Workers' Comp Line Turns Profit In 2006

The overall net combined ratio for the workers' compensation insurance industry dipped under 100 for the first time in recent memory last year, with the latest National Underwriter aggregate estimate coming in at 95.4 for calendar-year 2006.

Since post-9/11 pricing gains started putting the line back on the road to recovery in 2002, data compiled by NU shows workers' comp net incurred losses grew just over 20 percent, while earned premiums jumped more than twice as much.

The difference meant a 12-point drop in the net pure loss ratio--the ratio of net incurred losses to net earned premiums--to 59.7 in 2006 from 71.6 in 2002, accounting for the bulk of a 16-point combined ratio improvement over the same period.

A declining underwriting expense ratio explains the rest of the combined ratio drop. Dollars expended to write workers' comp policies grew at less than half the rate of net written premiums, pushing the expense ratio down to 20.7 in 2006 from 23.4 in 2003.

The industry saw less improvement relative to claims-handling expenses. The overall loss adjustment expense ratio--13.3 in 2006--remained at a level close to the 13.7 ratio recorded for 2003 after climbing a bit in the intervening years.

The figures--derived from premium, loss and expense data retrieved from the U.S. Insurance and Analyst PRO products of Highline Data (a data affiliate of NU)--exclude results for some state funds per an agreement with the National Association of Insurance Commissioners, the ultimate source of the information. As a result, some NU figures differ from those in a companion story by the National Council on Compensation Insurance.

Including the state funds, overall direct premiums would likely be at least $5 billion higher than the $47 billion total we show on the accompanying exhibits. Individually, the largest state fund exclusion is the State Compensation Insurance Fund in California.

Despite the state fund omissions, it is clear net workers' comp results have improved enormously over the six-year period reviewed by NU--and the magnitude of year-over-year improvements has grown incrementally greater since 2002.

For the groups included in our aggregate analysis, the overall net combined ratio dropped (that is, improved) 6.5 points in 2006, after falling five points in 2005, 3.6 points in 2004, and 0.8 points in 2003. (A much bigger improvement of 9.4 points in 2002 is most likely attributable to the inclusion of nearly $2 billion of Sept. 11 terrorist attack losses in the 2001 loss total used to calculate that year's combined ratio.)

The 6.5-point combined ratio improvement in 2006 owes, in part, to loss reserve takedowns by many insurers for prior loss periods. In total, insurance groups included in industry aggregate figures of this report (excluding the state funds referred to above) recorded $462.9 million of favorable prior-development in 2006, shaving 1.1 point off the calendar-year loss ratio.

In contrast, a year earlier, adverse development amounting to $2.2 billion--including $1.4 billion for top-ranked American International Group--added 5.6 points to the industry calendar-year 2005 combined ratio.

Experts also point to legislative reforms in several key states and declining claim frequencies nationwide to explain a steadily improving profit picture in recent years.

Karen Ayres, an NCCI actuary speaking at a Casualty Actuarial Society in May, noted medical cost containment has been a big focus of recent reforms, with new laws in several states focused on implementing or modifying medical fee schedules and limiting provider choices. Another emphasis has been implementing utilization controls and treatment protocols, she said.

"Florida Senate Bill 50A really was the biggest thing that's happened in an NCCI state in a number of years," she said, going on to describe key provisions of the Oct. 1, 2003 legislation in the Sunshine State, and a package of reforms enacted in Texas in September 2005.

While a comparison of loss ratios cannot pinpoint whether better results in some states than others are explained by reforms or by different populations of insurers (with differing levels of underwriting expertise), industry classes insured (with differing levels of hazard), employers (with differing safety and loss control practices) or other factors, a review of direct loss ratios shown on page 28 does reveal markedly better loss ratios in these two states and in California, as well.

Among the highlights:

o In Florida, lower-than-industrywide loss ratios have been pretty much the normal state of events for over a decade--both before and after 2003 reforms took hold.

In the aggregate, insurers in Florida have reported a lower direct loss ratio than the industry for all but three of the last 12 years (1995, 1996 and 1998). The average direct loss ratio for Florida from 2003-2006, at 49.2, is more than 16 points lower than the countrywide average of 65.1 over the same four-year period.

o In Texas, where direct loss ratios exceeded countrywide figures prior to 2002, they have since ranged anywhere from three-to-16 points below nationwide loss ratios. In 2006, the Texas direct loss ratio of 50.9 was more than seven points below the countrywide industry loss ratio calculated by NU of 58.2

o California has seen dramatic changes over the 12-year period reviewed by NU, with a direct loss of 60.2 in 1995 soaring to 116.0 in 2000.

In 2002 (the year that the first of three major reform bills took effect), the California direct loss ratio (excluding the SCIF) was 110.6, falling to 83.6 in 2003, and sinking down to less than half that figure--41.3--by 2006, nearly 17 points below the countrywide loss ratio.

Gerald Yeung, vice president and senior pricing actuary for Endurance Reinsurance Corp. of America--who reviewed key provisions of the California reforms at the May CAS meeting--noted that most have either achieved or exceeded estimates of medical and indemnity cost savings developed by the Workers' Compensation Insurance Rating Bureau of California when they were enacted.

In addition, he said, something that wasn't expected were the double-digit declines in claims frequency that have emerged each year. "Just in a matter of three years, we have 50 percent less claims even entering the system," he noted.

In contrast to these three states--which are the largest comp states based on direct written premiums--in the next four (Illinois, New York, Pennsylvania and New Jersey) loss ratios remain stubbornly above countrywide ratios.

In Illinois, where direct loss ratios have steadily worsened to 82.1 in 2006 from 70.3 in 2004, the Cambridge, Mass.-based Workers' Compensation Research Institute recently reported that average total costs per claim were 31 percent higher than a 14-state median for injuries arising from 2002-2005.

In its July report--"Baselines for Evaluating the Impact of 2005 Reforms in Illinois"--WCRI said medical costs per claim in the state (growing by nearly double-digit rates each year) were more than 60 percent higher than study states on average, and that Illinois has a higher percentage of seriously injured workers.

Two insurers with U.S. headquarters in Illinois--Chicago-based CNA and Shaumburg-based Zurich--were among four of the 10 largest insurers that failed to make an underwriting profit in the workers' comp line in 2006. (Boston-based Liberty Mutual and St. Paul-based Travelers Group were the others.)

While CNA's market share in the state is small (at only 2.3 percent), and while Illinois represented less than 6 percent of the group's overall comp direct premiums in 2006, CNA's direct loss ratio in the state--203.4--was poor enough to add more than eight points to its countrywide loss ratio (which was 71.2 in 2006, but 63.2 without Illinois).

On a net basis--with unfavorable loss development of $150 million or more adding 15 or more points to the net combined ratio in each of the last four years--CNA has consistently underperformed the industry in the workers' comp line in recent years, by 30 points on more.

At Zurich, however, loss ratios haven't been noticeably worse than the rest of the industry. Instead, loss adjustment expense ratios above industry averages have kept Zurich's combined ratio more than 12 points above its peers in the last two years.

On the other end of the spectrum, Warren, N.J.-based Chubb and Bermuda-based ACE have consistently reported net combined ratios below the industry in each of the six years reviewed by NU.

Chubb, in fact, managed to profit in workers' comp even in the most troublesome states for other insurers--posting loss ratios in Illinois and New Jersey around 30 points better than industry averages.

Combined Ratio Graph: