A recent report from Moody’s Investors Service shows that the U.S. workers’ compensation (WC) sector has improved significantly since 2011 as the domestic economy and labor market have gradually recovered and insurers achieved cumulative rate increases. However, competition is increasing and profitability, while good, is diminishing.
Further margin compression is likely over the next two years, according to the report, which noted that the WC sector’s fortunes are closely tied to the U.S. labor market, given the compulsory nature of the benefits the insurance provides. The falling national unemployment rate, 4.4% as of June 2017 from near 10% several years ago, is positive for the sector.
And if you were wondering about how much significance the WC sector has, Moody’s report notes that WC is the largest single commercial line for US P&C insurers, comprising nearly 19% of U.S. commercial lines premium volume and approximately 10% of the P&C industry’s total direct premiums written, behind only personal automobile and homeowners insurance.
PropertyCasualty360 interviewed Sid Ghosh, vice president and senior analyst for Moody’s, based in New York, regarding the report and its findings.
Claims trend flat
PC360: Were there any surprises in the report?
Sid Ghosh: One general observation is that the claims frequency trend has been flat to slightly negative in WC for a long time even as the economy has added a significant number of jobs in the last couple of years. With improvements in workplace safety, we expect frequency trend for our rated insurers to remain slightly negative, in line with their longer-term track record. In addition, with medical cost trends in the mid-single digit range, we expect overall loss cost trends to remain low unless there is an uptick in lawyer involvement or medical inflation.
PC360: What do you think is the most important thing for workers’ comp risk managers to do to maintain costs?
SG: Although we can’t comment on what a risk manager should or should not do with regard to maintaining and controlling costs, we can say that the role of a risk manager in an insurance organization is governed by its enterprise risk management (ERM) principles and guidelines. Most well-diversified national WC writers adhere to strict risk controls standards set forth by their ERM standards and guidelines. The complexity of assessing risks would depend on an insurer’s exposure profile and geographic diversification.
Workers’ Comp carriers can have the most impact on the market by focusing on controlling costs. (Photo: iStock)
Focus on controlling medical costs
PC360: What do you think is the most important thing for workers’ comp insurers to do to maintain costs?
SG: There are generally two broad categories for the vast majority of WC claims: medical and indemnity. Because indemnity costs are capped by most states, WC insurers generally focus on controlling medical costs, which are uncapped or unlimited.
WC insurers have been focused for a number of years on the rising medical costs associated with opioid usage through prescription painkillers. Many states have adopted legislation to enforce stricter regulations around prescriptions for opioids, which will help with cost containment. Connecticut, Maine, Massachusetts, New Hampshire, New York, Pennsylvania and Rhode Island are some of the states that passed stricter regulations around prescription of opioids, with more states likely to follow suit.
In addition, certain states have been implementing legislation around workers’ compensation drug formularies. A drug formulary is a list of prescription drugs that is designed to reduce prescription drug costs and decrease opioid and narcotic usage.
Controlling risk exposures is another way of managing costs. Many insurers have been reducing exposure in higher-hazard occupational classes and unprofitable accounts through improved risk selection and segmentation of data using predictive analytics, allowing for more granular pricing by risk tier.
4 key takeaways
PC360: What do you want readers of the report to understand?
SG: I think there are four key takeaways from the report:
- The WC sector is structurally correlated to the macro economy and the labor markets. The US economy has added five million jobs during 2015–2016, which led to a stable performance, although increased competition will lead to margin compression in the next couple of years.
- WC business is highly cyclical and is one of the most competitive commercial lines, and therefore vulnerable to pricing volatility. In aggregate, we expect WC pricing to fall modestly over the next couple of years, assuming a stable business environment. However, given the low interest rate environment and the generally long duration of WC reserves, we expect pricing declines to remain controlled in the current market cycle. It’s also important to remember that an individual insurer’s rates could vary, depending on its risk profile, industry sectors and the states in which it operates.
- Increased use of opioids is a growing concern for insurers as well as state legislatures, prompting states to adopt stricter regulations and controls around these substances.
- Big Data and machine learning will likely shape future markets. The emergence of artificial intelligence (AI), machine learning and big data will improve the underwriting and efficiency of processing the business. Some commercial insurers have already begun applying natural language processing to workers’ compensation claims files (doctors’ notes and prescriptions) to preempt complications from claims likely to be complex (for example, by flagging such things as opiate abuse, diabetes or obesity or other co-morbidities). Insurers are using big data and predictive analytics to comb through social media feeds for evidence of fraudulent activity, notably in workers’ compensation or injury cases. Given the extensive amount of data analyzed and used by insurers related to workers’ compensation claims, those insurers who fall behind in data analytics will be subject to adverse selection. However, advancements in automation and technology will change the nature of work and the underlying exposures in various industries over time as more routine tasks are automated.
Some workers’ comp carriers are moving away from high-risk professions like construction. (Photo: Shutterstock)
Other key findings
The report also suggests that increasing rate pressure will drive the 2017 accident year (AY) combined ratio near 100%. Although Moody’s believes the sector is profitable, the 2016 AY combined ratio deteriorated to 99% from 96% in AY 2015. Given relatively benign loss cost trends, Moody’s expects the sector’s combined ratio to remain below historical levels, at about 99.5% in 2017 and 100% in 2018.
Growth of construction jobs has significantly outpaced job growth in the manufacturing sector since 2011, given that increased automation and cheaper labor costs outside the U.S. eliminated many manufacturing jobs permanently. Some insurers have been shifting capacity away from higher risk classes such as manufacturing and construction and have moved into lower-risk occupational classes, which have good growth prospects in a stable or growing economy.
The unemployment picture by the largest states has also improved significantly since 2011, however, the number of full-time and part time jobs created in recent months has been somewhat volatile. This bears watching, the report says, because the exposures and premiums associated with full-time workers are much higher than part time workers even as the unemployment rate remains unchanged.
The sector is also vulnerable to public health trends, including the increased prevalence of diabetes, obesity and the abuse of prescription drugs, could lead to a rise in medical inflation, which would create reserving challenges. In addition, the current debate over the future of health care reform adds to the uncertainty around longer term costs for WC insurance.
For more information or to obtain a copy of the report, visit Moody’s website.