Workers’ Comp Market Analysis Shows Remarkable Improvement for Combined Ratio; Fall in Investment Income

May 16, 2003

The National Council on Compensation Insurance (NCCI) released its annual “State of the Line” preliminary workers’ compensation market analysis this week, with this year’s report indicating that the industry’s combined ratio for Calendar Year 2002 is 110 percent, a remarkable 12-point improvement from 2001. The improvement in the combined ratio for 2002 breaks a six-year string of deteriorating workers’ compensation market results.

In contrast, however, NCCI reports that investment income associated with workers’ compensation insurance transactions fell dramatically in 2001 to an estimated 14 percent – down from approximately 20 percent during 1997-2000. This year’s decrease to 12 percent is due to continued lower interest rates, as well as a reduction in realized capital gains.

Incorporating the combined ratio with the investment gains results in a slight pretax operating profit of 2 percent for workers’ compensation in 2002. Although positive, the return remains well below both historic returns and the cost of capital. The needed pretax gain in today’s investment climate is likely in excess of 10 percent to return the industry’s cost of capital. Considered in total, the workers’ compensation line will continue to have a cautionary outlook for the future.

In addition to the depressing impact of today’s investment income environment, the continued cautionary outlook is primarily due to medical inflation and the need to fund against potential terrorism events.

From 2001 to 2002, workers’ compensation medical cost trends for lost-time claims increased from 10.7 percent to 12 percent, a number that is significantly higher than the 1996-2002 average of 8.1 percent. And, while Congress offered the industry some protection by passing the Terrorism Risk Insurance Act of 2002, the fact remains that another attack could have a devastating financial impact on the industry.

“Our analysis of market conditions and the weak investment environment indicates that many workers’ compensation insurance carriers may need a combined ratio of less than 100 percent in order to return their cost of capital,” said NCCI Holdings, Inc. Chief Actuary Dennis Mealy. “Unfortunately, combined ratios this low are extremely rare in long-tailed lines like workers’ compensation, where underwriting losses are generally offset with investment income.”

Other results and market data reported by NCCI in the annual “State of the Line” report include:

*Premium Volume Continues to Increase – For the third straight year, net workers’ compensation premium volume for private carriers showed a strong gain, increasing $3 billion, or 11.7 percent from 2001. For several years, wages and salaries grew at a higher rate than net premium volume; in the last two years, premium volume growth has been higher;
*Accident Year Results Improved Significantly – The high mark for the workers’ compensation Accident Year combined ratio was 137 percent in 1999. The improvement since then has accelerated, moving to 107 percent in 2002 (18 points better than 2001). This improvement reflects, among other things, a combination of bureau rate/loss cost increases and a decline in pricing departures;
*Reduced Workers’ Compensation Reserve Deficiency – There was marked improvement in the workers’ compensation reserve deficiency in 2002, down to $18 billion after seven years of increases. Assuming losses are paid out during a 30-year period, the implied reserve discount rate is approximately 4 percent;
*Approved Rates/Loss Costs Beginning to Increase – Approved bureau rate/loss cost increases were significant in 2002, increasing 4.9 percent. These changes are prior to the application of individual company pricing programs. With some of the rate/loss cost filings effective in 2003 already approved, their impact for 2003 stands at +4.9 percent;
*Frequency Continues to Decline – Preliminary results indicate that during 2002, the frequency of lost-time claims declined by approximately 4.5 percent. This continued a decade-long trend of decreasing frequency, averaging 5 percent per year. Among the factors that NCCI cites in driving this long-term trend are continued emphasis on workplace safety in all employment classes, increased use of robotics, and increased use of modular design and construction techniques;
*Residual Market Growth – In 2002, the workers’ compensation residual market pools approximately doubled to $1.2 billion. Residual market premium as a percentage of direct written premium also grew from a low of 3 percent in 1999 to an estimated 8 percent last year. However, while residual market premium continues to grow, the current level remains far below the $4 billion reached in the residual market for each year from 1990 to 1993;
*Terrorism Remains a Concern – No single issue has had a bigger impact across all commercial lines of insurance than terrorism. The impact on workers’ compensation is unique because coverage and benefits are mandated by law, and exclusions or limits are not possible. Also, business that is declined by carriers does not leave the market – it is written by the involuntary pools. Despite the passage of the Terrorism Risk Insurance Act of 2002 (TRIA), the threat of terrorism remains a serious issue for workers’ compensation insurers.

“The improvement in workers’ compensation results is a positive sign,” said Mealy. “Good news includes continuing frequency decline and a manageable residual market burden.

“On the other side of the ledger, investment returns are low and that could impact underwriting,” he added. “Medical costs are accelerating. Individual states continue to struggle with market reforms and near-crisis market conditions. And industry efforts to find alternatives to manage the terrorism catastrophe exposure must bear fruit soon.

“During 2003, NCCI will continue to monitor results and support the industry by making adequate rate/loss cost filings that are fully responsive to emerging trends and catastrophe exposures. NCCI will also ensure that residual markets that we administer will continue to function smoothly with a focus on programs to reduce growth.”

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