At NCCI's Annual Issues Symposium this past May, we had theunhappy duty to tell some 700 industry executives and managersthat, in our view, the workers' compensation market was in aprecarious position. Unfortunately, the intervening months havedone little to improve our outlook regarding the state of theindustry.

By contrast, the overall propertyand casualty insurance industry has had a relatively quiet year.Underwriting losses have moderated. Catastrophes have beenmanageable, with few major hurricanes hitting the United States.And the stock market began to recover to some extent.

Unfortunately, the workers' comp industry had a more tryingyear. After very minor underwriting losses in 2007 and 2008, thecombined ratio for workers' comp shot up nine points in 2009–thelargest single year increase since the mid-1980s. Workers' comp wasone of only two of the major lines (along with general liability)that had an increase in combined ratio last year.

Deteriorating underwriting results, combined with the record-lowinterest rate environment, left workers' comp at only slightlybetter than breakeven after investment income is considered.

Once again, 2009 calendar year net written premium declinedprecipitously for both private carriers and the state funds. Therecessionary impacts, particularly on manufacturing andcontracting, along with price decreases took their toll on industrypremium–in fact, industry net written premium has declined analarming 23 percent over the last two years!

Obviously, these data show that the market faces a number ofsignificant challenges for the remainder of 2010 and into 2011. Andthese numbers only tell part of the story. The following offers amore complete analysis of the current market forces in play.

o Combined ratio up dramatically!

As noted above, the workers' comp calendar year combined ratiofor private carriers was up nine points from 2008–to 110 in 2009.This is the largest one-year increase in the combined ratio for theline since the mid-1980s.

However, three points of the increase in combined ratio were dueto the addition of more than $1 billion to excess workers' compreserves by a single carrier for accident years 2000 and prior.This reserve strengthening was almost 90 percent of the prior yearreserve strengthening for the entire industry.

Excluding that reserve addition, the industry combined ratiowould have been 107–still a significant deterioration from 2008.The 107 would make the recent pattern of combined ratios since 2006almost identical to that experienced from 1995 to 1998 (similarpoints in the last cycle). The 2009 accident-year combined ratio is107, up five points from accident year 2008.

o Reserve positions deteriorate!

NCCI estimates that the reserve position of private carriersdeteriorated to a $9 billion deficiency at year-end 2009, from a $6billion deficiency last year. After consideration of the allowablediscounting of the indemnity reserves of lifetime pension cases,the reserve position is a relatively slight inadequacy of about $4billion, on a total reserve base of more than $106 billion.

o A bright spot–claimfrequency continued to decline!

Claim frequency continued to decrease in 2009. For NCCI states,frequency fell 4 percent. The prior year's decline was 3.4 percent,while 2007 saw a 3 percent reduction.

NCCI's research anticipated that the recession would putadditional downward pressure on frequency, as the lack of hiringallows the work force to become more experienced and less prone toinjury.

o Rates largely on the decline!

Not surprisingly, workers' comp insurance prices also continuedtheir declines in 2009 in most jurisdictions.

Those drops were driven by bureau rate and loss-cost decreasesresulting from the frequency declines, which were only partiallyoffset by moderate increases in medical and indemnity average claimcosts. Carrier discounting from bureau rates and loss costsremained nearly constant in 2009.

o Medical and indemnity costs moderate–but remain aconcern!

Medical costs have moderated somewhat over the last few years,although they continue to increase faster than wages. In four ofthe last six years, the average cost increases have been about5-to-5.5 percent per year, down substantially from the neardouble-digit increases we were used to seeing in the late 1990s andearly 2000s.

Some NCCI research indicates that the moderating medical costtrends of the last few years are coincident with a moderation inthe number of medical procedures per claim that began in the early2000s. That flattening followed a period of sharp increases in thenumber of procedures per claim that began in the mid-1990s.

Indemnity claim costs also continue to outpace wage increases,although indemnity costs have also moderated since 2002. At thestate level, we have seen some push to increase benefits. However,little has been enacted, most likely due to the impact of therecession on the business climate.

