For Workers' Compensation insurers, profitability is thegreatest near-term challenge as accident-year combined ratiosincrease, and uncertainty in employment and medical-claim trendsweighs on the sector, according to a recent report.

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The Moody's Investors Service study, “U.S. Workers' CompensationMarket: Sector Profile,” notes that premiums increased in 2011 and2012, alleviating some of the rate inadequacy affecting thesector—“but further significant strengthening will be required toimprove underwriting margins to earn acceptable operating returnsand to offset the impact of sustained low interestrates.” 

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

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In terms of coverage availability, a number of insurersindicated a moderate decline in risk appetite for Workers' Compduring 2012, which, along with further rate actions, could lead tocontinued margin improvements for 2013. But the ratings agency saysit does not expect any major contractions in capacity, “and weexpect underwriting profitability to improve only gradually.”

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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 onemployment levels, including significant occupational segments suchas manufacturing and construction.” But manufacturing andconstruction at year-end 2011 were 15 percent and 30 percent belowpre-recession employment levels, respectively. Moody's says theresultant reduction in demand for Workers' Comp capacity may limitthe needed upward pressure on rates.

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To compensate for the reduced demand in the manufacturing andconstruction segments, Moody's notes that insurers have begun todivert capacity to occupational classes with improving employmentlevels: “Over the longer term, job growth in industries such ashealth care and energy may offset job losseselsewhere.” 

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Moody's indicates that a “number of issues” will presentchallenges when setting Workers' Comp reserves. “Prominent amongthese is relative growth in medical claims (vs. indemnity) as aproportion of Workers' Comp loss costs and the greater challengesassociated with reserving for medical coverage compared toindemnity.”

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