Workers’ Compensation: In-Between the Good, the Bad, and the Injuries

With overall claims frequency still on the decline and loss costs and rates relatively stable, the state of the workers’ compensation line nationwide continues to show positive signs of improvement. Nevertheless, the industry remains on the brink of change, anticipating that the next great “injury” may be just around the corner.

Industry experts continue to watch closely, taking a cautionary
approach when reviewing the market’s outlook. And the experts’ concerns are: irrational pricing and reserving by some carriers, unabated inflation in the cost of medical care for injured workers, and progress in the war against employee and employer fraud.

Reserve deficiency declines
An industry that is still feeling the effects of the collapses of Reliance, Legion, Fremont and Superior National, to name just a few failed workers’ compensation carriers, knows that at any given time there are some competitors in the marketplace that will buckle under pressure and choose to compete by slashing prices and fiddling with reserves. Industry analysts, regulators and workers’ comp writers continue to keep a watchful eye out for inadequate reserving practices and potential failures, even though players appear to be behaving.

According to a May 2004 study published by A.M. Best, Insolvency Study, Property/Casualty U.S. Insurers, 1969 to 2002, the primary causes of financial impairment for insurers in 562 of the 871 companies analyzed was “deficient loss reserves/inadequate pricing,” at 37.2 percent. Rapid growth, which is closely related to deficient loss reserves, was the second highest cause of impairment, at 17.3 percent, and alleged fraud was the third-highest identified cause, at 8.5 percent.

In January 2005, Weiss Ratings reported that the number of insurance companies to become insolvent in 2004 declined by 48 percent. “Insurers have been reporting robust profits for several quarters now, which reflects both an improved securities market and economic growth, resulting in fewer company failures compared to the numbers reported several years ago,” commented Melissa Gannon, vice president of Weiss, in a statement. According to Weiss, only 13 companies failed in 2004 compared to 25 in 2003. Of those that failed, three were life and health insurers and 10 were property casualty insurers, compared to four and 21 respective failures in 2003.

“Yes, we are seeing improvement in companies setting reserves,” said Peter Burton, senior state relations executive for the National Council on Compensation Insurance Holdings Inc. In fact, the NCCI estimated that the workers’ comp reserve deficiency for private carriers declined to $15 billion 2003, down from $18 billion in 2002 and $21 billion in 2001. However, Burton cautioned that there is more than one reason for carrier insolvencies. “The overall pricing that has been allowed to exist is inadequate,” he said.

“The deficiency has improved since ’01,” said Jennifer Tomilin, vice president and chief underwriting officer for workers’ comp at CNA. “But just thinking that number ($15 billion) is still out there along with the current rate of investment income, I think we still just need to be cautious in our underwriting discipline.”

CNA writes workers’ comp insurance in all states, except monopolistic states, where they do not write statutory coverage but do write stop gap coverage. At the year-end of 2004, CNA wrote $1.2 billion in statutory workers’ comp business, plus an additional $100 million in excess workers’ comp.

Tomilin, who has nearly 30 years of experience in the workers’ comp field, said the lesson learned from the soft market days of the 1990s is that “you have to price for the exposure.” She added, “In the ’90s the industry didn’t … the industry just clearly focused on top line growth and forgot about the exposure it was pricing for.”

Safety advances cover medical costs
Medical inflation has hit all U.S. businesses in some way and the workers’ comp system is no exception. While the industry has experienced continuous declines in claim frequency for workers’ comp injuries, medical severity experienced double-digit increases during 2004, with indemnity severity experiencing significant increases as well, reported the NCCI.

“It’s not a phenomena,” NCCI’s Burton said. “The whole healthcare system is just getting much more costly. People are living longer and technology is being introduced to expand people’s lives.”

“The severity increases are clearly due to the medical costs,” Tomilin added. “It’s not that lost-time claims have increased or the indemnity side has increased, it’s really medical.”

Despite double-digit increases in medical severity, the workers’ comp marketplace as a whole has improved over the last two years. For 2003, the combined ratio for workers’ compensation insurance dropped to 109.5 percent, a decline from the 2002 combined ratio of 111 percent and 2001’s 122 percent (1.9 percent due to Sept. 11). Nevertheless, the workers’ comp combined ratio still ranks well above the overall property casualty industry’s 2003 combined ratio of 100.1 percent.

