Chapter 22 Exercises

Work these with the chapter's habits of mind: in workers' comp, the class is the price, the mod is the company, and frequency is the disease. Ask of every account: is it classified by fact or by convenience? What is the mod actually telling me, and what is it hiding? Items marked with a dagger (†) have worked solutions in Appendix: Answers to Selected Exercises; the rest are for discussion or self-test. Section references like (§22.3) point you back to the chapter. All dollar figures are illustrative.

A. Recall and definitions

  1. † Define workers' compensation and explain what "the grand bargain" means for both the worker and the employer. (§22.1)
  2. What does statutory coverage mean, and why does it explain the absence of a per-occurrence limit on the core WC benefit? (§22.1)
  3. Name the four broad categories of benefits a WC statute typically provides. Which one is usually the largest controllable cost on a claim? (§22.1, §22.7)
  4. † Define NCCI class code and governing class, and explain the difference between the governing class and a standard exception. (§22.2)
  5. In one sentence each, define experience modification (X-mod), premium audit, monopolistic state fund, and employer's liability. (§22.3–§22.6)
  6. What is the exposure base for workers' compensation, and how is the WC rate quoted? (§22.4)
  7. A WC policy has two coverage parts. Name them, and state which one carries dollar limits and which does not. (§22.5)

B. Classification and the exposure base

  1. † A fabrication shop reports the following annual payroll: \$6,000,000 structural-steel fabrication (governing, loss cost \$5.00 per \$100), \$1,200,000 drivers (loss cost \$3.50 per \$100), and \$900,000 clerical (loss cost \$0.30 per \$100). Compute the manual premium for each class and the total manual premium (before mod, schedule rating, and loads). (§22.2, §22.4)
  2. Using the result of Exercise 8, if the company's X-mod is 1.20, what is the modified premium? If instead the mod were 0.85, what is the modified premium? (§22.3, §22.4)
  3. † Explain why misclassifying \$1,000,000 of fabrication payroll into a lower-rated class is dangerous in two ways — one to the premium and one to the file/the downstream reader. (§22.2)
  4. A broker insists their client "doesn't really do erection anymore." Last year's loss run shows a fall from height at a customer job site. How should the disciplined underwriter treat the classification question, and what will the audit do if the underwriter takes the broker's word? (§22.2, §22.4)
  5. Why is overtime generally included in WC payroll only at the straight-time portion? What is the underlying logic about exposure? (§22.4)

C. The experience modification factor (the X-mod)

  1. † Explain why the experience rating plan weights the primary (small-dollar) portion of each claim more heavily than the excess portion. What underwriting truth is the plan built around? (§22.3)
  2. Two shops in the same class each carry a 1.25 X-mod. Shop A's mod comes from one large claim three years ago, since followed by a complete safety overhaul; Shop B's comes from a steady stream of small claims that are still occurring. Which is the better risk going forward, and why can't the mod alone tell you that? (§22.3)
  3. † A company's actual three-year losses are well below what an average employer of its size and class would be expected to lose. Will its mod be above or below 1.00, and what is that called (debit or credit)? Roughly how would a larger such employer's mod compare to a small one's on the same relative experience, and why? (§22.3; Ch. 10)
  4. Why is the X-mod described as both backward-looking and lagging? Give one situation in which a risk is genuinely deteriorating but the current mod does not yet show it. (§22.3)
  5. Explain why a company's X-mod can cost it work, not just premium — and how that fact gives the better employers an incentive you can harness. (§22.3, §22.7)

D. Underwrite this submission

  1. † Underwrite the WC. A 90-employee custom welding shop, single state (NCCI), \$5,800,000 payroll (mostly fabrication, some drivers, a small office), submits for workers' compensation. The three-year loss runs show a string of back strains and two lacerations, no large claims, and a frequency trend that is rising year over year. The current X-mod is 1.18. The broker is pushing for a competitive price and "doesn't see why the mod should matter — there's never been a big claim." Decide your posture (accept / decline / modify), name the conditions or credits you would attach, and state in one paragraph how you would defend the decision to the broker. (§22.2, §22.3, §22.7)
  2. The same shop offers to implement a formal return-to-work program. Explain, mechanically, how that program would be expected to affect (a) the indemnity cost on future claims, (b) the X-mod over the next three years, and (c) the loss ratio on the account. (§22.7)
  3. A mid-size employer with a deteriorating loss history asks for a \$250,000 large-deductible plan to cut its fixed cost. What two distinct risks have you taken on if you agree, and what would you require before doing so? (§22.6)

