In our annual “State of the Line” study, the National Council on Compensation Insurance Inc. (NCCI) delivers a comprehensive report analyzing the entire workers' compensation market—from the implications of the overall economic environment, to current and expected industry conditions, to political considerations and more.

Unfortunately, our analysis this year shows that conditions in the workers' comp industry continue to deteriorate. The line continues to experience an ever-lengthening list of challenges, including poor underwriting results, declining (albeit more slowly) premiums, an uptick in claim frequency, and an uncertain regulatory and inflationary climate.

Let's broadly examine these negative forces and the overall market condition.

Challenging Market Indicators

This year's State of the Line report indicated that the calendar-year combined ratio for private carriers increased another five points in 2010 to 115. That's the highest level since 2001, the year with the highest combined ratio in the last underwriting cycle. And the 2010 accident-year combined ratio was 114, also up five points from accident-year 2009.

While the line benefited from increased levels of investment income, it still produced a 1 percent pre-tax operating loss for 2010. This is the first pre-tax operating loss since 2002.

In terms of premium, the economic recovery, faltering as it is, appears to have helped slow the precipitous declines in workers' comp net-written premium for private carriers that had been experienced from 2007–2009. For 2010, net-written premium for workers' comp private carriers declined just 1.3 percent, a much smaller decline than the prior two years. (From 2007 to 2009, workers' comp premium declined a total of 20 percent.) But private-carrier workers' comp premiums still have not been this low since 2002.

NCCI also notes that the reserve position of private carriers continued its recent pattern of modest deterioration in 2010. We now estimate the reserve deficiency to be $10 billion at year-end 2010, up $1 billion from year-end 2009. After consideration of the allowable discounting of the indemnity reserves for lifetime-pension cases, the reserve position remains at a relatively slight inadequacy of about $5 billion on a total-carried-reserve base of more than $109 billion.

In terms of prices, workers' comp insurance rates continued to drift down in many jurisdictions. However, that trend may be turning, as NCCI filed 14 increases in loss costs/rates in the 2010/2011 filing cycle, up from eight increases the previous cycle.

In a singularly distressing development, the nationwide lost-time claim-frequency decreases for NCCI states that occurred without interruption for the last 12 years came to an abrupt halt in 2010.

As can be seen, a significant number of industry trends are not moving in the direction we would like to see for a healthy market.

Unexpected Claims-Frequency Result

Of all the challenges facing the workers' comp market, perhaps the most surprising and disturbing negative development in the market was the aforementioned increase in injury-claims frequency—the first in 13 years.

Based on a preliminary analysis of data in the 35 NCCI states (and D.C.), the frequency of lost-time claims per $1 million of premium increased 9 percent in 2010, based on our standard measures of frequency change.

However, NCCI research indicates that there were several distortions in the data as the recession ended that resulted in an overstatement of the indicated change. Once adjustments are made for those distortions, frequency is up 3 percent.

(The largest distortion was the impact of premium audits on the calendar-year premiums. As the recession took hold, insurers discovered that the audits, rather than producing significant additional premium as in most years, were resulting in significant reductions to calendar-year 2010 premiums. Those reductions were more properly reflected in reduced exposures that really belonged in the 2009 year.)

Many of the new claims coming into the system and causing the frequency increase appear to be small lost-time claims that may have been medical-only claims in more “normal” times.

This is apparent when noting the change in the average cost of lost-time claims from 2009 to 2010. In NCCI states, the average indemnity cost per lost-time claim declined 3 percent from 2009. The average medical cost per lost-time claim increased 2 percent, yielding a total lost-time claim-cost change of 0 percent.

It's important to note that the small change in average severity of lost-time claims in 2010 is probably an aberration. It is likely caused by a temporary influx of medical-only claims becoming smaller loss-time claims as the recovery firms—and does not reflect an underlying reduction in medical and indemnity cost drivers.

And in spite of this shift, the underlying cost drivers for both indemnity, and particularly medical, are still present. This means that medical costs, absent the claim shifts, are still likely to be increasing in excess of medical CPI as they have done for many years.

Although adjustments reduce the frequency increase for 2010 to only 3 percent, it still must be viewed as an area of significant concern. NCCI will be watching the frequency situation closely to determine whether the increase is a one- or two-year occurrence (as happened in the early 1980s), or a more permanent and disturbing trend.

Notable External Forces

Apart from economic factors, a number of external forces can also affect the continued stability and smooth operation of the overall workers' comp system.

For example, the Patient Protection and Affordable Care Act (PPACA), passed by Congress in 2010, is still in its early stages of implementation. The only direct impact on workers' comp was changes to the Federal Coal Mine Black Lung program that liberalized criteria for qualifying for direct benefits and survivor benefits.

However, PPACA is a major reorganization of the healthcare industry that may have residual impacts on workers' comp. With court cases challenging the bill's constitutionality moving through several federal courts, the uncertainties surrounding PPACA and its implementation remain.

The federal government also continues to erect its Federal Insurance Office and the Financial Stability Oversight Council, both entities that may ultimately make recommendations that affect the way that insurance markets in the United States are regulated. With some elements of the government calling for an increase in federal oversight and regulation of insurance, all system participants will be keeping a close eye on developments in the months to come.

At the state level, there were some dramatic shifts in elected office last year, with Republicans gaining an increase of six new governors and 680 state legislative seats. Perhaps more significantly for the workers' comp industry, there were 24 new insurance commissioners in office as of the most recent count. That number of newly elected and appointed officials means that the industry will face a challenge in terms of education and information for the next few months at least.

Finally, we have noted over the past few months that many economists are expressing the concern that recent fiscal and monetary policies in the United States could lead to significant increases in inflation. If we do see higher levels of price inflation, that will make for continued difficult times for the workers' comp insurance industry.

Summing Up

Obviously, this is a challenging environment—but we've seen worse markets before. It's important to note that this year we are celebrating the 100th year of workers' comp insurance in America; we've faced and survived similar difficult periods in our past.

As we confront a deteriorating market position today, it becomes all the more important that all stakeholders realize they have an important part to play in maintaining the health of our system.

It will take all of us to work together to insure that our rates are appropriate—neither inadequate nor redundant—and that our residual markets are not allowed to deteriorate. We will need to ensure that legislative proposals are driven by good public policy that anticipates and avoids unintended consequences. Industry data and trend analysis must be available and properly analyzed.

In short, if we are to successfully navigate the deteriorating market conditions currently facing the workers' comp industry today, all system participants will need to work together to maintain those essential foundational elements required to allow our industry to recover and succeed.

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