what follows you should round each individual calculation to 3 decimal places unless the answer is a dollar amount (round to nearest whole dollar), or the rounding is called out explicitly."

Line Item(s)	Description/Notes
1.	This is the annual standard premium unless pricing a 3-year retrospective plan. In that case, multiple the annual standard premium by 3.
2. & 3.	You may be given the expected loss ratio or the expected losses. You need at least one of them and it must be for unlimited losses. For an intrastate risk, once you have one of the figures you can calculate the other by (rearranging if needed) (2) = (3) * (1). For an interstate risk the total expected unlimited losses (item 2.) is the weighted average of the state specific expected (unlimited) loss ratios where the weights are the estimated standard premiums for the states. Item 3. is the ratio of the total expected loss (item 2.) divided by the total estimated standard premium (item 1.).
4.	This value may be given to you in the question, or you may be given enough additional information to calculate it. The Policy Excess Ratio is the total expected excess loss divided by the total expected loss. It's calculated at the state/hazard group level using the table approach shown in the PDF. The policy excess ratio is the expected percentage of total loss (or loss plus ALAE if included) that will exceed the policy loss limit. By looking up the policy excess ratio in the second table found in Appendix A you can determine the correct sub-table to use later on. The Excess Ratio at Loss Limit is found in Exhibit 9 of the NCCI's Excess Loss Factor Calculations document which is not included as part of the study kit. Thus, you should be given those figures if needed. However, if they give you an extract from Exhibit 9 then make sure you look up the correct loss limit as the ratios vary depending on if it is a per-claim or per-occurrence loss limitation on the policy.
5.	This is the product of the Policy Excess Ratio and the Expected Loss Ratio.
6.	Subtract the excess loss factor from the expected loss ratio.
7.	This value may be given to you in the question, or you may be given enough additional information to calculate it. The Expected Number of Claims is calculated at the state/hazard group level and then summed. The state/hazard group calculation is the modified expected loss divided by the average cost per case. The modified expected loss is the manual premium for the state/hazard group multiplied by both the expected loss ratio and the experience modification factor for the risk (assuming the risk uses NCCI experience rating as well). This is best calculated using the table approach shown in the above PDF. This figure is used to find the Expected Claim Count Group using the first table in Appendix A.
8.	This is the standard premium multiplied by the expense ratio. If a three-year retrospective plan is being rated, calculate this for each year separately and then sum to get the provision.
9.	This is the ratio of the expected losses plus expenses, profit & contingency to standard premium.
10.	This is the product of the expected loss ratio and the loss conversion factor. It measures the ratio of the expected loss and allocated loss adjustment expense to standard premium.
11.	This is (Item 9.) - (Item 10.). It excludes the expenses contained within the converted losses (allocated LAE). This must be included in the basic premium, so forms part of the basic premium factor.
12.	This is the minimum retrospective premium factor divided by the tax multiplier.
13.	This is the maximum retrospective premium factor divided by the tax multiplier.
14.	This is the difference between the aggregate excess loss factors for the entry ratios which are implicitly used in (Item 15.).
15.	This is the difference between the entry ratios which determine the aggregate minimum loss factor at the minimum premium and the aggregate excess loss factor at the maximum premium.

Alice: "Let's pause going through the line items for now so we can focus on extracting the information we need from Appendix B."

At this point, if you haven't already, do the following:

• Use the expected number of claims and the first table in Appendix A to find the relevant expected claim count group. In the above example we have 20.95 expected claims which falls into group 48.
• Use the policy excess ratio and the second table in Appendix A to find the relevant sub-table you'll need in Appendix B. In the above PDF the entry ratio of 0.582 corresponds to sub-table 15. Conveniently this isn't the table you're given in the study kit so we'll have to trust the NCCI values provided.

Now turn to Appendix B and locate the appropriate sub-table then find the relevant column for the expected claim count group.

Next, pick pairs of entry ratios that have a difference equal to (Item 15.). In the example above, (Item 15.) is 2.28 so consider pairs such as (0, 2.28), (0.1, 2.38), (0.25, 2.53), ... For each pair (i, j) where j - i = (Item 15.), compute AELF_i - AELF_j using the values in the sub-table column you identified above. Here AELF means Aggregate Excess Loss Factor.

Your goal is to find the pair of entry ratios (i, j) so that AELF_i - AELF_j is as close as possible to (Item 14.).

A good way to do this is to use a table like the one below which shows the figures needed for the above example.

i	j	AELFi	AELFj	AELF Difference
0.04	2.32	0.9619	0.0732	0.8887
0.05	2.33	0.9527	0.0723	0.8804
0.06	2.34	0.9437	0.0714	0.8723

In the above example, (Item 14.) equals 0.8824 which is closest to 0.8804. You'll need to carefully use the values in the closest row (highlighted in green). Let's call this the "winning row".

