Workers' Comp Conditions Risky For Reinsurers, Moody's Says

Workers' compensation insurers and reinsurers are operating in a risky environment similar to the one in the late 1990s that "put a number of workers' comp [insurers and reinsurers] into the grave," according to a Moody's Investors Service report.

In its December "Reinsurance Monitor" report, Moody's referenced comments made by Liberty Mutual CEO Ted Kelly in November, when he described the workers' comp market as a ticking time bomb.

Moody's said while claim frequency has generally declined, the leaner economic times have led to injured workers returning to the workforce more slowly "because some don't have jobs to return to, and employers spend less money to support early return-to-work programs." Moody's said the longer workers stay on disability, the more often they seek additional medical treatment or sue, both of which increase claim costs.

The rating agency noted that underwriting cash flows tend to be a leading indicator of underwriting results. For example, Moody's said weakening underwriting cash flows during the 1996-1999 soft market presaged poor underwriting margins, and when insurers responded to the poor results by raising prices, significant improvements in underwriting results followed.

By the end of 2009, Moody's said, "underwriting cash flows appear to have deteriorated to levels seen at the onset of the 1996-1999 soft market. And reserve releases appear to be running out."

While not going so far as to say the workers' comp market will see a repeat of the 1996-1999 soft market, Moody's did say, "At the very least, we can make the case that the current soft market is no less risky."

Regarding some of the risk factors in the current market, Moody's noted that while the annual rate of medical claim inflation has declined since 2001, medical costs now make up a greater share of total claim costs. In 1998, for example, medical costs made up 53 percent of claim costs, whereas in 2008, the number rose to 58 percent.

Furthermore, Moody's said, "General inflation seems destined to go up at some point and possibly pressure claim severities. Moody's pointed to Fed policies pursued with the explicit goal of raising inflation, stating that "the final impact is hard to predict."

For reinsurers, inflation is an especially important factor, Moody's said. While noting that workers' comp reinsurers appear to be more disciplined than primary insurers, Moody's said, "The tough issue for workers' comp reinsurers is that they are particularly vulnerable to inflation. This is because much of workers' comp reinsurance is written on an excess-of-loss basis and inflation magnifies loss trends in excess layers."

Moody's said inflation increases claim frequency in the excess layer because claims that once fell below the excess layer attachment point now exceed that point after inflation. Inflation also increases severity in the excess layer because losses that already fell within that layer "experience the full effect of inflation."

Moody's said the uncertainty regarding inflation means "a decisive upturn in workers' comp reinsurance rates may be needed." But the rating agency acknowledged that convincing ceding insurers to forgo more premium "will prove difficult" in this economy.