Worker's comp: uncertainties remain
Hit by declining construction contracts, rising unemployment and the marked lack of an employment rebound in the US, workers’ compensation continues to face pressure after a stagnant few years. However, there may yet be light on the horizon as rates for workers’ compensation insurance look set to improve, although the situation faced by reinsurers continues to be marked by expectations of further softening.
Some good, some bad
Talking with reinsurers and brokers, it is evident that while downward pressures persist in the reinsurance arena, conditions might just be ripe for a turn in the insurance market after a protracted downward cycle. Addressing the situation faced by the reinsurance sector, Dennis Stokes, senior vice president at Endurance Specialty Insurance in Bermuda, said that further softening is expected, indicating that catastrophe rates for the line have been “trending downward, roughly in the 10 to 15 percent range over the year, and that has been the case for a while now”. He made clear that there was every expectation that downward pressure would persist. Addressing the wider state of workers’ compensation reinsurance, Karl Amidon, global workers’ compensation practice leader at Aon Benfield said that “while loss cost rates are trending upward, this has not resulted in higher premiums, as competition has taken away the effects of rate increases in the majority of states”. It would seem that the number of reinsurers offering workers’ compensation continues to hamper a rate recovery, while premiums ceded by insurers remain relatively unmoved.
Meanwhile, insurance rate-making decisions in the US look likely to result in the hardening of insurance pricing in 2011. Addressing the specifics of the line by US state, Aaron Bueler, global head of workers’ compensation specialty at Guy Carpenter, indicated that movement nevertheless remains dependent on state-specific conditions. He stated that “the 2010-2011 rate-making season is showing signs of a change in the mix of increases and loss cost trends. Forty-five percent of the National Council on Compensation Insurance rate-making actions in the 2010-2011 season are for a rate increase. This is a sharp increase, since the rate increases in the previous three rating seasons were 22 percent, 14 percent and 22 percent, respectively. The three major states not in the NCCI study are California, Florida and New York, all of which are [likewise] experiencing or projecting rate increases.”
Addressing the issue of geographical variation in the insurance arena, Amidon said: “California usually leads the pack in good and bad, and at this point, it is bad. The Workers’ Compensation Insurance Rating Bureau (WCIRB) indicated a needed rate increase of 27.7 percent as the 2009 accident year combined ratio was 125 percent. Illinois, Georgia, New York, New Jersey and Pennsylvania are not far behind. It seems that Florida and Texas are still profitable as their reform measures seem to be holding up better than others.” With a host of pressures across a number of US states, there may yet be a turn in the insurance market.
Looking at both insurance and reinsurance, it would seem that the picture for 2011 remains decidedly mixed. Rate-making actions look likely to exert some upward movement on pricing for insurance, but the level of competition in the reinsurance arena means downward pressure will likely be sustained, with further negative impacts being felt from the wider economy.
A host of pressures
Asked what pressures are prompting movement on the line, Nick Campbell, senior vice president and head of specialty treaty reinsurance at Endurance in Bermuda, said that “they are largely related to broad economic factors—unemployment has increased, so payrolls are down, and this reduction in exposure continues to provide pressure on the underlying line”. Aon Benfield’s Amidon echoed Campbell’s sentiments, indicating that “the economy has taken away a great deal of premium via lower payrolls. Competition for the remaining premium has intensified. The soft market is fully mature and this is characterised by multi-line and mutual companies competing harder for business. Workers’ compensation specialty companies have started backing off.”
Pressures on workers’ compensation reinsurance “relate primarily to the relative amount of capacity in the market”, Campbell said, with overcapitalisation prompting reinsurers to chase premiums despite rising combined ratios and continuing softening.
Talking with Bueler, it is clear however that a turn in the insurance market is already underway, with conditions finally right for the line to harden. Asked what factors were driving this change, Bueler listed a number of issues, namely:
• The 2009 pre-tax operating gain ratio for workers’ compensation is the lowest it has been in seven yearsInvestment yields are down and volatile. The current 10-year US treasury yield is down about 25 percent from 2006
• There has been an uptick in estimated calendar reserve deficiencies from $2 billion to $9 billion in the last three years
• Indemnity (the wage replacement portion) of loss time claims is increasing, while the average weekly wage decreased in 2009
• Actual medical costs per loss time claim are growing faster than the medical consumer price index
• Many of the workers’ compensation reforms that contributed to improved industry results are becoming ‘stale’—they’re not producing the same level of savings and are in need of review or refinement.
