A Methodology for Avoiding the Pitfalls of Excess Loss Development

Given the long-tailed nature of certain lines of business, such as workers’ compensation, and the impact of inflation on claim costs, determination of development factors, particularly in the tail, can be challenging. Reliance on excess loss development triangles can present challenges from both a credibility and volatility perspective. Furthermore, the application of excess development factors selected directly from excess loss triangles does not fully account for the impact of claim cost inflation, which has a greater impact on excess claims than on claims limited to a retention. Therefore many actuaries fall back on industry development patterns that are not necessarily indicative of the individual company’s development and may be impacted by other distortions (e.g., non consistent interpretation of limits or retentions across companies in the compilation of data). We will discuss these distortions and the limitations of reliance on excess data and then present an alternative approach that relies on more stable ground-up data and can adjust for changing retention levels by year via calculation of excess development factors using excess loss factors (ELFs). We will discuss the theory behind the formula and its own benefits and limitations.

Keywords: Workers Compensation, Excess Loss Development, Reserving, Deductible