A wake-up call for workers' comp

January 2012 renewals resulted in a mixed picture for workers’ compensation re/insurance, although there were some positive signs after a protracted run of difficult underwriting years. As Bill Yit, senior vice president for property and casualty at Alterra, indicated: “We were pretty pleased with how the renewals fared, with fair rate rises observed by the industry, although there is generally some way to go.”

Significant rate rises were largely confined to primary lines, with positive rate development yet to translate fully into the reinsurance arena. A significant factor in this price differentiation has been “insurers’ ability to increase rates, which has been significantly stronger than reinsurers’ ability to increase reinsurance rates”, according to Mirek Wieczorek, senior vice president for specialty and casualty lines at Tokio Millennium Re. He added that while rates on primary workers’ comp lines had drifted upwards over the last year or so, with proportional and quota share reinsurance covers “having benefited from these positive trends”, in the case of excess of loss reinsurance covers, effective rate improvements were yet to translate into the reinsurance sector. Wieczorek said that the situation was, however, “not unexpected”, with reinsurer rate movements traditionally lagging behind those in the direct market.

Nevertheless, positive rate movement—even if limited to the primary side—was a welcome change to the existing dynamic. It seems that some good news was ushered in by the new year.

The level of cheer, however, depends very much on geography. As Yit outlined, pricing and its movement differs widely by state. Many insurers have been running combined ratios that have been well above 100 percent for several years, the National Council on Compensation Insurance (NCCI) indicating that the 2010 average for workers’ compensation insurance was 115 percent for private carriers. For state funds the picture was even bleaker. Overall,2010’s combined ratio was 137 percent. Yit said that state-by-state differentiation is “largely driven by loss experience”, although issues such as legislative intervention also play a part in price heading.

In California, for example, combined ratios for primary insurers have reached the dizzy heights of 130 percent, while at the lower end of the scale, combined ratios in Texas are currently at 93 percent. These differences offer reinsurers the opportunity to work the market to their advantage, said Yit, with Alterra pursuing such openings in competitively-priced US states, although it is evident that in some instances pricing is reaching unsustainable territory.

Rumsfeldian reasoning

Addressing the factors that have driven combined ratios to such dramatic heights, Wieczorek said that results had been deteriorating for a number of years. “Like any ratio it is driven by both numerator and denominator, but we feel in the last few years that unexpected changes in the denominator—meaning primary rate decreases due to competition and an unfavourable macroeconomic environment—have placed considerable downward pressure on pricing,” he said.

He argued that recent high combined ratios “are more a function of insufficient pricing—a known known—than unexpected loss development or inflation—an unknown known”.

“Insufficient pricing is a known known, because it is known to be dangerous, as the prior soft market of the late 1990s clearly demonstrated. However, after the dust settles and actual results materialise, insufficient pricing is often portrayed as a known unknown, as most carriers’ business plans intended to charge an adequate rate, but debits, discounts and price competition resulted in an inadequate price,” Wieczorek explained.

“Similarly, ‘unexpected’ loss developments, inflationary pressures and rising loss costs are really unknown knowns, but are often portrayed as unknown unknowns—as unforeseen effects of increased utilisation, escalating medical inflation or increased prescription drug use,” Wieczorek said. It would seem that the industry needs to pay closer attention to a true view of the market, rather than one that suits its immediate outlook, in order for pricing truly to reflect the risk and investment environment.

"The industry needs to pay closer attention to a true view of the market, rather than one that suits immediate outlook, in order for pricing truly to reflect the risk and investment environment."

With combined ratios still generally north of 100 percent and primary players holding most of the rate rises back, what are expectations for the coming 24 months? Yit said that he was confident about reinsurers’ prospects and indicated that he was convinced that there will be a continuing upward trend, “although rates still have some way to go before they will be ‘adequate’ for the industry”. He added that “with investment income standing ataround 2 percent and combined ratios as high as 130 percent, it is evident that rate increases on the line are still necessary”.

