The workers compensation market is in turmoil and agents need to prepare for rate increases and possibly even coverage cancellations. Some observers even anticipate a repeat of the mid-1980s, with serious market dislocations and a resurgence of alternative markets. Agents who want to best serve their commercial clients will need relationships with a variety of alternative market mechanisms.
The workers comp combined ratio was estimated to be over 120 in 1999. It closed out 1998 at 115, a deterioration of seven points. But, despite these results, "competition is continuing unabated," notes Bob Menninger, president of Commercial Insurance Research, LLC. "Premium discounts are at the highest level we have seen in many years. A recent report from the Illinois Insurance Department pointed out that several companies were discounting by 60%, and one company offered a 90% discount."
Menninger continues: "The competition appears to be coming from companies that have excess capacity and may not necessarily understand the nature of the comp market and the potential risk of loss. In a number of states that we assessed, the market share of the leading writer of workers comp has dropped precipitously, but other players have come in and picked up the slack. We are very concerned by the fact that the people who know the market best are leaving. This clearly is not an indication that the market is healthy."
The much ballyhooed excess capacity has produced a situation where underwriting has almost become a lost art. In a report published by NCCI, the premium to surplus ratio for workers compensation writers has fallen to 0.6 to 1. At that level, a modest investment return can support combined ratios close to 120. And apparently, some companies are willing to write at those levels, as evidenced by the continuation of discounting in the face of uncomfortable combined ratios.
The real problem is that all of this euphoric underwriting has been predicated on the continuation of favorable loss development. Losses incurred have been declining steadily over the last decade thanks to workers comp reform, the changeover to a service economy and the current full employment. All of these factors contribute to better workers comp loss results. And this has been accompanied by steady decreases in premiums. However, the number of workers covered has increased significantly with the result that the industry has increased its exposure base and received less money for doing so. It will not take much of a change for the loss ratios to deteriorate significantly.
At the same time, "the drop in premiums that has accompanied the improvement in losses has put enormous pressure on the expense ratio," according to Menninger. He points to figures published by NCCI that show the expense ratio rising 12.4 points from 27.9% in 1994 to 40.3% in 1998 in the states in which NCCI operates. "As a result," he continues, "underwriting losses totaled 11.7% of premiums, all of that attributable to the sharp rise in expenses." Some estimates place the expense ratio at over 45% in 1999. Menninger adds that, "because premium rates are predicated on loss costs, at some point continued success on the loss side will reduce premiums to such an extent that there will be insufficient premium dollars to support the expenses. The sharp increases in the expense ratio would indicate that we have reached that point."
The 1998 underwriting loss of 11.7% came about when the loss ratio was at a relatively healthy 66.1%. "The real concern is that the loss control efforts have reached a plateau, and we could begin to see an increase in the frequency of losses. This could easily push the loss ratio up to untenable levels and may very well jeopardize the financial stability of some companies," Menninger suggests. And regulators are not likely to be sympathetic to insurance companies who suddenly feel the need to increase rates. In a recent bulletin from the Illinois Department of Insurance, they made it very clear that "we cannot and will not tolerate premium increase shock to policyholders based strictly on changing economic market conditions. Nor will we condone massive non-renewals or cancellations due to a market downturn." In other words, you made your bed now you must lie in it.
The strong economy has been an important factor in the improving results and, despite promises by candidates that the economy will remain vibrant, there are concerns that the boom may very well be slowing down. At the same time, there already are reports of rate increases for some business sectors. It could get very ugly and this will be met with resistance from the regulators who are not about to tolerate another "crisis" nor will your clients accept premium increases when they have done a good job of controlling losses. Agents need to be prepared with alternatives to traditional insurance or face the prospect of losing commercial clients to those who are prepared. *