As the economy improves, some may sense it is an opportune timeto review benefit levels and past reforms, to the potentialdetriment of efficiently run and well-balanced workers' compsystems.

o Low investment yields expected tocontinue!

Low investment yields will likely continue for a while longer.As the economy begins to recover, all eyes will be on the FederalReserve to see what it plans to do with interest rates and with allof the monetary stimulus that it has pumped into the economy overthe last two years.

At this juncture, there is a school of thought that suggests asignificant increase in inflation is an inevitable result of thefiscal and monetary stimulus poured into the world economy sinceearly 2008.

However, there are some who feel the recovery is still fragile,depressing demand so much that with reasonable central bankactions, and some serious attempt to rein in the federal budgetdeficit, significantly higher inflation is not a certainty.

o The effect of national health carereform!

Although the new national health care legislation passed inMarch did not directly change the way medical services aredelivered, paid for or regulated for workers' comp, the bill willcertainly impact the line.

The most direct impact to workers' comp was a provision insertedinto the bill that was not related to health care reform. Thatprovision dealt with the Federal Black Lung benefits for coalminers and their survivors. The change contained in the billloosened the requirements for miners and their survivors to qualifyfor benefits.

Another aspect of the health care bill that directly impactsworkers' comp is the potential to change the price levels andprocedures for Medicare reimbursements. Many states base theirmedical fee schedules on various aspects of Medicarereimbursements. Those states will have to watch for impacts totheir fee schedules as the Medicare changes are made.

Lastly, provisions in the health care bill increase taxes onmedical device manufacturers, pharmaceutical companies and healthinsurers, and any higher costs will likely be passed on to theworkers' comp system.

However, there could be some benefits to workers' comp from thehealth care bill, as well. The fact that a higher percentage of thepopulation will have access to health insurance may take somepressure off of workers' comp. Also, the bill has some provisionson wellness and treatment protocols that could help to addresshealth risks such as obesity–a factor that we know from ourresearch significantly affects the cost of workplace injuries.

Another issue industry stakeholders are watching closely is thefinancial services reform law. Although mostly focused on WallStreet and the banking industry, there are some aspects andoutcomes that could significantly affect the p&c insuranceindustry.

LOOKING FORWARD

As can be plainly seen in the results, the workers' compindustry did not fare quite as well as the broader p&c marketin the past several months.

Although the industry benefits from a strong capital positionoverall, the nine-point increase in the workers' comp combinedratio is troublesome.

In addition, the line is taking a very hard hit to revenue dueto the recession's impact on business payrolls, particularly in themanufacturing and construction industries, which traditionally havegenerated more than 40 percent of the industry's premium. The lineis posting combined ratios that are not sustainable at these lowinterest rates, and reserve adequacy is starting to slip.

In sum, the line faces a number of challenges, ranging from poorresults to uncertainty surrounding medical costs. Theseinclude:

o The impact of national health care reform onworkers' comp is uncertain, from new taxes to changes in Medicarereimbursements to the strain on the medical care system from thenewly insured.

o The current combined ratio, together with lowinvestment yields, is not close to providing an adequate return onthe industry's capital. Even with some modest increase ininvestment yields, the combined ratio will need to be reducedsubstantially to earn a reasonable return on capital.

o The contentious political situation inWashington, D.C., makes for a continued period of uncertainty forinsurers.

o The underwriting cycle could be nearing aninflection point, but the early signs are still faint.

Although fewer, there are some positive market indicators,including:

o The industry's capital position.

o The fact that claims frequency continues todecline.

o A moderation in claim severity increases.

o Continued depopulation of the residualmarket.

Along with every other industry participant, NCCI will continueto monitor market results in the coming weeks and months, and wewill report on both positive and negative developments.

Until the economy begins a significant move toward recovery,however, we expect that most stakeholders will remain in theaforementioned precarious position, looking for new signs ofstability and growth–signs that cannot appear quickly enough!

Stephen J. Klingel, CPCU, is president and CEOof NCCI Holdings Inc. in Boca Raton, Fla.

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