NU Online News Service, June 15, 12:10 p.m. EDT

Workers' compensation results are a drag on the P&C insurance industry's numbers, producing a combined ratio that is 7 points worse than the industry as a whole, according to a report by Fitch Ratings.

“Recent premium rate increases in workers' compensation are an encouraging sign that the market has reached a cyclical bottom,” says Jim Auden, managing director at Fitch, in a statement. “However, claims costs will continue to be affected by rising medical severity and premium rates will need to improve significantly for the market to reach an underwriting breakeven.”

Fitch say workers' comp came in with a statutory combined ratio of 117.2 for 2011, about 9 points worse than the commercial-lines aggregate for last year. During the five-year period from 2007-2011 the line generated a combined ratio of 108.5, about 7 points worse than commercial lines as a whole.

Since 2006, premium volumes have fallen 23 percent for workers' comp, which the report attributes to “numerous factors” that include severe price competition and the effects of the recession.

The business is also dealing with sharp increases tied to medical costs. Medical severity from workers' comp rose annually at an average rate of 4 percent from 2007-2011, the report notes, citing statistics from the National Council of Compensation Insurers.

Fitch says that workers' comp shifted back to positive written premium growth of more than 7 percent last year thanks to economic improvements producing more jobs, as well as increasing exposure numbers and rate increases during the second half of 2011.

Rates are expected to improve further this year, but they need to improve “by a considerable margin to return to an underwriting profit.”

Referring to Conning's Mid-Year 2012 “Workers' Compensation Insurance Segment Report,” Josh Youdovin, vice president of insurance research, says workers' comp has had the “highest combined ratio relative to other casualty lines of business since 2006.”

Medical inflation and more use of narcotics will have a negative impact on workers' comp profitability, he notes. With rising loss costs and premium rate inadequacies from past years, reserve releases are “likely to diminish or end for many companies, exerting more financial pain.”

One bright spot, says Youdovin, is that premium is growing because of the combination of rate increases and job growth. He cautions that there is concern that premiums “will still not be able to keep up with rising loss costs.”

While rates are firming, the line has not yet entered a hard market–and one is not seen for the foreseeable future, he says.

“It is a fear of downgrades or inadequate capital, leading to withdrawals of capacity from some competitors, that tends to lead to a hard market,” says Youdovin.

That's what happened in 2000, when 14 out of the 28 companies that failed were workers' comp insurers. In 2010-2011, 11 companies failed, but most of them were captives, he notes.

Rates in the future will continue to increase, as evidenced by an 8.9 percent hike in Florida effective early this year and a 9.1 percent rate increase in New York last year.

While producers will benefit from increased commissions, policyholders may look to decrease their expense, with some forming captives, says Youdovin. Another concern is that loss frequency could continue to increase “as lesser-trained workers adjust to new jobs.”

According to Fitch, the markets are seeing a shift as state funds and residual markets are shrinking their policy counts. In terms of net written premium, over the five-year period from 2006-2011, American International Group has lost ground to Liberty Mutual as the number-one writer of workers' comp.

In 2011, Liberty had 10 percent of the market, taking the number-one spot, while AIG holds just over 9 percent and is ranked second. However, Liberty's share of net written premium is down more than $1 billion over the five-year period to just over $3.5 billion.

Fitch notes that both Travelers and The Hartford have significantly increased their workers' comp premium over the five-year period, almost doubling their share of the market and rising to third and fourth place, respectively.

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