For workers’ compensation insurers, profitability is the greatest near-term challenge, as accident-year combined ratios increase, and uncertainty in employment and medical-claim trends weighs on the sector, according to a recent report.
The Moody’s Investors Service report, “U.S. Workers’ Compensation Market: Sector Profile,” notes that premiums have increased in 2011 and 2012, alleviating some of the rate inadequacy affecting the sector, “but further significant strengthening will be required to improve underwriting margins to earn acceptable operating returns and to offset the impact of sustained low interest rates.”
There are some positive signs for insurers. Moody’s says it expects the accident-year combined-ratio deterioration to moderate as rate increases outpace loss-cost trends, although the overall impact will vary by company depending on mix of business.
Additionally, says Moody’s, “A number of insurers indicated a moderate decline in risk appetite for workers’ comp during 2012, which, along with further rate actions, could lead to further margin improvements for 2013.” But the ratings agency says it does not expect any major contractions in capacity, “and we expect underwriting profitability to improve only gradually.”
On the other side of the supply/demand coin, Moody’s says that, more than most other insurance lines, workers’ comp results are strongly tied to the macroeconomy. “Demand for workers’ compensation coverage depends directly on employment levels, including significant occupational segments such as manufacturing and construction.” But manufacturing and construction, at year-end 2011, were 15 percent and 30 percent, respectively, below pre-recession employment levels. Moody’s says the resultant reduction in demand for workers’ comp capacity may limit the needed upward pressure on rates.
To compensate for the reduced demand in the manufacturing and construction segments, Moody’s notes that insurers have begun to divert capacity to occupational classes with improving employment levels. “Over the longer term, job growth in industries such as healthcare and energy may offset job losses elsewhere,” the report says.
Moody’s says it expects “a near break-even reserve position for carried workers’ comp reserves for our universe of rated issuers as of year-end 2012.” More specifically, the ratings agency predicts that deficiencies in the 2010-11 accident years and potentially smaller shortfalls for accident years 2009 and 2002 will be offset by redundancies in accident years 2003-2008.
Looking forward, Moody’s indicates that a “number of issues” will present challenges when setting workers’ comp reserves. “Prominent among these is relative growth in medical claims (vs. indemnity) as a proportion of workers’ comp loss costs and the greater challenges associated with reserving for medical coverage compared to indemnity.”
Moody’s says the high rate of medical-cost inflation for services and prescription drugs, the trend toward more intensive utilization of medical goods and services, and emerging health issues such as obesity and diabetes are among the primary drivers of high medical loss costs.
“The greatest challenge associated with medical claims inflation is not only a sizable trend rate but also the attendant uncertainty of its projection well into the future for purposes of setting adequate loss reserves,” says Moody’s.