All Wrapped Up in Workers’ Comp

No surprise, but with the first quarter of 2004 drawing to a close, workers’ compensation remains, as it has been for many years, one of the most troubled lines of insurance in the United States.

On a calendar year basis, the combined ratio for workers’ comp has lingered for a decade, well above the 100 break-even mark. Low points were the 120.8 and 120.9 registered in 2000 and 2001. The 112.2 posted in 2002 was somewhat better, but barely so. Calendar-year results reflect claim payments and changes in reserves for accidents that happened in that year or earlier.

Accident year results, which perhaps reflect a better picture of industry performance, are hardly better. The combined ratio here ranged from dreadful highs of 137 and 133 in 1999 and 2000 to an almost respectable 107 in 2002. These results include only losses from one particular year.

In 2001-2002, workers’ comp insurance was the third largest individual line of property/casualty coverage in the United States and the largest of the commercial lines segments. In net premiums written, workers’ comp, at $36.5 million, accounted for 10 percent of all property/casualty insurance and 19 percent of all commercial business. It trailed only private passenger automobile, the largest P/C line by far at 37 percent overall and 78 percent of personal lines, and homeowners multiple peril coverage, which accounted for 11 percent of all P/C insurance and 22 percent of personal coverage.

Direct premiums written in workers’ comp in 2002 totaled $10.9 million in California, far and away the national leader. In Florida, the total was $3 million and in Texas $2.6 million. In Illinois it was $2.2 million, and in New York and Pennsylvania $2 million.

Since the 1980s, reform efforts have been underway in various states to curtail spiraling growth in claim costs.

“The new laws,” said the Insurance Information Institute, “provided greater ability to manage workers’ compensation medical care costs and to coordinate and oversee medical care costs and to coordinate and oversee the treatment plan and return-to-work process; allowed the use of large deductibles, which make employers more safety conscious; increased emphasis on fraud prevention; and instituted residual market reforms, which have encouraged greater competition in some states and provided strong incentives to employers to improve their safety record in others.”

But these reforms lost steam, according to Keith Bateman, vice president for workers’ comp of the Property Casualty Insurers Association of America, the new amalgam of the National Association of Independent Insurers and the Alliance of American Insurers.

“The cost control mechanisms of the early ’90s are losing effectiveness because the provider communities have found new ways to get around them,” Bateman said.

Medical costs and utilization issues, especially in the chiropractic area, are still problematic in many states, he added, and questions still abound on the appropriateness of treatment offered.

“There are cases,” he said, “where people pay more for out-patient than for in-patient treatment.”

Peter Burton, a senior division executive, state relations, for the National Council of Compensation Insurance, looks at the workers’ comp world through the prism of NCCI filings.

Of the 31 NCCI filings to date in the current cycle, he reported, 17 have been for loss cost increases, two for no change, and the remaining 12 for decreases. “So the pattern is similar to what we experienced in the previous year,” Burton said, noting that the last two filing cycles indicate that loss costs are going up.

“This reversed itself a couple of years ago,” he added. “We were filing in general more decreases than increases around the country, but the last two filing cycles have demonstrated that loss costs are going up.”

The largest filing submitted this year by NCCI and approved was in Alaska, a filing for a 21.2 percent increase, followed by an approved increase of 13.1 percent in Kentucky. The only one pending now (of 31 submitted) is Vermont, at 15.1 percent, “and we hope to have a decision on that in short order,” Burton said.

He said the pattern is the same for the assigned risk market. “Of the 18 filings we’ve made, 10 have been for increases, 3 for no change, and 5 for decreases,” he said. The top four increase filings are: Tennessee at 23.8 percent, Alaska at 22.2 percent, and New Mexico at 13.6 percent, all approved. Vermont, at 20.9 percent, is pending.

“This is the best barometer we have,” he said.

The other is the size of the residual market, which peaked last year. It’s now at $1.1 billion in written premium in the mechanisms NCCI administers. “That’s gone up substantially from previous years, an indication that companies are more judicious in their underwriting,” he said. “When you see a market marked by deterioration of results, you see a growth in the residual market.”

The four NCCI states most in rate need and currently in the legislative mode are Tennessee, Alaska, Vermont and Texas. California, too, of course, though it’s not an NCCI state.

