Legislative changes and captive actuarial analytics

One of the many benefits captives can offer their owners is the ability to react swiftly to changes impacting their risk portfolios. The traditional insurance market may take several years to adapt to emerging or evolving risks, due in part to the burden of creating products which appeal to a wide range of customers.

Captives don’t necessarily share this burden and can offer policies targeting the specific needs of their insureds. This ability can be vital to maintaining a sound risk financing strategy, especially when a company’s risk portfolio is faced with the impact of significant legislative changes.

While laws passed at the state level can affect several aspects of captive operations, this article is primarily interested in examining the influence they might have at the claim or risk level. From an actuarial perspective, the most common impact is likely to claim frequency and severity, but other aspects of loss experience could also see a change, such as claim timing or report lag.

The effects this can have on an actuarial analysis range from negligible to dramatic and might require significant adjustments to the reserve analysis and to loss projection. It is therefore essential that new or revised legislation affecting a captive’s risk portfolio be clearly communicated to its actuarial partner.

What form might these legislative changes take? Let’s start by examining one of the most commonly impacted coverages: workers’ compensation.

The benefit levels associated with workers’ compensation insurance can vary from state to state and are dictated by the current legislative environment. Over time, a state’s lawmakers might amend, reverse, or introduce laws determining the parameters of compensable claims, such as the duration of disability payments or types of compensable medical treatments.

The National Council on Compensation Insurance (NCCI) attempts to quantify the impact of these changes over time with benefit level change factors (BLCFs), which are compiled separately by state. Because of the rate at which relevant laws are passed or amended in each state, benefit levels are in a relatively constant state of flux. This has made the use of BLCFs common practice for actuaries analysing workers’ compensation losses, and these factors have become a standard piece of actuarial reports.

NCCI provides annual updates to these and many other state-specific factors, so the impact of such legislative changes are generally reflected in actuarial analytics without requiring a great deal of input from, for example, a captive’s management team. That said, one of the key assumptions in many analytical exercises is that historical information is indicative of what lies ahead. This makes it crucial that the information provided is holistic and any gaps in quantitative information are supplemented with qualitative knowledge. In other words: talk to your actuary.

As an example, consider a captive providing workers’ compensation coverage to an insured with operations moving into or being removed from certain states. These operational changes might lead to risk exposure in states with drastically different workers’ compensation benefits from the insured’s historical operations. Without adequate, advanced communication from the captive management team, the subsequent actuarial analytics may potentially result in an under- or overstated loss projection and, thus, premium. The financial impact of such an oversight can easily be avoided, but as mentioned earlier, its avoidance relies on communication.

Liability issues

Workers’ compensation is obviously not the only coverage affected by legislative changes. Laws relating to liability exposures, such as sexual misconduct, can also require significant adjustments to actuarial reporting. In 2022, the governor of New York signed the Adult Survivors Act, establishing a one-year lookback window for lawsuits relating to sexual assault cases with certain parameters. Most importantly, this act removed any limitation on when the offence occurred for lawsuits made during the window. The state of California passed a similar bill removing such limitations for sexual assault lawsuits made over a three-year timeframe.

Newly introduced legislation such as the examples above can swiftly change the outlook of a captive whose risk portfolio includes sexual misconduct liability exposures. Captives writing claims-made policies might require a significantly revised approach to estimates of future loss, and similarly, those providing liability coverage for claims on an occurrence basis could be faced with deterioration in the actuarial reserve estimate for expired policy periods.

Some of the changes discussed thus far have focused on the lengthening or removal of statutes of limitations, but shortened statutes can also affect historical and projected actuarial loss estimates. Earlier in 2023, the state of Florida enacted sweeping changes to its legal environment through House Bill 837. Among other revisions, such as updated standards on the value of medical damages in wrongful death and personal injury claims, the statute of limitations for general negligence claims was moved from four years to two. With a much quicker deadline in place, attorneys specialising in these types of cases have brought a surge of new claims for companies with Florida liability exposures.

Alongside statutes of limitations and benefit levels, another factor of loss experience impacted by each state’s lawmakers is capped damages on specific types of claims. An example of this brings us back to California, where Assembly Bill 35 went into effect at the beginning of 2023. While California has held one of the lowest caps for damages in medical malpractice cases prior to 2023, the passing of AB35 has significantly increased that cap and will continue to elevate it going forward. Adjustments to this cap are applied based on when a claim is resolved, and the current belief among insurance professionals seems to be that this will directly affect the timing of filings and resolutions for medical malpractice claims as a result.

Since actuaries can no longer rely upon the relatively consistent attributes for medical malpractice claims in California, they must now determine what loss experience for this risk might look like in the near and the long-term future. A higher loss severity is one of the most likely adjustments, but the new bill’s effect on timing could also mean that the tail of California medical malpractice exposures will be extended beyond historical indications. Captives writing policies in this and other states with similar changes will need frequent discussion between the management and actuarial teams to reevaluate the impact as data becomes available.

While the risks covered in this article represent only a small portion of those driven by legislative changes, captive owners and management teams can use the strategies outlined below as a guideline for addressing this type of issue on a wider basis:

The insurance world is constantly evolving, and exponentially so for the types of risks commonly insured through captives. History has shown that a captive with an engaged, communicative management team can be one of the best tools for navigating these changes. Creating such a tool requires work and commitment, but the benefits it offers your company’s stakeholders are well worth the effort.

Michelle Bradley is a consulting actuary at SIGMA Actuarial Consulting Group. She can be contacted at: mb@sigmaactuary.com

Enoch Starnes is an actuarial consultant at SIGMA Actuarial Consulting Group. He can be contacted at: enoch@sigmaactuary.com