E. Price this risk

  1. † A structural-steel fabricator has \$10,000,000 of governing-class payroll at a manual rate of \$4.60 per \$100, \$1,000,000 of driver payroll at \$3.40 per \$100, and \$1,000,000 of clerical at \$0.30 per \$100. (a) Compute the total manual premium. (b) Apply a 1.22 X-mod. (c) Then apply a net 10% schedule credit for documented loss controls (Chapter 11). Give the indicated premium before expense and profit loads, and explain in one sentence what each step represented. (§22.2–§22.4; Ch. 11)
  2. Two employers have identical payroll and class. Employer A has a 0.80 mod; Employer B has a 1.30 mod. Express, as a ratio, how much more B pays than A for the same manual exposure, and explain in plain language what the marketplace (general contractors, owners) does with that difference. (§22.3)
  3. The deposit premium on a growing account was set on a payroll estimate 20% below what the company actually paid. What happens at audit, and why is a deliberately low deposit a problem for the insurer during the policy term, not just at the end? (§22.4)

F. Find the red flag

  1. † A WC submission lands with the following features. Identify the three strongest red flags and say what each one means: (a) the renewal payroll estimate is 30% lower than last year's audited payroll, with no stated change in operations; (b) the broker has classified all shop employees as "assembly" though the application describes arc welding and steel cutting; (c) the X-mod is 1.40, driven by nine lost-time claims in three years that are still occurring; (d) the company carries a clean severity record (no claim over \$50,000). (§22.2, §22.3, §22.4, §22.7)
  2. Why is "a clean severity record but a rising frequency trend" a red flag rather than a comfort in workers' comp? Connect your answer to what the X-mod is built to measure. (§22.3, §22.7)
  3. An employer operating in four states, one of them monopolistic, asks you to quote "all of it" on one WC policy. What is wrong with the request, and what does the program actually need? (§22.6)

G. Memo and communication

  1. † Write the coverage recommendation (short memo). In 150–250 words, recommend a WC pricing and terms posture for a coastal fabrication account with a debit X-mod and a string of back injuries. State the governing class, the mod posture, the single most important loss-control condition, and the one sentence you would put in the file to defend the price to an auditor. (§22.2, §22.3, §22.7)
  2. A broker emails: "Your WC quote is 25% over the expiring carrier's — they must be writing it cheaper. Match it." Draft a three-to-five-sentence reply that holds the price without burning the relationship, grounded in the mod and the loss history rather than in stubbornness. (§22.3; Ch. 11)

H. Ethics and judgment

  1. † A sophisticated insured has clearly worked its loss data and disputed an erroneous claim that was inflating its mod, legitimately lowering the mod from 1.10 to 0.98. A colleague calls this "gaming the system." Is correcting bad loss data that feeds the mod a legitimate practice or a manipulation? Argue the ethics, and distinguish it from a genuine abuse (e.g., misclassifying payroll to dodge premium). (§22.2, §22.3)
  2. WC benefits are set by statute and are unlimited for the injured worker, even when the employer's premium turns out to have been inadequate. Connect this to the book's sixth theme (insurance serves a social function): why does the "no limit" rule exist, and what obligation does it place on the underwriter to price adequately rather than win business cheap? (§22.1; Ch. 1, Ch. 3)
  3. An employer in your book is illegally operating without required workers' comp on part of its workforce. Beyond the legal exposure, explain why this is an underwriting and fairness problem — for the workers, for the honest employers in the pool, and for your own loss experience. (§22.5)

I. The Underwriting File

  1. † Harbor Steel — classify and price the WC. Using only the facts in the file (≈\$11M payroll across welders, fabricators, drivers, and office; several WC claims including back injuries and a serious laceration near-miss), state the governing class, predict the direction of the X-mod and why, name the single loss-control lever you would attach, and identify the one classification question you must verify at inspection. (§22.2, §22.3, §22.7, The Underwriting File)
  2. The Harbor Steel file mentions a catastrophic single-claim possibility (a young worker with a life-altering injury) but the chapter says you do not price that into the working layer. Where does that tail go, and why is that the right treatment? (§22.1, §22.7; preview of Ch. 27)
  3. Suppose, at inspection, you discover Harbor Steel does erect steel at customer job sites with a meaningful share of payroll. Explain how that changes the classification, the price, and your view of the risk, and why letting it ride as "fabrication" would be both a pricing error and a misstatement of the risk. (§22.2, The Underwriting File)
  4. Extend the file: list three things about Harbor Steel's WC that this chapter has now settled and two that remain open for later chapters (the audit, reinsurance for the tail, the safety-culture question). (§22.4, §22.7, The Underwriting File)