Burton gave this rundown.

Alaska, which has significant problems, has two rate increases under consideration, one in the assigned risk and one in the voluntary market. The state has been hit by two insolvencies that are seriously taxing the guaranty fund. Legislators there are looking at a number of bills aimed at reducing systemic costs.

Vermont had a study committee last fall that made a series of recommendations on ways to reduce costs. These are currently being debated.

Texas, whose legislature meets every two years, also has study committees eyeing one of the most costly workers’ comp systems in the country.

In California, said industry consultant Andrew Barile, a number of entrepreneurs are trying to start up companies to take advantage of market conditions. “Now is the time to come into the California marketplace,” he said, “but to put it right will take time and is going to take a large consensus.”

Peter Burton said every state is “wrestling with the conundrum of high medical costs, that pops up as one of the biggest cost drivers in each state,” and pharmaceutical costs in particular “which are rising at a higher rate than any other medical component.”

They’re also looking at efficiencies in delivering benefits to injured workers: getting claims through the system as quickly as possible, reducing attorney involvement, instituting quick return-to-work risk management programs, and, of course, the looming issue of fraud, which is a major issue in California.

Workers’ comp fraud is much on the mind of Monte Gale, CEO of a new startup in New York, First Pavilion Insurance Company. Gale noted that fraud prosecutions have kicked up in states like New York, Florida and California against those who don’t pay any premium, who pay a small percentage of what they should pay, or otherwise defraud the system.

Gale claimed to have an interesting perspective. “We see all the dead bodies,” he said. “We look at mistakes. We see errors in workers’ comp premiums, in billings, in auditing, and in underwriting. We’ve seen the best stuff that ever came down the pike in those areas. We review underwriting files and claims files from 40 different carriers.”

Gale started in the property/casualty business with Liberty Mutual in 1979 and was involved in both the claims and the underwriting process. It was Liberty Mutual, he said, that first developed a workers’ comp analysis, when the first personal computers came out, that recognized that workers’ comp premiums could go up or down depending on experience modification, besides the rates and payroll modification.

He said most people look at workers’ comp and say, “Gee, if I cut my payroll, or if I get my rates lowered, I’ll get my premiums lowered. That’s true for the year you’re lowering your payroll and rates. But if that goes into an experience modification formula, wherever you cut your premium, if the losses are plugged in at the same value, your premium will go up in subsequent years because your claims have stayed the same, but the measure against the claims has decreased. This ratio of your actual losses compared to your payroll/expected losses is what experience modification is. It’s a comparison.”

The brief history, he said, is that in 1940 most states adopted an experience modification formula of some sort: basically the same comparison of expected losses to actual losses. The idea being that with “so many people cheating on their payrolls” that, instead of doing investigations and prosecutions “we’ll have this formula so as they cut their payrolls their modification will go up and we’ll cut their premiums anyway.”

Many insureds, he said, when they understand they’re paying premiums based on their payrolls, or a classification rate, they’ll take all the people in the factory and declare them as clerical, or they’ll say payroll is $2 million, not $5 million. “It doesn’t happen that often, but often enough,” Gale said. “Carriers realized they were probably losing 20 percent of the premium they should collect.”

The hard market, he noted, has put an end for the moment to the kind of cash-flow underwriting and the mad chase for market share that has led to the current horrendous state of affairs in workers’ comp in California, for example. “Underwriting then became an ancient art that only four retirees knew about,” he said.

He expects the market to soften again in maybe a year and he hopes the search “for the lowest price tag” won’t leave the companies yet again “shooting themselves in the foot.”

Generally speaking, he sees plenty of opportunity in the workers’ comp area in coming years.

Overall, there are plenty of new ideas in the marketplace for grappling with the difficulties of workers’ comp. “How successful they’ll be,” said PCI’s Keith Bateman, is still an open question.”

Tom Slattery, a veteran independent journalist, was the longtime executive editor and publisher of National Underwriter. He is also a former executive editor of Insurance Journal and editor at large for Leaders Edge magazine. He is currently managing director of Slattery-Esteramp Communications, Baldwin, N.Y. He can be reached at t.j.slattery@worldnet.att.net.