For Workers' Compensation insurers, profitability is the greatest near-term challenge as accident-year combined ratios increase, and uncertainty in employment and medical-claim trends weighs on the sector, according to a recent report.

The Moody's Investors Service study, “U.S. Workers' Compensation Market: Sector Profile,” notes that premiums increased in 2011 and 2012, alleviating some of the rate inadequacy affecting the sector—“but further significant strengthening will be required to improve underwriting margins to earn acceptable operating returns and to offset the impact of sustained low interest rates.”

There are some positive signs for insurers. Moody's says it expects the accident-year combined-ratio deterioration to moderate as rate increases outpace loss-cost trends, although the overall impact will vary by company.

In terms of coverage availability, a number of insurers indicated a moderate decline in risk appetite for Workers' Comp during 2012, which, along with further rate actions, could lead to continued margin improvements for 2013. But the ratings agency says it does not expect any major contractions in capacity, “and we expect underwriting profitability to improve only gradually.”

Moody's notes that, more than most other insurance lines, Workers' Comp results are strongly tied to the macroeconomy. “Demand for Workers' Compensation coverage depends directly on employment levels, including significant occupational segments such as manufacturing and construction.” But manufacturing and construction at year-end 2011 were 15 percent and 30 percent below pre-recession employment levels, respectively. Moody's says the resultant reduction in demand for Workers' Comp capacity may limit the needed upward pressure on rates.

To compensate for the reduced demand in the manufacturing and construction segments, Moody's notes that insurers have begun to divert capacity to occupational classes with improving employment levels: “Over the longer term, job growth in industries such as health care and energy may offset job losses elsewhere.”

Moody's indicates that a “number of issues” will present challenges when setting Workers' Comp reserves. “Prominent among these is relative growth in medical claims (vs. indemnity) as a proportion of Workers' Comp loss costs and the greater challenges associated with reserving for medical coverage compared to indemnity.”

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Profitability Challenged in a Workers&rsquo; Comp Market Beset by Uncertainty

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Profitability Challenged in a Workers’ Comp Market Beset by Uncertainty