Singer Bob Dylan’s song, “The Times, They Are a Changin’,” was cited as a cautionary reminder by Steve Klingel, NCCI Holdings Inc.’s president and CEO, as he gave a positive report on 2005 results for the workers compensation industry during the National Council on Compensation Insurance’s May 11 to 12 annual Issues Symposium in Orlando, Fla.
While recent statistics have been positive, “the pendulum will swing and results similar to those encountered in the 1990s are not in the too distant future,” Klingel said.
“We have seen these before and been able to deal with them in the past,” Klingel said. He predicted they could soon play a part in everyone’s future.
The workers’ compensation insurance industry had another excellent year in 2005 on an accident-year basis, according to Klingel and NCCI officials. NCCI estimates the combined ratios for both 2004 and 2005 accident years to be about 90 percent, the best results in recent memory. This is a 50-point improvement since the 140 percent peak in 1999, and it is the third consecutive year of accident year underwriting profits for the line.
Even calendar year results looked better. The most recent calendar year figures indicate a 102 percent combined loss ratio for 2005, a five point improvement from 2004 and the best result since 1997.
NCCI presented its annual “State of the Line” preliminary Workers’ Compensation Market Analysis during its issues symposium.
“The year 2005 was another year of significant accomplishments for the workers compensation insurance industry,” said NCCI Chief Actuary Dennis Mealy. “All of the major financial performance measures for the line experienced significant improvement. Even the workers compensation calendar year combined ratio, which has remained stubbornly higher than most other major lines of insurance during this recovery cycle, has finally improved to a range that allows the industry to show a reasonable, albeit not outstanding, return on the surplus supporting the business. In fact, workers compensation was the only major line of insurance that had an improved combined ratio in 2005.”
Despite the good news, Klingel urged caution in the face of changing times.
“NCCI’s longer view remains guarded due to the long-term challenges facing the business,” Klingel explained. “Those challenges include such issues as controlling skyrocketing medical costs, passing and maintaining legislative reform initiatives and continuing to reduce the size of the residual market.”
He said the industry also faces “nontraditional forces” including the threat of another terrorist attack and new forms of healthcare service delivery, whether through government or private programs.
“To continue to achieve the industry’s recent positive outcomes, we will need to rely on our collective ability to understand that our market is changing in significant ways ad to adopt new plans to address those changes,” Klingel advised.
Klingel said positive workers’ compensation market developments include:
• The loss reserve position of private carriers improved. The deficiency, which peaked at $21 billion at year-end 2001, had declined to $9 billion at year-end 2005. (After consideration for the allowable discounting of lifetime pension cases, the deficiency has now declined to a manageable $3 billion.)
• Net written premium increased about 9 percent for private carriers in 2005. This was the sixth consecutive year of increases for private carriers. Premiums were up a more modest 2.5 percent when state funds are included. This apparent anomaly was caused by the private carriers’ growth in the California market at the expense of the state fund following the successful reforms in that state.
• Claim frequency trends continue to be favorable, continuing a decade-long decline. Based on a preliminary analysis of data in NCCI states, the frequency of lost-time claims declined another 4.5 percent in 2005. The moderation in indemnity claim cost increases observed in recent years also continued. Even medical claim cost increases moderated somewhat last year, although they remain much higher than the Medical Consumer Price Index.
• Finally, recently enacted reforms in several states including, California and Florida, appear to be positively impacting the results in those jurisdictions—as well as the countrywide numbers. In Florida, for example, the reforms led to consecutive rate reductions of 14 percent in 2003, 5.2 percent in 2005, and 13.5 percent in 2006.
Areas of concern
However, even in a time of relatively good financial results, NCCI does identify several areas of concern for the industry:
1. While interest rates continue to rise, there has been limited impact on industry investment yields.
The Federal Reserve has continued to raise short-term interest rates since June 2004. Although this has raised the market rates on short-term securities, the long-term rates have only recently started to move upward slightly, with the 10-year Treasury note exceeding 5 percent in April 2006. This is the first time the 10-year note has been above 5 percent since June 2002—meaning that the Fed’s actions have had limited impact on the yields of the industry’s investment portfolio. NCCI’s models indicate that combined ratios at or near 100 percent are needed for carriers to earn their cost of capital in workers compensation.
2. While improving, residual market volumes in some states remain at unacceptably high levels.
The industry is finally starting to see some significant depopulation of many states’ residual markets, particularly for larger policy sizes. Data for first quarter 2006 indicates that the number of policies over $100,000 in the residual markets administered by NCCI is down 36 percent from first quarter 2005. This is good news. The market is returning to more normal functioning following the rapid expansion of the residual market since 2000. However, several states are still experiencing growth in their residual markets as their markets react to escalating costs and inadequate loss costs or rates.
3. Medical inflation continues at a double-digit pace.
Medical cost increases, while moderating somewhat, have increased at or near double-digit rates in the last few years. Today, these increases have pushed medical losses to nearly 60 percent of the total losses in workers compensation for NCCI states. Because of the rising tide of medical costs, many states have been looking for ways to control medical costs in their workers compensation systems. And the increased interest in medical benefits and costs on the part of public policy makers, regulators, and carriers is demanding ever more detailed data on medical payments.
4. The uncertainty surrounding the fate of the Terrorism Risk Insurance Extension Act of 2005 (TRIA) remains.
Although Congress extended TRIA for another two years, through December 31, 2007, it was with significantly higher retentions for the industry and a message that a permanent solution needs to be found. Time is already running short for finding that permanent solution. In a little over six months, policies will be written that will have some exposure after the TRIA extension expires.
5. Other challenges continue to confront the workers compensation line.
• Some individual states have workers compensations systems that are in disarray due to rapidly escalating benefit costs resulting in poor results and market disruptions.
• Challenges to recently enacted benefit reforms have been mounted or are being discussed in several states, either through the political process or through the courts.
• The current underwriting cycle is likely at or near its cyclical peak.
“The workers compensation insurance industry had another solid year of financial results in 2005,” Mealy said. “Both the calendar year and accident year combined ratios are at levels that allowed the industry to strengthen its reserve position and earn a reasonable return on surplus. Reserves are in the best position in a decade. Frequency continues to decline and indemnity claim cost increases have moderated.”
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