In Short-term, Workers’ Compensation Outlook is Positive

By Stephen J. Klingel | May 19, 2008

But rising medical costs, regulatory landscape and insurers’ low investment yields make the long-term outlook less certain


The workers’ compensation insurance market turned in solid overall results in 2007, and the short-term view for the market is optimistic. But the long-term outlook is cautionary due to the myriad of uncertainties that continue to face the business.

NCCI recently released the annual State of the Line workers’ compensation market analysis, available at www.ncci.com. This year’s report indicates that the workers’ compensation calendar year combined ratio stands at 99 percent — the second consecutive year that the line has realized an underwriting profit, albeit a 6-point deterioration from 2006.

However, NCCI continues to observe that a low interest rate environment, combined with the modest performance of the equity markets, have left the line with post-tax returns on surplus that are far below record levels — and these results barely return the industry’s cost of capital after the significant payments of federal income taxes.

In other 2007 results, calendar year net written premium declined for private carriers for the first time in eight years. (It was the second straight year of premium declines for the line inclusive of the state funds.)

Also, the 2007 accident year combined ratio came in at 92 percent. On an accident year basis, the current underwriting cycle peaked in 2006, with an 84 percent combined ratio (more than a 55 point improvement since 1999).

The State of the Line report indicates a significant impact on the countrywide numbers caused by the state of California. Excluding California would increase the calendar year combined ratio by about 5 points — to more than 104 percent. And, excluding California from the accident year combined ratio would raise it from 92 percent to about 97 percent.

In terms of pricing, workers’ compensation insurance prices accelerated their declines in 2007. Significant reductions continued in California and Florida since the reforms in those states favorably impacted costs and improved marketplace conditions.

Other Market Analysis

In other market analyses reported on by NCCI:

  • Favorable frequency trends continued — and along with payroll increases, were more than enough to offset medical and indemnity claim cost increases. This resulted in bureau loss cost and rate filings that generally were downward last year, with a couple of notable exceptions.
  • Although frequency continued its downward path during 2007, it did so at a slower rate than the last couple of years. For NCCI states, the frequency decrease for 2007 was 2.5 percent. (The prior two years had very large frequency decreases of almost 7 percent.) The 2.5 percent decrease in 2007 is closer to the longer-term trend for the frequency decline. Of note, NCCI has found that frequency tends to decline during periods of economic slowdown. Therefore, despite the ease from decline of previous years, the frequency decline should continue.
  • NCCI’s estimates of the reserve positions of private carriers improved to about a $2 billion deficiency at year-end 2007. After consideration of the allowable discounting of the indemnity reserve of lifetime pension cases, the reserve position is fully adequate. This is in sharp contrast to the $21 billion deficiency at year-end 2001. Achieving reserve adequacy is one of the major accomplishments for the industry in the last five years.
  • Depopulation of the residual market continued at an accelerating pace in 2007 and 2008. Premiums dropped to about $1 billion for policy year 2007, down from $1.2 billion in 2006. Overall, the market share of the residual market pools serviced by NCCI for 2007 dropped to about 8 percent, down from about 10 percent in 2006. This is a great improvement from the 13 percent market share peak that was reached in 2004 in this cycle.
  • NCCI is estimating that the average workers’ compensation indemnity claim cost increased 4 percent in 2007. This is slightly lower than the 5 percent increase in 2006 and is only modestly higher than the change in average wage levels last year.

Why the Cautionary Outlook?

The short-term view of the workers’ compensation line remains positive, however, even in this time of excellent underwriting results and good financial performance, areas of concern remain. Among these issues are low investment yields, with the potential of a stagnant stock market. That means that combined ratios need to be at or near historic lows for insurers to earn an adequate return on capital. Additionally, the current underwriting cycle is past its cyclical peak.

Other issues of concern include, medical costs, regulation, terrorism insurance, and other federal insurance legislation.

Medical costs. Medical costs continue to increase at or near double-digit rates. These increases have pushed medical costs to nearly 60 percent of the total losses for NCCI states. The increased interest in medical benefits and costs on the part of public policy makers, regulators, and carriers is creating the demand for ever more detailed medical data. In 2007, for example, NCCI was called on to provide pricing analysis on more than 100 legislative proposals. Of those, approximately 30 percent included a medical component.

Regulatory landscape. After the 2006 midterm elections, the political landscape for many states changed considerably. As a result, we observed increased legislative activity in 2007 compared with 2006 — a pattern we expect to see continue into 2008.

In some states, there has been renewed interest in revisiting issues that had been dealt with in past reform efforts. And other states have seen interest in reviewing reforms that have been in place for over a decade. Given the relatively good results posted for workers’ compensation insurers and for the property/casualty industry in general, some parties may feel that now is a good time to review benefit levels, administrative guidelines, and cost controls — to the possible detriment of efficiently run and well balanced workers’ compensation systems.

TRIEA … and other federal issues. Congress approved a seven-year extension of the Terrorism Risk Insurance Program (TRIA), created in the aftermath of the Sept. 11, 2001, attacks to provide $100 billion in insurance capacity for terror-related commercial property/casualty risks. President Bush signed the bill, the Terrorism Risk Insurance Program Reauthorization Act of 2007 (TRIPRA) on Dec. 26, 2007.

As passed, TRIPRA extends the current program through 2014. The bill eliminates the distinction between foreign and domestic acts of terrorism, but otherwise keeps the program largely intact under its current terms. A key component of the first House bill — the requirement that most insurers provide coverage for nuclear, biological, chemical and radiological (NBCR) attacks by 2009 — was converted to a year-long study by the U.S. Comptroller General in the Senate version.

Despite some characterizations of TRIA as an insurance industry bailout, NCCI’s modeling shows that under current law, for 99 out of every 100 modeled scenarios, the federal government would pay virtually nothing.

In other federal legislative action (or inaction), no movement has been undertaken on either the Senate or the House bills to repeal the McCarran-Ferguson antitrust exemption. And no action has been taken nor has a hearing been held on the Senate’s optional federal charter (OFC) bill. The proposed OFC bill in the House has also seen little action.

Building on Recent Success

The workers’ compensation insurance industry financial results were solid in 2007.

Moving into 2008, NCCI will continue to work with all workers’ compensation market stakeholders to help ensure that rates and loss costs are adequate, to provide unbiased quantification of the impacts of legislative reform proposals, and to strive for self-funded residual markets.

These objectives will help to maintain a healthy workers’ compensation insurance market — able to deliver promised benefits quickly, fairly, and efficiently to the injured worker and provide the proper incentives to create the safest workplaces possible.

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