A "conflicted" workers comp marketplace

And that's an improvement from last year, as some trends turn positive

By Dennis H. Pillsbury

Drum roll please. This year's descriptor for the workers compensation marketplace is "conflicted," according to Steve Klingel, CPCU, WCP, president of the National Council on Compensation Insurance (NCCI). The appellatives for the previous two years were "precarious" in 2010 and "deteriorating" in 2011. Speaking at the opening session of the Council's Annual Issues Symposium, Steve said, "We thought long and hard about this. Some fundamental indicators have stopped deteriorating, but significant areas are not improving—hence 'conflicted.'"

Starting with the positive side of the ledger, Steve noted that claims frequency "had been a consistent bright spot prior to last year's report, when 2010 saw the first increase in 13 years." He noted that there was concern that this could be a new normal, but hope that it was an anomaly. In 2011, he was happy to report, claims frequency again headed down, "supporting the idea that 2010 was an anomaly. This was a very important and positive sign for the marketplace." However, he did warn that the decline was smaller than usual.

Another positive sign was that net written premium increased for the first time in five years. (See Chart 1.) However, he added, "I am sad to report that there was no price strengthening accounting for this increase."

Other positive indicators cited included the fact that the accident year combined ratio improved by two points, the economy appears to be improving, and medical inflation continued to grow at a moderate rate. (See Chart 2.)

Unfortunately, there were equal numbers of negative factors.

The calendar year combined ratio was 115. (See Chart 3.) Steve added that in 2010, one carrier added $800 million to excess workers compensation reserves, adding three points to the combined ratio, "meaning there really was a deterioration from last year."

Also of concern was the fact that the reserve deficiency has grown to five times higher than 2007. "It's still small, but the trend is concerning," he noted.

The growth of the residual market was also cited as a negative. (See Chart 4.) Steve pointed out that the residual markets have been relatively self-sustaining, so this maybe should not be considered a negative. However, he added, "As they grow, there is a tendency for them to be less self-sustaining. This is something for us to be wary of."

And the final negative was the low interest rate and the impact that has on investment income.

Turning to politics, Steve noted that it was a relatively light year although there is a growing involvement at the federal level that could be of concern. He pointed to new black lung legislation and Medicare reimbursement changes. He also noted that the industry was still waiting for the Federal Insurance Office report to be issued.

At the state level, there was little action although two states bear watching. A bill in Oklahoma would have established an opt-out program for workers compensation. It was narrowly defeated but could re-emerge. "A lot of other states were watching this closely," Steve noted. And in Vermont, the governor is backing single-payer legislation for health care that would include workers compensation.

Steve concluded by pointing out that the industry is in a much better position than it was in the "crisis environment" of the early 1990s. Reforms enacted since then remain in place, the residual market burden is quite small compared to the $4 billion of the 1990s, providing loss costs instead of final rates has allowed greater flexibility for carriers, and the increased information and shared knowledge available today have helped carriers and regulatory officials react more quickly and effectively to changing environments. "These are interesting times for workers compensation stakeholders, but we remain confident that we will see our way out of this conflicted environment."

Expanding on Steve's overview was the much-anticipated presentation of NCCI Chief Actuary Dennis Mealy, FCAS, MAAA. He reiterated Steve's concerns about the high combined ratio, adding that for the property/casualty industry overall, the "108 combined was the highest since 2001, with every line showing a combined over 100." He noted that catastrophes affected homeowners (a 15-point jump), CMP (a 12-point rise) and fire & allied lines (up 19 points) especially hard, noting that the $40 billion in catastrophe losses was especially damaging to primary insurers. Since most of the catastrophe losses came from events other than hurricanes and earthquakes, "reinsurance did not soften the blow as much as it did in other years."

He also expressed concern about the property/casualty industry's investment gains, which were at a healthy 12.9% of earned premium, but which were being bolstered "by realizing capital gains out of the bond portfolio, essentially borrowing gains from future years. Eventually that party will end."

Despite these concerns, he noted that the industry's "surplus has been performing pretty well" although it was down a little last year. "The premium to surplus ratio is still at a very strong 0.8 to 1." (see Chart 5.) The continued improvement in this ratio has been "a recognition of the industry's exposure to hurricanes and terrorism."

Turning to workers compensation, Dennis pointed out that "workers compensation, because of its direct connection to employment and the labor markets, has been the line most significantly affected by the economic turmoil." And even though workers comp premiums rose for the first time in five years (see Chart 6), there was still a lot of room for improvement as employment continues to lag behind real GDP growth. (See Chart 7.)

What is especially troubling for workers compensation insurance is that employment in key sectors that have higher-than-average workers comp rates—manufacturing and construction—continues to under-perform the dismal employment picture, with overall 2011 employment still at only 95% of 2007 levels. At the end of 2011, employment in the construction industry was at 72% of 2007 levels; for manufacturing, employment was 85% of 2007 levels. He went on to compare the manufacturing sector of today to agriculture in the last century, where technology allowed for greater productivity with fewer people. "The United States still manufactures about 22% of the world's output. It's just doing it with fewer people," Dennis noted.

Turning to the investment income for workers compensation carriers, Dennis noted that it was surprisingly high not just because of the selling of bonds, but also because premiums were down by almost 30% since 2007, while loss reserves—"a big driver of investment income"—were up about 15%. "This ratio will begin to drop as premiums start to grow again," he warned.

What is perhaps most concerning in light of the better-than-expected investment income is the fact that workers comp carriers had an operating loss for 2011. (See Chart 8.) "This is a pretty dismal performance," Dennis commented, adding that the graph was the "most cyclical" and really displayed that aspect of the insurance business.

In closing, he reiterated the positives and negatives noted by Steve but added one more that may indeed be a prelude to better times ahead—"It appears that the market is firming." (See Chart 9.) The agent response to the Goldman Sachs survey found, for the first time in quite a while, that more than three-quarters of those surveyed were seeing an increase in workers comp rates in January 2012. And less than 6% were still seeing any kind of decrease.

Are we out of the woods? Only time will tell, but the indicators certainly are better than they have been. And if the economy continues to improve . . . and if employment continues to grow . . . It's going to be an interesting ride.