Financial Troubles Weigh On WC Market

The state of the workers' compensation market can be aptlydescribed as highly difficult, with preliminary 2001 resultsreflecting one of the worst years in the markets history. Much ofthe bad news is tied to the Sept. 11 terrorist attacks onAmerica.

Clearly, the terrorist attacks had a profound impact on theperceived stability and nature of the workers comp insurancemarket. For example, prior to last year, large-scale terrorism inAmerica had not been considered a likely event. Workers comp claimswere typically single incidents that affected one person or, atmost, a small group of people.

Today, the hardened economic condition facing the market hascombined with continuing fallout from the terrorist attacks toleave workers comp insurers facing a daunting array of issuesranging from diminishing investment returns and rising medicalcosts, to such terrorism-related issues as primary coverage,reinsurance availability, anticipated federal legislativesolutions, and policy exclusions.

Looking at workers comp market results, preliminary estimates bythe National Council on Compensation Insurance indicate that theworkers comp combined ratio for calendar year 2001 is 121 (seeChart 1). With an increase of three points from 118 in 2000, thisyears results mark the sixth-straight year of deterioratingcombined ratios.

Less than two percentage pointsor $500 millionof the calendaryear 2001 combined ratio on a net basis is attributable to claimsresulting from the terrorist attacks of Sept. 11. This impact issubstantially less than originally expected because the vastmajority of losses were ceded to reinsurers, and will not appear inthe workers comp line on a net-of-reinsurance basis.

Although initial estimates contemplated between $3 billion and$5 billion in workers comp losses attributable to Sept. 11, theseinitial estimates were based on a projection of more than 6,000deaths. Actual deaths were half that number. Accordingly, NCCI hasadjusted expected losses downward to between $1.3 billion and $2billion. As additional claims–such as respiratory diseases andstress–become more certain, the ultimate impact of Sept. 11-relatedclaims may continue to change.

Investment income associated with workers comp insurancetransactions fell dramatically in 2001 to an estimated 14percent–down from approximately 20 percent during 1997-2000. Thedecrease in investment income is due to drastically lower interestrates as well as a reduction in realized capital gains.

Incorporating the combined ratio with the investment gainsresults in a pretax operating loss for workers comp of 7 percent(see Chart 2). From a historical perspective, 2001 marks thefifth-consecutive year of declining pretax operating ratios.

Apart from the economic realities described above, there are anumber of other significant forces at work in the industry,including premium volume that continues to increase.

For the second-straight year, net workers comp premium volumefor private carriers showed a strong gain, increasing 4.9 percentfrom 2000. Wages and salaries have increased at a substantiallyhigher rate than net premium volume for the past few years.

Meanwhile, accident year results continue at sizable losses.After two years with high combined ratios (137 in 1999; 133 in2000), the preliminary 2001 figures are likely to improve to acombined ratio of 127, taking into account the impact of Sept.11.

We are also seeing workers comp reserve deficiencies continuingto grow. The potential reserve deficiencies in workers comp on anultimate payout basis could be as much as $21 billion in 2001.

At the same time, approved rates/loss costs have been relativelystable. After a period of material increases in the early 1990s,the average decrease from 1994 through 1999 was approximately 5percent annually. Even though California had significant increasesin 2000 and 2001, the overall countrywide indications remainmodest.

However, the rate of change in the cost of workers compindemnity claims has continued to increase in the last few years(see Chart 3), with claims increasing an average of 6.6 percentannually since 1996. (Claims rose 9.9 percent in 2000, and 6percent in 2001.)

During this period, medical claim costs have also been on therise, up an average of 7.5 percent during the last six years. Aswith indemnity, the 2000 (8.1 percent) and 2001 (11 percent)average rates of change for medical severity have shown notablyworse results (see Chart 4).

Preliminary results indicate that the frequency of lost-timeclaims declined during 2001 by approximately 4 percent. Thiscontinued a 10-year trend of decreasing frequency averagingapproximately 5 percent a year.

Looking at residual market growth, we find that the workers compresidual market expanded by 74 percent to $615 million in 2001.Furthermore, during the first quarter of 2002, the number of newlyassigned policies in the residual market increased by 22 percent,and the premiums increased by 63 percent, compared with the firstquarter of 2001. Residual market premium as a percentage of directwritten premium also grew from a low of 3 percent in 1999 to anestimated 6 percent last year.

However, while residual market premium continues to grow, thecurrent level remains far below the excess of $4 billion reached inthe residual market from 1990-1993.

Looking ahead, it helps to consider what participants can expectfrom the market, given this challenging environment.

For the workers comp industry, 2002 is likely to be a transitionyear. Although the events of last fall have forced companies backto the drawing board, insurers are expected to continue evaluatingand adjusting their strategies.

Carrier consolidation can be expected to continue as companiesstruggle to remain profitable in a difficult environment. Themarketshare of the 15 largest workers comp carriers is close to 70percent, compared with 58 percent five years ago. That marketconcentration may well increase further in 2002.

Although diminished investment income might inhibit results inthe short term, a revitalized economy and better investmentopportunities could help improve results over the long term. Afinal government solution to limit insurer exposure to catastrophiclosses in this line is vital if workers comp is to return tohealth.

As it has to-date, the remainder of this year promises to be achallenging time for workers comp players as the market attempts toestablish a firmer financial footing.

As market participants structure their business plans for 2002,NCCI will continue to support industry initiatives by analyzingdata and conducting research on the economic factors affecting themarket, including the fallout and proposed remedies associated withSept. 11.

Dennis C. Mealy is chief actuary at NCCI Holdings Inc. inBoca Raton, Fla.

Reproduced from National Underwriter Property &Casualty/Risk & Benefits Management Edition, August 19, 2002.Copyright 2002 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.