With the current investment environment not benefitting Workers' Compensation insurers, companies may be pressured into a harder market as they try to achieve underwriting profits in a line that hasn't seen combined ratios of less than 100 since 2006, according to a new report.
Conning Research and Consulting's "Workers' Compensation: A Bumpy Road from Recession to Recovery" says Workers' Comp specialists have tended to invest a higher portion of their assets in bonds since 2008. But with "extremely low" interest rates projected for 2012 and even beyond, Conning adds that insurers that "relied heavily on income from bonds will have a difficult time relying on investment income as they did in the past."
As such, the firm says insurers may be pushed into a harder market by seeking profits from underwriting.
Even if interest rates rise, the benefit in improved investment returns may be tempered by the corresponding possibility of higher inflation. "Historical results have shown that medical inflation often moves in the same direction as general inflation," Conning notes in the report. Rising medical costs would increase Workers' Comp loss costs.
These types of double-edged-sword scenarios emerge in other sections of the report as well. For example, Conning notes that such companies as The Hartford have reported significant Workers' Comp reserve increases in 2011. While reserve strengthening could lead to a hardening market as it has in the past, it could also draw scrutiny from regulators.
Additionally, an economic recovery that leads to job creation would benefit Workers' Comp insurers by increasing payrolls, and therefore premiums. But Conning notes that overall claim frequency is also expected to increase with an economic recovery because an influx of workers will be learning new jobs, particularly in the manufacturing and trade/transportation/utilities sectors.
"Because new workers often are earning much lower wages than experienced workers, there is a potential mismatch of risk and exposure in these sectors," Conning reports.
Citing premium and loss volatility, as well as medical inflation, Conning says states have implemented insurance reforms in recent years with "varying levels of success."
Florida and Texas, for example, have been effective at keeping insurers profitable, the report notes. Florida focused on reducing legal fees while Texas addressed medical costs through such provisions as requiring an approved list of certified doctors to provide care to claimants and requiring pre-authorization for some procedures.
California, which had early success with reforms, has seen a depressed job market, higher prescription-drug costs and inadequate premiums drive loss ratios upward, Conning says. And New York is still suffering from rate inadequacies despite approving a 9.1 percent increase in October 2011 and a 7.7 percent increase the year before.
Conning notes that other states have pursued rate increases as well but adds that implementing these during an economic recovery is difficult.
Ultimately, Conning says, future profitability in this line will depend on insurers' ability to adapt to changes during the recovery and on cooperation among all stakeholders: the medical community, injured workers and employers.
"State governments and insurance departments will also need to lead the way," Conning adds. "Hopefully, the lessons learned from successful reforms in states such as Texas and Florida will play a role in fixing the Workers' Compensation industry for the future."
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