Better results can be seen in the accident year combined ratio which dropped from 125 percent in 2001, to 106 percent in 2002, to a low of 101 percent in 2003.

U.S. workforces may be the safest they have ever been thanks to advances in technology and improved risk management practices, and this further aids the industry’s results, according to Burton.

“Probably one of the best stories the workers’ comp system can tell, is that over the last multiple decades, work places are getting safer,” Burton added. “If you were to go to any state and ask what their incident rate for lost work time injuries (was) almost every state will have a great story saying these are the lowest levels we’ve seen in 20-25 years.”

Reducing work place injuries has helped the industry mask all the other cost increases, including medical inflation, simply because fewer people are getting hurt.

Burton contends that loss costs and rates for the workers’ comp industry are pretty flat on a national basis. “The barometer didn’t really move,” he said. “But if you look at each individual state, you’re going to find some interesting developments on a state-by-state basis.”

Burton added that of the 33 state filings the NCCI submitted to state regulators, 19 have been for increases, one was for no change and 13 were for decreases. The NCCI submits workers’ comp rates to state regulators in 33 states, including the District of Columbia, but does not submit rates for those states that have independent bureaus or are considered monopolistic states.

“We are filing for more increases than decreases and that’s similar to what happened in the two previous years,” Burton said. But when factoring in the larger states and the smaller states the barometer for work comp rates remains relatively unchanged. “For example, in Oklahoma we filed for an 11.5 percent increase, and Illinois, which is our second largest state, (we filed for) a one-tenth of 1 percent increase. So the numbers aren’t huge.”

Fraud takes a stab into profitability
Investigators say it’s tough to attach specific numbers to the impact of fraud on the workers’ compensation system but the dollars behind the headlines of fake injuries and fabricated payroll records add up. One estimate, by the Coalition Against Insurance Fraud, claims that the industry dishes out at least $80 billion a year to fraudsters.

“Workers’ comp fraud is probably one of the more difficult areas to define,” said Dennis Jay, executive director of the CAIF. “We’ve seen estimates from 3 percent to 30 percent having some element of fraud … it’s probably somewhere in the middle.”

The CAIF is an industry funded non-profit organization that consists of insurers, consumer groups and state agencies.

There are two primary instances of fraud: premium fraud by the employers and employee fraud. Two states that have had higher incidences of fraud, perhaps due to an already troubled workers’ comp system, are California and Florida, Jay said.

“It’s usually that once there is a crisis with rates, that’s when people tend to focus on fraud,” Jay said. “It’s somewhat of vicious cycle because as higher rates push up, they cause more people to defraud. When rates go up, employers look to scale back benefits … maybe they have to defraud to get a better deal.”

The most common type of premium fraud exists when employers tell insurers that their employees are working safer jobs than they actually are. “You might see a construction company list a large percentage of its roofers as sales people which are lower risk professions,” said James Quiggle, CAIF’s director of communications. “Another very common scam is to artificially reduce the size of your payroll.”

Quiggle added that premium scams tend to be lower in volume throughout the workers’ comp industry than in other insurance lines, but produce higher dollar losses.

Workers’ compensation fraud remains especially widespread in the construction industry, employee leasing and professional employment organizations.

“PEOs will do payroll processing, health insurance, personnel management and other insurance matters such as employment practices liability,” Jay said. “Wonderful concept and most act honestly, but some in order to make their price competitive will cut corners. We’ve had three cases in the last two weeks where they took in premium money from employers and never paid the workers’ comp premiums, or bought from a bogus offshore company.”

So are agents aiding their business clients in fraud tactics, Insurance Journal asked?

“Yes, there have been situations where an agent will help a client fudge on applying for coverage in order to keep the business,” Jay said. The CAIF said agent fraud is actually on an upswing all across the country. “Most agents are trying to get the best deal for their clients,” Jay said. “In days past when workers’ comp carriers did an audit and found a little bit of fudging all they would do is go back to ask the client for more premium. It created a little bit of a culture of fudging.”

Today, more insurers have adopted zero tolerance and are doing upfront audits, even dropping agents who are doing a little bit of fudging. “Fraud is something we will not tolerate,” CNA’s Tomilin said.

Topics Carriers USA Fraud Agencies Workers' Compensation Talent