Injured But Still Standing
Like the economy, the workers’ compensation market has suffered in recent years. Results for 2011 were no better than 2010. The good news: results for the market were not worse either.
The combined ratio held steady at 115 for the workers’ comp line of business, according to the NCCI Holding Inc.’s “State of the Line” report published on May 10. That’s the same as in 2010. While stable, the reported combined ratio stands as the highest combined ratio for all major commercial lines for the third straight year.
A number of factors contribute to the line’s challenging conditions, the experts say. The weak economy, high unemployment rates, rising claims frequency and unrelenting medical inflation all contribute to the market’s health.
Another reason for workers’ comp’s under-performance is rate inadequacy.
“The rate inadequacy is definitely an issue,” says Tom Koval, senior vice president, general counsel and government affairs, for FCCI Insurance Group based in Sarasota, Fla.
As the economy starts to rebound and payrolls jump, premiums will increase, leading to better results. However, Koval says the workers’ comp industry still needs relevant rate increases to come out ahead.
Chris Cunniff, senior vice president and product manager for workers’ compensation at Liberty Mutual, agrees rates fell behind, partly due to unexpected circumstances such as a rise in claim frequency in 2010.
“I think the bureau rates put forth by the NCCI and other bureaus did fall behind a little bit,” he says. “The NCCI has been filing for bureau rate increases to catch up. We’ve seen some other increases filed in other non-NCCI states as well.”
Cunniff believes other circumstances have contributed much more to the problem of rate inadequacy than bureau rate recommendations.
“If you look at the data, the biggest driver (of rate inadequacy) has been companies filing deviations or discounts below bureau loss cost levels in an attempt to retain or win business,” Cunniff says. That is the primary driver of rate inadequacy, he says.
Despite low rates in recent years, payrolls and premiums do appear to be trending up.
In its report, the NCCI found that 2011 premiums for workers’ comp were up by $36.3 billion, or 7.4 percent from 2010 levels.
Even with that increase, rates have not kept up with overall workers’ comp cost drivers, the experts say.
“Workers compensation, because of its direct connection to employment and the labor markets, has been the property/casualty line most significantly impacted by the continued difficult economic environment,” said NCCI Chief Actuary Dennis Mealy. “Combined ratios remain at unsustainably high levels, and investment returns are not sufficiently high to generate operating returns near the cost of capital.”
Since 2006, NCCI loss costs have declined but so far in 2012, loss costs have generally increased, with NCCI loss costs up 2.5 percent on average and countrywide bureau loss costs up 7.8 percent.
The increase in 2012 is due to a large increase in bureau loss costs in California, the NCCI stated.
Dave Bellucsi, chief actuary for the Workers’ Compensation Insurance Rating Bureau of California, says loss adjustment expenses, which were high to start with in his state, have continued to rise. Some of the factors driving that trend are medical liens, he says.
In the Golden State’s workers’ compensation system, a lien is a direct claim against the defendant for a benefit which is not otherwise payable to the injured worker. Medical liens — a California phenomenon — are jamming up the administrative system, Bellucsi says. Liens must be resolved by a workers’ comp judge, so the overall cost on the system is burdensome even if the lien amount is small.
Other factors behind loss cost increases in NCCI states — 38 states in total — include longer claim durations and upward pressure on claim frequency.
Bellucsi says claim frequency has also been an issue for California.
“For the last 40 years, with the occasional exception, frequency declined,” he said. “In 2010, that reversed. We saw a healthy spike of close to a 10 percent increase in 2010. In 2011, it didn’t get any worse, but it didn’t get any better.”
The spike in claim frequency in California stems from a sharp rise in cumulative injury claims, according to Bellusci. “Those are claims that occur over a longer period. They’re not tied to a specific event.” Most end up in litigation as well, he says.
The rising cost of medical care is not helping worker’s comp results either, Koval says.
“We don’t expect that medical inflation is going to stop so rate adequacy becomes that much more important,” Koval says.
In California, medical inflation grew significantly over the last five years, Bellusci says, but that growth has slowed. “Over the last year or two there has been signs of medical inflation moderation.”
At least in Texas, a non-subscription workers’ comp state, the market looks better, thanks to the state’s economy.
“I do know that there is some concern about the market, nationally, probably linked to the recession,” says Terry Frakes, senior vice president of public affairs for Texas Mutual Insurance Co. “But in Texas, the market is very good by almost any indicator that we use.”
Frakes said 2012 is outpacing last year in premium growth as of the end of April. The number of policies written, the number of submissions received, and the carrier’s retention levels are all up. Even workers’ comp audits are positive, he says.
“Back in ’09 and ’10, we were giving money back at the end of the policy period, significant amounts because payroll was declining,” Frakes says. “Beginning last year, and the end of the first quarter this year, it’s going the other way. We are taking in more money than we are giving back. All of those indicators tell us that the economy is very good in Texas.”
The cyclical nature of the workers’ comp pricing environment is no different than that of the overall property/casualty market, says Peter Burton, senior division executive, state relations for NCCI.
