A.M. Best: New Regulations, Market Conditions and Financial Crisis Wreak Havoc on Workers’ Comp Line

Challenging market conditions, the financial crisis and the recession drove profitability downward for the U.S. workers’ compensation market in 2008.

Changing regulatory conditions and reforms have also impacted the workers comp market, probably more than any other line of business,

In its special report titled – “Workers’ Compensation: How Bad Will it Get?” – A.M. Best says changes to the regulatory climate, market conditions and the ongoing financial crisis have created major turmoil with respect to pricing, competition, loss costs, frequency, severity and, ultimately, profitability.

“While 2008 was expected to be a difficult year, with continued pricing pressures and limited investment opportunities, few predicted the magnitude of the financial crisis and its impact on the workers’ comp market,” said A.M. Best.

According to A.M. Best, the workers’ compensation composite, which consists of 103 groups and unaffiliated single companies (including state funds), saw net income deteriorate by $1.4 billion, or 62 percent, to $0.9 billion in 2008.

This year-over-year decline in earnings was largely due to both the downturn in the financial markets, which resulted in realized losses, and the significantly reduced premium volume related to the prolonged period of soft pricing, competitive market conditions, legislative reform measures, the economic recession, rising unemployment and decreases in payrolls.

The composite’s 2008 net premiums written (NPW) fell to its lowest level since 2000, down approximately 30 percent from its high of $20.9 billion in 2004.

The composite’s top line continued to be pressured through the first quarter 2009, declining about 20 percent to $3.0 billion from the same period in 2008, the report said.

A.M. Best says the workers’ compensation composite’s profitability came in above average during the past few years, largely following legislative reforms in California and Florida and earlier years of pricing improvement. Even so, the rating agency noted that the impacts from ongoing competition, the economic downturn, increasing medical costs and decreases in payrolls have escalated in the most current years and eroded underwriting profits.

After posting relatively strong underwriting results in 2005 and 2006, the composite recorded underwriting losses of $1.2 billion and $1.5 billion in 2007 and 2008, respectively, with combined ratios of 106.5 and 110.8 for the same periods, the rating agency said. This represented the highest combined ratios posted by the composite since it hit 118.7 in 2002.

While the workers’ compensation composite posted a combined ratio of 111.1 through the first quarter of 2009, A.M. Best expects the composite to report modest deterioration through the remainder of the year, as limited rate stabilization and projected reserve releases should partially offset economic pressures in the subsequent quarters of 2009.

Workers’ Comp Premiums

A.M. Best reports that the net premium written (NPW) in the workers’ comp line of business fell for the third consecutive year in 2008, declining about 12.0 percent to $39.7 billion – far faster than the 2.0 percent decrease for the overall U.S. P/C industry.

NPW for the workers’ comp line has declined nearly 20 percent since it reached its high of $48.6 billion in 2005, the report said.

“As with the A.M. Best workers’ compensation composite, the decline in NPW for the line has been driven primarily by reductions in premium rates, a highly competitive environment, lower exposure levels and rising unemployment. A good portion of the decline in premium volume came from California and Florida, which accounted for approximately 23.0 percent of all U.S. workers’ comp direct premiums written (DPW) in 2008,” the report said.

Overall, DPW for California and Florida fell nearly 18.0 percent to $9.9 billion in 2008, down from $12.1 billion in 2007. A.M. Best says that while most lines of insurance have stabilized over the past 12 months, workers’ comp rates continue to decline, but slower than in previous years. The rise in unemployment has also added to the decline in premiums.

While the underwriting results for the A.M. Best workers’ compensation composite fell sharply, the year-over-year underwriting performance of the workers’ comp line of business fared much better. According to A.M. Best, the workers’ comp line reported a calendar-year combined ratio of 104.4 in 2008, up only slightly from 103.6 in 2007, but up sharply from the low of 98.5 reported in 2006.

A.M. Best predicts both the workers’ comp line of business and the workers’ compensation composite are projected to deteriorate throughout 2009 and well into 2010.

A.M. Best Outlook

Despite today’s challenging conditions, A.M. Best doesn’t expect that the workers’ comp line of business will experience the same level of losses it did in the late ’90s.

“The segment still faces a great number of challenges over the near term, including the economic pressures that are constricting top-line growth and generating expense pressures; challenges to state reforms; increasing loss-cost trends; and ongoing competitive market conditions as the market struggles to maintain underwriting discipline,” the report noted.

If insurers maintain underwriting, pricing and reserving discipline, A.M. Best expects NPW in the workers’ comp line to decline just 6.0 percent and the combined ratio to deteriorate above 108.0 in 2009.