Workers’ Comp Claims Frequency Down

The workers’ compensation insurance industry experienced a year of mostly solid results in 2008, according to Dennis Mealy, NCCI Holdings Inc. chief actuary. In its annual “State of the Line” report, the NCCI (National Council on Compensation Insurance), said the workers’ compensation calendar year combined ratio was 101 in 2008. The 2008 accident year combined ratio was 100 percent.

Calendar year and accident year underwriting results continued near breakeven, Mealy said, “which in this investment climate is a necessity if the industry hopes to earn a reasonable return on its capital.”

“We are pleased to report that the workers’ compensation insurance industry continues to function quite well, with active competition for business and a shrinking residual market,” NCCI President and CEO Steve Klingel added. “However, the low interest rate environment that has persisted for several years, combined with the dismal short-term performance of the equity markets, continues to leave the line with post-tax returns that barely meet the industry’s cost of capital.”

Among the challenges NCCI expects the workers’ comp insurance industry to face:

• Medical costs continue to rise faster than wages;
• Indemnity claim costs also continue to outpace wage increases;
• Low investment yields may keep pressure on industry underwriting results;
• The underwriting cycle is entering a period of uncertainty;
• A changing state political environment may result in more legislative proposals; and
• The political situation in Washington, with proposals to revamp the nation’s health care and financial regulatory systems, makes for a period of uncertainty.

The recession is having a effect on the workers’ compensation insurance industry. “The macro economy clearly influences, and, to a large extent, drives the key financial components of workers’ compensation: exposure, frequency and severity, and investment income,” said Harry Shuford, NCCI Holdings practice leader and chief economist.

NCCI said unemployment would likely help reduce workers’ comp costs. Employment has been declining consistently since December 2007. Job losses have averaged nearly 430,000 a month in the three months ending December 2008, and have gotten worse since. And a weak outlook for employment portends declines in exposures, especially in the more cyclically sensitive (and hazardous) manufacturing and construction sectors.

“Claim frequency is also likely to come under downward pressure, both from the loss of more hazardous jobs and because, in recessions, companies tend to lay off their least experienced workers first, which has the effect of increasing the skill-level of the remaining workforce,” the group said.

Shuford noted workers’ comp claims frequency has declined about 1 percent per year for the past 80 years, and there is no evidence to suggest that the trend will end anytime soon. Even as unemployed workers submit workers’ comp claims, it is unlikely to play a major role in the claims frequency patterns.

“In part, this reflects the dynamic of the U.S. economy; large layoffs happen all the time,” he wrote. The frequency change from 2007 to 2008 was -4 percent. The prior year’s change was -2.6 percent.

As wage gains slow in 2009, reflecting both weak labor demand and rising unemployment rates, there will likely be some slowing the growth rate of indemnity severity, because changes in indemnity benefits are tied to wage movements in most states, NCCI said. Indemnity severity will likely rise, but at a slower pace, the group predicted.

Although people might think workers’ comp claims increase with a recession as people seek to increase their incomes and fraudulently submit claims or increase the severity of claims, this may not be the case.

“Some argue that injured workers will stay on workers’ comp longer to postpone going on unemployment; others believe that workers have an incentive to return to work sooner to reduce the risk of being laid off,” Shuford said. However, data from the past three recessions in reality suggests that the key driver of indemnity severity is the slowing of growth in wage rates. “There might be some element of fraud, but there’s also evidence that those who have a job won’t file a claim because they don’t want to lose their job … and the data seems to suggest that one behavior offsets the other,” he said.

NCCI said higher medical care inflation will place upward pressure on medical severity, which is also being impacted by substantial increases in utilization. “The best forecast is medical severity will continue to grow due to increasing utilization regardless of changes in economic conditions,” Shuford said.

While indemnity loss costs will ease or even drop modestly, anticipated increases in medical prices and utilizations will more than offset the easing of frequency. “Medical loss costs will continue their steady up-trend, even as the economy weakens,” NCCI said.

While the recession may help to reduce claims, the recession will likely make workers’ comp insurers’ investment income fall, restraining operating gains and return on equity, the group predicted. The Federal Reserve has reduced the key federal funds interest rate to a record-low. “This lower interest rate environment will negatively impact new-money returns,” it said.

Other highlights from NCCI’s “2009 State of the Line” report:

• As to the reserve position of private carriers, NCCI estimates about a $6 billion deficiency at year-end 2008, up from a $2 billion deficiency the previous year. After consideration of the allowable discounting of the indemnity reserves of lifetime pension cases, the reserve position is essentially adequate.
• California is large enough to have an impact on the countrywide workers’ comp numbers; excluding it would increase the calendar year ratio by about 5 points to 106 percent, and would leave the accident year combined ratio unchanged at 100 percent.
• Net written premiums, including the state funds, had a third year of decline, dropping more than 12 percent to $39 billion. The private carriers dropped by about 10 percent to $34 billion – the largest drop in workers’ comp net written premium in many years.
• Depopulation of the residual market continues at a rapid rate. Premium dropped about 30 percent in 2008 and is now about $700 million, less than half the volume in 2004. Overall, the market share of the residual market pools serviced by NCCI dropped to about 6 percent, down from 8 percent in 2007. This is an improvement from the 13 percent market share peak reached in 2004.

For more information, visit www.ncci.com.