The above table makes it look easy to find the correct row. The key is to fix the right difference between the entry ratios and then recall that as you increase both of the entry ratios (by the same amount), the difference between the AELFs always decreases. So if your difference is too small then move up the table by making the entry ratios smaller, and if the difference is too large then move down the table by making the entry ratios larger.

Alice: "Okay, now we've got those factors and entry ratios let's finish up the calculation."

Line Item(s)	Description/Notes
16.	This is the smallest entry ratio in the "winning row", i.e. the i value.
17.	This is the largest entry ratio in the "winning row", i.e. the j value.
18.	This is the Aggregate Excess Loss Factor for (Item 17.), i.e. AELFj
19.	This is the Aggregate Minimum Loss Factor for the entry ratio in (Item 16.). The Aggregate Minimum Loss Factor (AMLF) is given by [math]AMLF_r = AELF_r + r -1[/math]. The subscript r stands for the entry ratio used to look up the AELF in Appendix B.
20.	The Net Aggregate Loss Factor is the difference between the aggregate excess loss factor at the maximum premium and the aggregate minimum loss factor at the minimum premium, multiplied by the loss conversion factor and the expected limited loss ratio (Item 6.). The net aggregate loss factor can be less than 0 provided the basic premium factor is not negative.
21.	The Basic Premium Factor is the sum of the net aggregate loss factor (Item 20.) and the Expense, Profit & Contingency in Basic Premium (Item 11.). Both of these are a percentage of standard premium. To get the Basic Premium, multiply the basic premium factor by the estimated standard premium.

Alice: "Wow, that is a lot to digest. Time to put it into practice!"

Practice Problem: Calculate the NCCI Basic Premium Factor

Exhibits 7 & 13

Exhibit 7 is very similar to Exhibit 13; both describe how to apply the retrospective rating plan. The biggest difference is Exhibit 13 applies to Alaska only whereas Exhibit 7 applies in the other NCCI states.

Rules Common to Both Exhibits

The rating plan period covers one-year from the effective date. If the policy covers more than one insured then the retrospective premiums are determined using all insureds combined. If retrospective rating is used for more than one state or policy then the standard premium is summed over all states and policies.

A retrospective rating plan calculates the retrospective rating premium using all loss information available initially as of 6-months after the end of the rating period and then annually thereafter, so at 6-months, 18-months, 30-months, ...

There are five standard elements and two optional elements of the NCCI retrospective rating plan.

Standard Elements

No.	Name	Description
1.	Standard Premium	This is the premium that would be charged if the plan was not retrospectively rated. It does not include any of Premium discount Expense constant Premiums from nonratable element codes Premium developed by the occupational disease rates for employers subject to the Federal Mine Safety & Health Act Premium developed by the catastrophe provisions
2.	Basic Premium	This is the basic premium factor multiplied by the standard premium. The basic premium factor includes: General admin costs for the insurer Cost of loss control services Net aggregate loss factor
3.	Incurred Losses	This is the paid loss and outstanding case reserve for losses, interest on judgements, recovery expenses and employers liability for loss adjustment expenses. It may or may not include allocated loss adjustment expense (ALAE) depending on how the policy is set up. The following types of losses are not included: Non-ratable element code losses Portion related to disease losses covered under the Federal Mine Safety & Health Act Resulting from the application of catastrophe provisions Fraudulent claims Non-compensable claims
4.	Converted Incurred Losses	This is the incurred loss multiplied by the loss conversion factor.
5.	Taxes	Taxes are a percentage of basic premium, converted incurred losses and any elective elements

Optional (Elective) Elements

No.	Name	Description
1.	Loss Limitation	This restricts the amount of loss counted as incurred loss. Limits apply separately for each person sustaining bodily injury by disease and separately to all bodily injury claims arising from any one accident. The charge for the loss limitation is called the excess loss premium. The excess loss premium is a percentage of the standard premium multiplied by the loss conversion factor.
2.	Retrospective Development	When elected the appropriate factor can be applied to each of the first three retrospective rating premiums to stabilize the premium adjustments. Retrospective development factors vary by state, loss limitation and evaluation point.

The retrospective rating premium formula is [math]R = \left(B+cL +\mathbf{XS} + \mathbf{retro}\right)T[/math]. Here, B is the basic premium, cL is the converted incurred loss and items in bold font are the optional elements. XS is the excess loss premium and retro is the retrospective development premium.

Differences between Exhibits

Exhibit 13 applies to Alaska only and has a different cancellation provision (7.5% of unearned premium cancellation fee vs short rating used in Exhibit 7.

Alice: "Wow, you've taken a lot in. Have a break then resume by reading the NCCI.InformationalExhibits article which will walk you through the new NCCI methodology used to produce the Aggregate Excess Loss Factors."

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