by Tom Cammann, Managing Director, U.S. Casualty Practice and Kay Everts, Managing Director, National Brokerage

At the beginning of the year, Marsh’s U.S. Casualty Practice Leader Jonathan Zaffino highlighted the top 10 marketplace drivers we expect will have the most impact on casualty insurance programs in 2011.

Two of those related to workers’ compensation (WC):

• A potential emerging WC crisis that may begin to evidence itself through increases in pricing, lack of capacity, and increases in underlying claims costs. There is a growing dislocation between the “technical market”—the technical factors that drive the WC market—and the “trading market”—competition among insurers.
• The continuing acceleration of WC medical costs. It is estimated medical costs will exceed 60 percent of total workers compensation claims costs.

As the largest U.S. state in terms of WC premiums and losses, California influences underwriters’ perception of the overall WC marketplace. Therefore, it can be said that a look at the CA marketplace is a microcosm of the overall industry in the United States. During the first quarter of 2011, activity in California reinforced views about the potential significance of these drivers on an organization’s total cost of risk.

In California, the Workers’ Compensation Insurance Rating Bureau (WCIRB) Actuarial Committee establishes the methodology and provides the analysis used to determine rate adequacy. The Actuarial Committee’s analysis is delivered to the WCIRB Governing Committee, which is tasked with recommending rate adjustments, which then need to be acted upon (approved, amended, or rejected) by the Insurance Commissioner. The chart below shows the outcome from this process over the last three years.

On April 1, 2011, the WCIRB Actuarial Committee issued its review of insurer experience as of December 31, 2010. Consistent with prior findings, the committee’s analysis suggested a deterioration in results (adverse loss development on the 2009 accident year, an increase in claim frequency in 2010, weakness in state wage growth, and increased expense levels). This led the committee to conclude that rates would need to increase by nearly 40 percent to achieve adequacy.

As illustrated in chart 1, the Governing Committee customarily follows the Actuarial Committee’s analysis in recommending a rate action to the Insurance Commissioner. This time, however, the Governing Committee chose not to propose a mid-year rate action of any kind. Instead, the WCIRB made an “informational filing” highlighting the cost drivers supporting their analysis.

There remains considerable debate around the WCIRB’s analysis and recommendations. Some maintain that the WCIRB’s recommendations do not consider factors that should be weighed in when determining rate adequacy. For instance, in response to the WCIRB’s 2010 filing recommendation, Compline, a privately held company that publishes WC experience and other data, suggested that the industry had a $600 million profit versus a $1.5 billion loss.

In an effort to sort through this conflicting information, some WC industry fundamentals should be analyzed.

Worker’s compensation combined ratios (losses plus expenses divided by premiums) increased during the late 1990s due to open competition and WC medical inflation. Subsequent reforms produced favorable results for the insurance industry; however, price cutting and medical inflation are forcing combined ratios to increase again. With preliminary results for the year ended December 31, 2010, recently released by the WCIRB, it appears that the deterioration of results has either peaked or taken a pause from its post-reform climb:

Following years of declining indemnity claims frequency, the WCIRB reported that indemnity claims frequency increased by 4.5 percent in 2010 compared to 2009. While the WCIRB’s estimate of average indemnity claims cost is relatively flat for accident year 2010 ($62,000 in 2010 vs. $63,000 in 2009), the average indemnity claims cost is now more than 20 percent higher than the pre-reform “peak” in the 2001 accident year.

A recent study by the California Workers’ Compensation Institute shows average payments for treatment, pharmaceuticals and durable medical equipment (DME), medical management/cost containment, and medical-legal reports now cost more than pre-reform levels. Comparing 2009 costs to the 2005 lows, their report shows the average amounts paid increased as follows:

+48.9%	Treatment
+106.5%	Pharmaceuticals and DME
+142.6%	Medical management/cost containment
+73.3%	Medical-legal reports

 

While there may be some debate regarding the overall profit or loss of the line, there are clear indicators of stress in the technical WC market:

• overall market results continue to hold at unhealthy levels,
• indemnity claim frequency is showing a significant year-over-year increase,
• indemnity costs now exceed their 2001 pre-reform peak, and
• medical costs are showing a steady, material increase.

Though there are significant differences between the last market dislocation in California in the 1990s and today, the technical signs are pointing in the same direction. It does not appear a matter of if the market will correct, it appears to be a matter of when and to what degree.

As noted in our article, “The U.S. Casualty Market in 2011: Top 10 Marketplace Drivers,” there is a distinct separation between these technical market indicators and the behavior of the trading market. During the first quarter and early second quarter of 2011, insurers have been pressing to firm prices; nonetheless, clients with improving business conditions (e.g., revenue and/or payroll increases) and reasonable loss experience continue to see WC renewals with flat to modest rate reductions.

Against this backdrop, it appears that clients that focus on attacking the loss cost drivers behind WC through targeted pre- and post-loss claims management programs will deliver sustainable cost savings that afford their organizations a competitive advantage today and into the foreseeable future.

WC Market Update by State

New York
In October 2010, the New York State Insurance Department approved an increase for the Second Injury Fund assessment: the rate increased from 14.2 percent to 18.1 percent of standard premium (manual rates times payroll times experience rating factor).

To add to employers’ pain, the New York State Insurance Department recently approved a major change in the calculation of the workers’ compensation regulatory assessment. This assessment supports a fund covering the costs of operating the Workers’ Compensation Board and special funds such as the reopened case fund, special disability fund, and the special funds conservation committee, as prescribed by law.

Historically, this assessment was calculated based on deductible premium. Now, for all policies that incept on or after March 1, 2011, the workers’ compensation regulatory assessment will be 5.5 percent of standard premium. This change puts an additional burden on businesses that have deductible programs, as standard premiums are typically multiples of deductible premiums.

Illinois
Illinois statutory benefits are among the highest in the nation. A plan was proposed to overhaul the Illinois workers’ compensation system earlier this year. In April 2011, the plan failed due to concerns regarding whether workers should be required to prove that injuries are job related.

Montana
According to reports, Montana ranked highest in the nation in terms of WC rates. In April 2011, bill HB 334—a historic reform of Montana’s workers’ compensation system—was signed into law. This legislation is expected to cut WC premiums by 40 percent over a three year period by trimming benefits to workers and cutting costs in other areas.

North Carolina
In an effort to control the rising costs of the state’s workers’ compensation costs, North Carolina lawmakers are considering a bill that would limit injured workers benefits and make changes in medical benefit levels.

Kansas
A bill designed to protect legitimately injured workers and employers from litigation was signed into law in April 2011. This bill is the most significant workers’ compensation reform in the state since 1993 and is backed by both business and labor groups. The bill raises benefit caps for injured workers, raises the minimum for an incident to fall under the act, and gives employers credits for preexisting conditions.

Whether by market dynamics or regulatory action, the first quarter of 2011 showed some definite signs portending to a continued deterioration of the workers’ compensation market. Simultaneously, we saw several states attempting to implement reforms designed to control rising WC costs without pursuing rate increases. As other states take notice of the developments in California, New York, Illinois, Montana, North Carolina, and Kansas, we will keep you informed about these recent developing dynamics and how they may affect your organization.