The Latest Word On WC Residual Mar-kets

In general, most employers are under statutory obligation to obtain workers compensation insurance and provide their employees with medical benefits and compensation for lost wages due to injury, occupational disease or death arising out of employment. This coverage is usually purchased from a voluntary market insurance carrier.

For a number of reasons such as unstable financial status, poor loss experience or the inherently dangerous nature of the work, some employers cannot find a voluntary market carrier who will provide them with workers compensation insurance. So that these employers have a means of meeting their statutory obligations, some states have created a market of last resort, which is referred to as "the residual market," "the assigned risk market" or "the involuntary market."

States may provide residual markets in several ways. Some states establish state funds, which accept all the risks that are rejected by the voluntary market. Florida has a workers compensation joint underwriting association. Under the Florida approach, policyholders are liable for any JUA deficits. Most states, however, establish a workers compensation insurance plan.

NCCI develops and manages workers compensation insurance plans in 20 states.

The plan is the basic instrument through which eligible employers that would otherwise be unable to obtain necessary insurance coverage can secure workers compensation insurance. The plan includes the state-approved rules that govern the assignment, administration, eligibility and coverage requirements.

While the plan provides the mechanism through which to distribute employers equitably among participating insurance carriers, each carrier receiving an employer is subject to the possibility that the employer might present exposures not totally within the expertise of the carrier or may include the risk of catastrophic loss. To manage these unpredictable exposures, many carriers become participants of a residual market reinsurance pool.

The pool is a financial agreement among carriers to share in the operating results of the state insurance plan. The largest of these pooling arrangements is the National Workers Compensation Reinsurance Pool (NWCRP or National Pool). The NWCRP provides reinsurance in 22 states. It is a series of state reinsurance pools with a national administration in order to keep costs as low as possible.

The following items highlight key information related to the fourth-quarter 2002 operating results for all residual market pools administered by NCCI:

During the fourth quarter of 2002, projected ultimate losses increased by $242.4 million for all pools combined.

Of the $242.4 million, $211.6 million came from new exposure. The $211.6 is roughly 81 percent of the $261 million of premium earned in the quarter.

Nearly $29 million of the increase stemmed from expected loss ratio adjustments for policy years 1970 to 1992

The remaining $1.8 million was generated by expected loss ratio adjustments for policy years 1993 to 2002

Of the $29 million increase for policy years 1970 to 1992, nearly $25.7 million was attributable to the National Pool. This increase in the National Pool was caused by higher than expected loss emergence in recent quarters.

The latest information for the first half of 2003 indicates a change in the number and in the average premium size of employers seeking coverage in the workers compensation residual market. For the first half of 2003, NCCI saw a 1.0 percent increase in new premium bound versus the same period in 2002. The number of new policies bound increased 18 percent for the same period.

This represents a significant change in the growth of new premium entering the residual markets from the past three years when the rate of new premium growth was over 50 percent. It also indicates that larger accounts might now be finding coverage more available in the voluntary market.

For example, in the past three years NCCI found the largest rate of growth in new accounts seeking coverage in workers compensation residual markets coming from accounts with annual premium of $50,000 or more. In the first half of 2003, accounts with less than $5,000 in premium are growing, while the number of larger size accounts seeking residual market coverage is decreasing.

As of July 1, 2003, the average size account in the workers compensation residual markets is $5,900.

While these are encouraging signs for the workers compensation system, an ominous trend is emerging. For the sixth straight year, we are seeing an increase in the operating losses–to $176 million–for the workers compensation residual market pools serviced by NCCI.

All state regulators need to focus on these operating losses in order to achieve self-funded residual markets. Self-funded residual markets are a critical part of maintaining a healthy insurance market. In particular, Illinois, Oregon, Massachusetts, New Jersey and Georgia are producing large operating losses in their workers compensation residual markets. These five states account for 65 percent of the $176 million operating losses valued as of December 31, 2003.

These operating losses need to be properly addressed through adequate residual market rates, safety incentive programs, depopulation programs and anti-fraud efforts.

State regulators in Alaska, Vermont, Kansas, Virginia and New Hampshire also need to be wary of workers compensation residual market shares in their states. Each has over 10 percent of the total state workers compensation premium in the residual market, with Alaska having the highest residual market share at 18.2 percent.

These high residual market shares are one indicator of troubled voluntary markets in these states. Attention to rate adequacy, system cost drivers and other system conditions are needed to reduce reliance on residual market mechanisms and the associated strain on the health of the workers compensation environment.

Many states have enacted higher residual market rates and various rating plans, like the mandatory residual market Loss Sensitive Rating Plan (LSRP) and Assigned Risk Adjustment Program (ARAP), to control their residual market operating losses and provide safety incentives.

LSRP is a mandatory retrospective rating plan applicable to accounts over $200,000 in annual premium. It adjusts the policyholders premium based on actual losses during the policy year. ARAP applies to all experience-rated risks in the residual market. It works in conjunction with the Experience Rating Plan, but relies more heavily on the total loss experience of the insured in developing the final premium.

In addition, the availability of residual market expiration lists, anti-fraud measures and loss prevention programs can help stabilize the residual market and control its growth.

Constant change is the norm in workers compensation residual markets. With appropriate actions to achieve rate adequacy, promote depopulation efforts, fight fraud and encourage safety, state regulators and NCCI can effectively manage workers compensation residual markets.

James R. Nau, CPCU, ARM, the president of the CPCU Society, is general manager, residual markets, for the National Council on Compensation Insurance, Boca Raton, Fla. Jim can be reached at jim_nau@ncci.com.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, August 18, 2003. Copyright 2003 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.