It seems workers’ compensation may just have reached the bottom of a deep cycle, with an uptick in insurance rates likely to have a knockon effect upon reinsurance rates. However, with continued levels of overcapitalisation characterising the sector, it may not be until after 2011 that reinsurance rates for workers’ compensation improve.
Impacts from the wider economy
The wider economic situation in the US, which is yet to recover from the lows of 2008-2009, is further complicating the recovery of workers’ compensation. “High unemployment levels have taken approximately $8 billion to $10 billion of premium out of the workers’ compensation system,” Amidon said. Declining hours worked have also bitten into premium levels, he said, indicating that “we wouldn’t be surprised to see overall nationwide workers’ compensation premium have decreased up to 20 percent over the last two years”.
Further exacerbating the situation, Amidon said that the incidence of compensation claims had actually increased in the downturn. “Recently, and for the first time in many, many years, we have seen frequency reverse its downward slope. If that trend continues, current workers’ compensation rates will prove to be inadequate,” Amidon said. Such a situation could well help to spur reinsurance rates. The question is whether wider economic conditions will be enough to overcome overcapacity and long-term softening.
Health and safety
Asked what impact an increasing emphasis upon health and safety in the workplace has had on levels of ceded premiums, Bueler indicated that “much of the decline in loss frequency has been credited to increased safety practices and awareness, as well as the loss of some of the more hazardous manufacturing to locations outside the United States”. Whilst this has helped to dramatically reduce workplace fatalities and create a safer working environment, such improvements have had obvious implications for levels of premium. As Amidon made clear, “effective loss control and health and safety have been part of the influences impacting workers’ compensation for the past 30 years.
These efforts have been reflected in the continued drop in frequency relative to workers’ compensation loss experience, and lower losses produce lower policy premiums and consequently lower ceded premiums.” Looking to future pressures, Bueler said that “obesity and an increased average worker age are forward-looking risk factors that will require strategies to mitigate loss potential”.
Breaking the cycle?
Addressing the issue of what might break the present soft cycle, Amidon said that “insurance companies change pricing when they have lost enough capital and decide not to lose anymore. The industry will lose capital in 2010 and 2011. Any number of events could trigger a pricing change, including catastrophe loss, or the recent frequency change continues making current rates inadequate.”
Campbell concurred, saying that “the line is under a lot of stress, with combined ratios at well over a hundred percent. In times of high investment yields, underwriting at this level is sustainable, as it is a long-tailed line, so companies have the opportunity to invest the premiums they get and achieve a significant investment return before they have to pay losses. In today’s markets, where interest rates are so low, there is no opportunity to do that, so there is no question that the current combined ratios are not sustainable in the long run.”
“That said, companies [in the reinsurance space] are still fairly well capitalised and there is a lot of competition for deploying premium, so we don’t see the market turning in the short-term. I think that there is an expectation that things may start to steady a bit into 2012, but I don’t think we’ll see a dramatic hardening in the market,” Campbell said. “Finally, there is the question of whether a large event generating significant losses would make people feel a little less complacent about the profitability of the catastrophic programmes in the workers’ compensation line and that might influence pricing—although from a human perspective, you hope you never find out,” Campbell concluded. It seems neither Amidon nor Campbell are confident that the critical tipping point for reinsurers has yet been reached.
For insurers meanwhile, Bueler indicated that the soft cycle has in fact already come to an end. “I believe that ship may have already left the dock, given the growing number of primary rate increases indicated for 2011. However, where there is a political component to the rate adjustment process, there is going to be a lot of pressure to keep rate increases minimal in order to allow employers to invest in more jobs rather than increasing workers’ compensation costs,” he said. “Workers’ compensation carriers are going to need to look carefully at the rate actions by state, analyse their own results, and evaluate new exposures to determine their level of interest and chances for adequate returns.” It seems that 2011 will be a more positive year for insurers, but those pressures that have finally driven up rates are, in all likelihood, unlikely to impact reinsurance rates this year with the line still awaiting a break in what has been a long, soft cycle.