AFTER enduring several consecutive years of deteriorating results, the workers compensation insurance system is showing signs that it may be on the mend. The industry's calendar-year combined ratio, after rising for five straight years to 122 in 2001, dropped to 111 in 2002, according to figures released last year by the National Council on Compensation Insurance. Estimates of reserve inadequacy also took a turn for the better, dropping to an estimated $18 billion in 2002 following a seven-year climb that peaked at $21 billion in 2001. In light of rate hikes that were approved last year in many jurisdictions, there is reason to hope that this spring, when NCCI releases its 2003 estimated results, they will show continued improvement.

Not that all is well with workers compensation insurance. NCCI reported that in 2002 the line suffered a 0.1% pre-tax operating loss (following a horrendous 7.7% loss in 2001). And given the weak investment climate, an NCCI report last year stated that “many carriers may need a combined ratio of less than 100% to return their cost of capital.” Uncertainties also abound, ranging from the effects of OxyContin on the workers comp system to whether the Terrorism Risk Insurance Act will be renewed in 2005.

To get an idea of what may lie ahead for workers compensation, we recently contacted the NCCI, as well as two prominent workers comp insurers and two intermediaries. Following are their comments.

National Council on Compensation Insurance
(www.ncci.com)

As the workers compensation insurance system moved into 2004, Peter Burton, senior division executive for state relations at NCCI, sounded cautiously optimistic. Burton called the state assigned-risk plans, which provide coverage for businesses that cannot obtain insurance in the voluntary market, a “barometer” of industry profitability. In 2002, the volume in the 20 or so assigned-risk pools that NCCI administers rose to an estimated $1.2 billion from $632 million in 2001, according to a report NCCI released last year. But Burton said growth has started to flatten in recent months. “The residual market may have peaked,” he said, which would presage better times ahead for workers compensation insurers.

NCCI files advisory loss costs and, in a few cases, advisory rates for workers compensation in 38 states. Its filing cycle runs from July 1 to June 30. As of last month, NCCI had made 28 loss-cost filings, Burton said. Of them, 15 were for increases, 11 for decreases, and two for no change. Burton said the pattern of filings was similar to that of 2002. In the current cycle, NCCI sought-and was granted-a 21.2% loss-cost increase in Alaska. A similar filing in Kentucky, for about a 20% increase, was scaled back to 13.1% by state regulators. Burton said most of the other increases NCCI sought were in the single-digit range. “In most cases, the recommendations we've made with state regulatory authorities have been approved as proposed,” Burton said. “They recognize that the market is changing, that cost pressures.”

Chief among the cost drivers are medical expenses. Years ago, Burton said, they were relatively small compared with indemnity expenses. “Now it represents as much as 54% nationally of what is paid out in benefits to injured workers,” Burton said. He added that NCCI recently conducted a study of what's driving medical costs and determined it to be prescription drugs, particularly such potentially addictive and frequently abused pain-killers as OxyContin. “Pharmaceuticals probably represent a little less than 10% of the overall cost in medical,” Burton said, “but it's the fastest growing element.” (According to a press release issued in August by the National Association of Independent Insurers, OxyContin has become the second-most prescribed drug, in terms of dollars spent, in the workers compensation system. In the same press release, NAII's Workers Compensation Committee expressed alarm over the growing abuse of OxyContin, which is said to be capable of producing a heroin-like “high,” and announced its support for state legislation “to provide tighter guidelines under which the drug may be prescribed and for clearer safeguards once it is prescribed.”)

On the other hand, loss frequency, while leveling out in some states, continues to decline in others, thanks primarily to a continuing emphasis on workplace safety. “That's really been the saving factor for workers compensation costs,” Burton said.

One big unknown on the horizon, Burton said, is the fate of the Terrorism Risk Insurance Act of 2002. The act has helped stabilize the market by capping the losses insurers could suffer in the event of terrorist attacks of foreign origin. But TRIA is scheduled to expire in 2005, and whether Congress will reauthorize it is anybody's guess.

Shortly after TRIA was enacted, NCCI sought and obtained terrorism loads in all states for which it files advisory loss costs. They averaged roughly 2% of payroll for the voluntary market, Burton said, and about a point more for the assigned risk plans. No further loads currently are contemplated, Burton said, adding that NCCI would have to revisit the issue if the TRIA backstop were removed.