Wieczorek was rather less bullish about prospects. “We don’t expect any significant changes, with flat to very small rate increases set to continue for the next year at least,” he said, citing positive premium audits as a likely upward driver, but added that with premium audits usually lagging by around a year, “this year you might get a rate that you should have received the year before”.

Further compounding concerns have been the state of the capital markets and the continuing low interest rate environment. Meagre investment returns have placed further pressure on a line that has “traditionally relied on the asset side of the business to offset high combined ratios”, Yit said.

Wieczorek spoke in asimilar vein, arguing that “our inability to rely on investment income in the current low interest rate environment to adjust the overall earnings” is further complicating a difficult situation on the line. With prospects for noticeable improvements in the global economy stubbornly elusive, it may be that poor investment returns will finally exert some upward pressure on the line. In the short term however, until rate rises tip combined ratios below 100 percent and primary writers pass on rate increases, feeble investment returns will continue to present a challenge to those writing workers’ compensation business.

Society and economy

Significant pressures continue to be exerted on workers’ compensation pricing by both economic and societal factors. With more people out of work in the US thanks to the current economic climate, employers are generally buying less workers’ compensation insurance. As Wieczorek indicated “claim frequency is expected to remain low due to weakness in employment”, while an ageing workforce, which has traditionally been more careful, will further drive down claims frequency. Meanwhile,average cost per claim or indemnity severity are “well contained as we have weak growth in wages”. However, the issue is complex. As Yit explained, despite a shrinking workforce, those workers claiming compensation who might have previously returned to work may now continue collecting compensation because there is no vacancy for them to return to. The dynamic has the potential to place both upward and downward pressure on rates on the line.

Improved work practices and safety at work initiatives have, meanwhile, reduced the level of claims. Wieczorek cited researchcarried out by Liberty Mutual, which found that the five most common work-related injuries account for 70 percent of workers’ compensation claims. And it isn’t only safety practices, but the make-up of the workforce, that is affecting claims frequency and severity. As Yit outlined: “Now with the baby boomers’ generation at retirement age, the length of time that people stay in their jobs is much longer on average, meaning that they are more experienced and less prone to injury at work.” Evidently there are opportunities to reduce risks at work, while the realities of a changing landscape at work are helping to drive down workers’ compensation claims.

Medical costs remain the leading upward driver for the line. As Wieczorek outlined, “medical inflation will continue to drive up workers’ compensation costs, and will remain a dominant cost factor for the sector”. Yit similarly highlighted the significance of medical claims. “Drug and medical technology costs have been going up for nearly a decade, with annual changes well above inflation,” he explained. According to statistics from the NCCI, medical costs rose by an average of 6.7 percent per annum between 2002 and 2009. Such trends suggest that workers’ compensation rates should reflect increasing medical costs, but as Yit made clear, “workers’ comp rates have not followed in step”.

Finally, state legislative changes have also affected rates on the line. Legislative wrangling over the direction of workers’ compensation rates is often a three-way tussle between the labour unions, the lawyers and doctors involved in claims, and the employers, Yit said, with the outcome of these battles varying widely by state. As Wieczorek indicated, there are both rate increases and decreases being proposed by state legislatures at present with the market remaining “extremely dynamic”. Citing Florida as a case in point, he said that 9 percent rate increases had been introduced in January, although he added that it is “worth noting that workers’ comp insurance rates in Florida are about 50 percent what they were in 2003”. In the case of California, recent increases in combined ratios have led the California insurance rating bureau to recommend significant rate increases, which may yet be taken up by the legislature.

It would seem that there are a number of factors serving to dampen rate rises on the line, although the magnitude of combined ratios in some states would suggest that positive rate development must occur soon. As Wieczorek indicated, “practically every ceding company that we talked to assured us that the primary rates are increasing or, at least, flattening and that positive premium audits seem to be uniformly present. However, at the same time the workers’ comp market remains competitive and its availability is not a problem”. It would seem that there may yet be positive news, although state differentiation and the health of the US economy are likely to determine just how encouraging rate developments will be.