Hard Mkt., Soft Economy: Are We Playing Fair?

77 percent of commercial policyholders reported that casualty-lines premiums rose upon their most recent renewal, according to a survey by Prudential Securities.

73 percent of agents responding to a July survey of agents by Goldman Sachs reported decreased availability of workers' comp coverage.

Applications to state residual market pools are up sharply this year.

Clearly the buyers of workers' comp insurance are taking it on the chin in 2001. For many employers, todays higher workers' comp costs could not have come at a worse moment. At a time when the economy is teetering on the edge of recession (growing by a scant 0.7 percent during the second quarter), profits have become anemic or non-existent and major layoff announcements have become an everyday affair, a bigger bill from the insurance company must seem like adding insult to injury.

Yet surprisingly, the millions of employers who by law must buy this coverage have remained relatively quiet. Media attention to the issue appears to be headed to an all-time low this year.

How can this be so? The proprietors of the nations six million businesses are certainly not known as a recoiling bunch. During the early 1990s, when workers' comp costs were soaring and the economy was flat on its back, the howls of protest from the business community were not only deafening, but also instrumental in pressuring states to enact substantive reform legislation.

It is somewhat amazing that insurers have been able to sustain a robust, broad-based hard commercial lines market in the face of a very chilly economic headwind and penny-pinching policyholders. All the more remarkable is that workers' comp, with its roots sunk directly into the payrolls of nearly every employer in America, has not only been able to keep up the pace, but in fact to lead the way.

There is no question that workers' comp insurers were in desperate need of financial relief, as last year they paid out nearly $1.40 in losses and expenses for every dollar they took in. Even after factoring in investment income–which in most years is more than enough to offset underwriting losses–the line still lost an estimated $1 billion, making 2000 the worst year in nearly a decade for workers' comp insurers.

The National Council on Compensation Insurance in Boca Raton, Fla., puts the industrys aggregate reserve deficiency at $20 billion. Message: we need higher rates, we need it bad and we need it now.

Now imagine the plight of the poor, hapless risk manager tasked with trimming expenses to help bolster profitability in the face of sagging revenues. His CEO and CFO could not care less about how badly the companys insurers need higher rates. The only thing that matters to them is the next quarters earnings statement. Managers of other divisions, also told to reduce costs, dutifully fulfill their obligations by deferring capital spending, cutting back on corporate travel and laying off staff.

But whats the risk manager to do? His broker told him that despite his best efforts, all commercial property and liability policies would renew 10 percent to 12 percent higher, and that the cost of workers' comp coverage would rise by nearly 15 percent.

In most property and liability lines, risk managers can temper the increase by accepting higher deductibles and coinsurance provisions, reducing coverage limits or even self-insuring some exposures. All of these strategies are potentially very risky, of course, and subject the company to potentially significant earnings volatility, but they at least offer the possibility of some short-term benefit.

The risk manager has fewer options with respect to workers' comp. Deductibles can be raised but the statutory nature of workers' comp greatly limits what risk managers can do.

How can a risk manager shine along with his ax-wielding counterparts and avoid seeing his own head roll? Here are some suggestions:

Demonstrate that the cost of managing workers' comp risk is still far lower than it was a decade ago. The typical employer is still paying far less for workers' comp coverage (as a percentage of payroll) than five or 10 years ago.

Demonstrate that even as the cost of the companys workers' comp program declined, the workplace became safer. The typical employer has experienced a one-third decline in the frequency of workplace injuries since 1990.

Come armed with a bold, new loss control plan. Remind management that investments in workplace safety can produce a rate of return that may exceed anything the company can get from the sales of products and services during the current economic downturn. A dollar invested in safety can save two or three dollars down the road in the form of lower workers' comp costs and higher productivity.

Most risk managers will be able to demonstrate significant cost savings and gains in workplace safety, while direct investments in safety could appeal to senior management at a time when few other profitable investment opportunities are available.

The sagging economy will inevitably spark debates over the fairness of imposing rate increases on struggling businesses. Like the separation of church and state in matters of governance, there should be no confusion between economics and equity in the rate approval process. Unfortunately, regulators are already being pressured to consider the economic circumstances of policyholders when considering insurers rate change requests.

Truckers, for example, have alleged that rising workers' comp costs are forcing them out of business. In reality, however, the trucking industry–historically one of the most cyclical of all industries–is suffering from a sharp slowdown in shipments and significantly higher fuel costs.

Workers' comp costs are not the make-or-break issue for the trucking industry, or any industry for that matter. The fortunes of the industries we serve are determined by economic forces far beyond our control or the control of insurance regulators.

Market forces determine the availability and price of workers' comp insurance to a much greater extent today than in the past. More than 30 states now have adopted competitive rating laws in workers' comp, up from a handful during the late 1980s. These laws permitted greater pricing flexibility and led to much lower workers' comp costs for most employers during the 1990s.

But these same laws cannot be applied in a capricious, arbitrary or asymmetrical fashion. Market forces drove the price of workers' comp coverage down for years; those same market forces are now driving them up.

Every turn in the business cycle produces "haves" and "have nots." Despite the current hard commercial market, insurers are still among the "have nots"–2001 will still probably produce one the biggest underwriting losses in the history of property-casualty insurance. Our "hapless" risk manager, on the other hand, is still ahead of the game.

Robert Hartwig, Ph.D., is vice president and chief economist at the Insurance Information Institute in New York. He can be reached at bobh@iii.org.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, August 27, 2001. Copyright 2001 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.

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