AIG Specialty Workers Compensation
(www.aig.com)

Jim Roberts, president of AIG Specialty Workers Compensation, a division of American International Group, said he expects 2004 to be another year of growth. Roberts' division primarily serves small and midsize businesses looking for guaranteed-cost, first-dollar coverage. In the year ahead, Roberts said he expects growth to be in the 15% to 20% range, adding that it likely will be fueled more by increasing payrolls than by continued rate hikes. For the industry overall, he said he expects workers compensation rate increases to average 3% to 5% in 2004.

“I think there has been some recognition that the insurance industry in general under-priced workers compensation in the late 1990s,” Roberts said. As regulators saw some carriers go out of business, causing hardships for mainstream businesses, many acknowledged the need for rate increases, he said, benefiting the markets in their states. He added, however, that there are some states, “particularly those that will not allow rating flexibility, either up or down from standard rates,” that will continue to be difficult for carriers to serve. “They are the states that have the capacity problems,” he added.

Roberts said he doesn't anticipate any downward pressure on rates for the foreseeable future because he doesn't see a lot of new capital entering the market. He noted that workers compensation insurance is a labor-intensive line, due to the significant regulatory data-reporting requirements insurers face. “Quite frankly, we think first-dollar workers compensation insurance is not an easy market to enter,” he said.

Until recently, many observers have characterized the current business expansion as a “jobless recovery,” but Roberts said he has seen indications of a change. Through 2002 and the first half of 2003, his division's workers compensation premium audits collectively resulted in a return of premium to employers, Roberts said, a sign of shrinking payrolls. But in the past few months, the company has noticed a small but definite change in the outcome of premium audits. “We've gone from returning money in aggregate to collecting it,” he said.

Job growth is not always an unalloyed blessing for workers compensation insurers, Roberts noted. While it definitely increases premium volume, it also can lead to higher claim costs. “We see frequency of claims increasing when you are running unemployment rates of less than 5%,” he said, adding that he thinks that's because the most marginal workers, who are involved in a disproportionately high number of accidents, are the first laid off when the economy falters and the last to be hired when it picks up again.

Roberts also noted that when an economy gets booming, new businesses are established-but not always by people with the necessary skill and experience. “An inexperienced manager generally will have more workers compensation claims,” he said. “So in a growing economy, we generally are a little bit tougher when looking at new entities.”

Roberts advised agents and brokers to be circumspect when evaluating such prospects in the year ahead. He also said agents and brokers should stress the value of early return-to-work programs to clients and, perhaps not surprisingly given AIG's financial position, to emphasize the importance of placing their business with top-rated carriers.

Zurich North America
(www.zurich.com)

Continued medical inflation will be one of the major factors affecting workers compensation insurance in the year ahead, according to Bob Rheel, senior vice president and director of workers compensation for Zurich North America. Like NCCI's Peter Burton, Rheel cited concerns about the increasing costs of pharmaceutical drugs, especially OxyContin and similar pain-relievers. He also noted that assigned-risk plans in some states, like New Jersey, are continuing to repopulate. “Basically, rates need to continue to rise to cover inflationary costs,” he said.

Rheel said it is hard to characterize the overall regulatory environment. On the positive side, he cited reform efforts in Florida and California. “But then we're also seeing certain state jurisdictions that are not passing reforms and are beginning to suppress rates,” he said. Rheel said he doesn't expect any significant changes in workers compensation capacity next year, except perhaps for certain areas with above- average exposure to terrorism-related losses. “In particular, in several cities we're seeing a general pullback from (businesses with) high concentrations of employees,” he said. “We suspect it will continue in 2004.”

Zurich North America writes workers compensation insurance in all segments of the market. “I would characterize it as a stable book,” Rheel said. “We're not looking to make changes next year and we expect to continue to grow.” He said the carrier's risk-engineering and claims services, along with its extensive PPO networks in many states, will enable it to compete effectively.

In the year ahead, Rheel advised agents and brokers to continue to encourage their clients to be proactive in regard to safety and to manage their loss costs. “In particular, those customers that are active in utilizing PPOs for medical care will attract more of the market than those who do not,” he said.