“It’s not uncommon that worker’s comp has cycles,” Burton says. “Particularly, we see cycles that are generated when there’s a need for major reform in the workers’ compensation system and states engage in deliberations over reforms. In many cases, reforms and legislative changes are put in place, mainly due to such things as rising costs.”
Reform is always a possibility as states attempt to improve the efficiency of the worker’s comp system, Burton says. Reforms tend to work well for a number of years then costs go up, again, he says.
“Over time, some of the reforms erode and system costs tend to escalate again, which then provokes another series of legislative changes. It’s not dissimilar from other cycles you’ll see in the property insurance business.”
One of the biggest cost drivers nationwide is the cost of medical care, Burton says.
“You have the whole issue of frequency of injuries, workers getting injured more commonly than they were before. That happens. Then you have medical cost pressures that we all know in our health insurance coverage, but they’re also affecting workers’ comp.”
Aside from those cost pressures, workers’ comp reform can also drive cost, he says. “Legislatures pass new laws that expand the compensability of coverage for injury; that makes the system more costly,” Burton said.
Reforms influence the underlying cost of each state’s worker’s comp system. “Each state is kind of a unique ecosystem because all state laws are different and each state has to be looked at in its own context,” Burton says.
In the end, it’s the cost drivers in the states that adversely affect the cost structure, Burton says.
NCCI and other rating bureaus set the baseline, or the loss cost projections. “Then, companies in most states now have this latitude of their own expense considerations on top of our loss cost, their own contingency factor.” In addition, carriers use other tools in the rating process that may drive prices below loss costs based on the carrier’s underwriting appetites, experience and pressures.
However, Burton says when the NCCI sets rates it doesn’t examine all the competitive tools carriers use. “We bring everything back to our normalized level, our loss cost level. We set the rates from that standpoint.”
Burton says while NCCI and other independent workers’ comp bureaus set the rate/loss cost levels for states, the pricing tools are not adversely affecting the rate.
“Now, I’m not going to say that the tools that are being used, and being overly competitive in the marketplace, may not have an impact on performance results,” he says. “But it wouldn’t be causing inaccurate setting of loss cost. That’s something we do, and we do it very well. We are audited by the NAIC and audited by individual actuarial firms. Most of our plans are approved as proposed.”
Liberty Mutual’s Cunniff says like the overall P/C market, the problem with rate inadequacy in workers’ comp cycle is a “self-inflicted” problem.
“If you look at the historical data, you see that the workers’ compensation results do follow a cycle. Primarily the cycle has been brought about by price inadequacy. Private carriers have, over several years, lowered prices at such a level that they’re not sustainable in the market. It’s very unprofitable,” Cunniff said. “It’s mostly a self-inflicted cycle where carriers cut premiums to a level that’s not adequate.”
Despite the challenging conditions in workers’ comp today, including inadequate pricing to support cost drivers, the line overall remains strong; injured but standing.
In terms of premium (including state funds), net written premium increased to $36.3 billion in 2011. This 7.4 percent increase in premium is the first increase since 2005, and a shift following the cumulative 27 percent decline in premium from 2006-2010.
In its annual “State of the Line” report, NCCI President and CEO Steve Klingel said: “In some ways, we are seeing an improved condition from 2010.”
By other measures, however, the market remains in a worrisome state, Klingel said. “In sum, we see a market that is conflicted as to its forward trajectory, and that makes for a challenging environment.”
Other market indicators/trends highlighted in the NCCI report include:
- NCCI estimates that the combined ratio for private carriers for Accident Year 2011 is 114 — down 2 points from 116 in 2010.
- The private carrier reserve position continued its modest deterioration in 2011 — for the fourth consecutive year. NCCI’s estimate of the reserve position for the private carriers as of year-end 2011 is an $11 billion deficiency.
- Lost-time claim frequency improved in 2011. After increasing 3 percent in 2010, claim frequency in 2011 declined 1 percent on average in NCCI states.
- In 2010, the average indemnity cost per lost-time claim decreased by 2.8 percent. In 2011, the average change was still a very modest increase of 2 percent.
- The average medical cost per lost-time claim showed similarly favorable results. In 2010, the average cost per claim was just 1.3 percent, while in 2011 the increase was 4.0 percent. These are the lowest increases in average claim costs since the early 1990s.
- Although investment yields remain low, investment gains for the workers’ compensation insurance industry remained strong in 2011. Investment gains as a ratio to premium held at 14 percent of premium, higher than the average return of 11.6 percent that the industry earned from 2001-2010.
- Although the investment gain has improved, combining the underwriting loss with the large investment gains, the result is a pretax operating loss of 1 percent for the industry in 2011. This is the third consecutive year of near-zero operating gains.
- The combined ratio of the residual market pools also increased slightly, from 120 in 2010 to 121 in 2011. At this time, the pools are quite small, so individual losses and states can have a disproportionate impact on the combined ratio.
- Residual market premiums grew by 13 percent in 2011 to approximately $509 million. Overall, the market share of the residual market pools serviced by NCCI for 2011 increased from 4.6 percent to 5 percent.
Liberty Mutual’s Cunniff says to return the line to a better state will take several years of increases in rates.
“Given expected loss cost trends, we would need several years of rates going up to return workers’ compensation to a profitable combined ratio.”