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

Less than two percentage pointsor $500 millionof the calendar year 2001 combined ratio on a net basis is attributable to claims resulting from the terrorist attacks of Sept. 11. This impact is substantially less than originally expected because the vast majority of losses were ceded to reinsurers, and will not appear in the 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, these initial estimates were based on a projection of more than 6,000 deaths. Actual deaths were half that number. Accordingly, NCCI has adjusted expected losses downward to between $1.3 billion and $2 billion. As additional claims–such as respiratory diseases and stress–become more certain, the ultimate impact of Sept. 11-related claims may continue to change.

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

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

Apart from the economic realities described above, there are a number 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 volume for private carriers showed a strong gain, increasing 4.9 percent from 2000. Wages and salaries have increased at a substantially higher 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 in 2000), the preliminary 2001 figures are likely to improve to a combined ratio of 127, taking into account the impact of Sept. 11.

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

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

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

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

Preliminary results indicate that the frequency of lost-time claims declined during 2001 by approximately 4 percent. This continued a 10-year trend of decreasing frequency averaging approximately 5 percent a year.

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

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

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

For the workers comp industry, 2002 is likely to be a transition year. Although the events of last fall have forced companies back to the drawing board, insurers are expected to continue evaluating and adjusting their strategies.

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

Although diminished investment income might inhibit results in the short term, a revitalized economy and better investment opportunities could help improve results over the long term. A final government solution to limit insurer exposure to catastrophic losses in this line is vital if workers comp is to return to health.

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

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

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

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