Applied Underwriters
(www.applieduw.com)

Recent turmoil in the workers compensation markets should give stable insurers more opportunities to write business in 2004, according to Carl DeBarbrie, senior vice president of Applied Underwriters Inc., a San Francisco-based financial services company offering workers compensation insurance and various employer-related services through independent agents and brokers across the country. Applied Risk Services, one of its subsidiaries, is an MGA that underwrites workers comp on behalf of Virginia Surety, rated A IX by A.M. Best.

DeBarbrie noted that in the past year, a number of workers compensation insurers, as well as multiline carriers with significant workers comp books, have been downgraded by A.M. Best and other rating agencies. Some have merged with others insurers or have sold their books of business. DeBarbrie said he expects such developments will lead to a lot more marketing of accounts in 2004, as producers react to the consolidation and attempt to ensure their clients are placed with financially secure carriers. The downgrades, along with what has been a lackluster investment climate, also have obvious implications for insurers, he said. “I think the consolidation will really emphasize the necessity of underwriting to a profit,” he said.

Even with the economy picking up steam, DeBarbrie said Applied Underwriters plans no major changes in its approach to business. Rather, he said, the company views the improved economic outlook as “an opportunity to strengthen our core business” and to focus on “controlled, profitable growth.” He said the company will continue to emphasize the need for agents to provide accurate data on currently valued losses and historical payrolls, and in some cases to furnish financial statements.

In general, the company focuses on small and midsize businesses, DeBarbrie said. One of its programs is geared toward companies that are paying up to $100,000 for workers compensation insurance. It can accommodate a broad array of risks, including some of the more difficult ones, like construction, transportation and certain manufacturing classes. Another program, which provides profit-sharing opportunities to clients in a position to share risks and control losses, focuses more on large fixed-location risks paying $150,000 to $1 million in annual workers compensation premiums.

DeBarbrie said he doesn't expect the reinsurance market for workers compensation insurance to soften, as it might for the property line, and believes it is likely to remain fairly stable in 2004. “In general, the regulatory environment seems a little better too,” he said. “In California, we believe there has been some excellent movement toward reform. I think you're going to continue to see that in other jurisdictions too.”

PMC Insurance Group
(www.pmcinsurance.com)

“I'm feeling very optimistic,” Greg Malloy, chairman and CEO of PMC Insurance Group, said when asked about the outlook for workers compensation insurance in 2004. PMC is a wholesaler that writes workers compensation insurance exclusively. It operates on a nationwide basis, although it derives a quarter of its business from New England and upper New York.

Malloy said he attributed his upbeat outlook to an improving economy, which should result in higher workers comp premiums as employers begin hiring again, and a workers comp market in which rates, while perhaps still not adequate, are at least stabilizing.

“I don't see rates changing much, only minor changes up or down,” he said. “I also don't see any use of schedule credits or deviations.”

With the industry's negligible return on surplus, Malloy said he's not looking for a lot of additional capital to enter the workers comp market. But on the other hand, barring unforeseen circumstances, he doesn't expect to see comp carriers leaving the market in great numbers. “I think we've seen that already,” he said. He added, however, that the disappearance of more multiline carriers could contribute to a contraction in the workers comp market.

Captives and other so-called alternative markets should continue to prosper in 2004, Malloy said, since most standard carriers still are not offering options like retrospective rating plans or dividend plans to insureds in the $500,000 to $1 million premium range-as they were several years ago.

Malloy said PMC is expanding its staff and putting more people in the field in its core New York/New England territory in anticipation of writing more business in 2004. PMC also will look for opportunities in other areas where it can bring a new product to the market or otherwise offer workable options. “For example,” he said, “we do a really good job in Florida for those accounts that are larger and are willing to go on a consent-to-rate basis.” (Under consent-to-rate regulations in the various states, a large insured can file an application with state insurance regulators in which it consents to a rate that is higher than one the state has approved.) He said PMC also recently obtained a retrospective rating plan with a minimum $150,000 premium that it can offer to qualifying insureds. He added, however, that it remains difficult for PMC to do business in certain states, including California, Florida and New Jersey, and that he has trouble placing professional employer organizations, regardless of where they are located.

Malloy said he expects the residual markets to continue to grow in 2004. But before agents give up on finding voluntary coverage for their clients and place them in an assigned-risk plan, Malloy advised them to contact a wholesaler, which might have access to markets that the agent can't otherwise reach. Such an alternative can mean a lower premium for the insured and a higher commission for the agent, he noted.

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