Results for 2005 for the workers' compensation insurance community will be positive and "will continue to be strong" throughout 2006, according to Standard & Poor's Ratings Services, but because of mispricing and stronger competition, profitability could be reaching a peak.
The encouraging results for the 2005-2006 period reflect the reduction of loss trends sparked by multiple state reforms implemented over the last few years and from improving claims frequency, said the S&P research document, "State Reforms, Strong Results Point To Good Outlook For U.S. Workers' Compensation."
However, these benefits could be partially offset by "expected long-term medical inflation, especially for prescription drugs, increased competition and improving, although still deficient, reserve adequacy," the document noted.
* Loss ratios. Direct loss ratio will likely improve during 2006 as reforms enacted over recent years in California, Florida and Texas, the three largest workers' comp markets, take hold. Should any partial reversal of these changes occur, "the financial impact . . . is unlikely to be immediate, so current loss ratios should continue through 2006, but could be more in question thereafter," the report said. The national consolidated loss ratio for 2004 was 73.2 percent, trending downward from the 77.4 percent, 82.5 percent and 91.2 percent levels of 2003, 2002 and 2001, respectively. "Continued loss frequency improvements are possible on a national basis, but we believe the rate at which improvements will occur will decrease," the report said.
* Medical costs. The report said a "key challenge" to workers' comp providers has been how to contain medical loss costs. Recent reforms, such as provider networks, prescription formularies and limitations on physical chiropractic therapies, have sought to reduce medical costs, "but whether those reforms will produce any lasting savings is unclear." While overall growth in severity of workers' comp indemnity claims has slowed over the past few years, the medical portion has experienced double-digit growth in three of the last four years, the report said. "Because of these continuing increases, the proportion of workers' compensation losses due to medical costs rose to 57 percent in 2004 from 49 percent in 1994 and 44 percent in 1984."
* TRIA. The risk of terrorism is another problem for insurers. Although the Terrorism Risk Insurance Extension Act of 2005 will let insurers manage risk aggregation more easily, "the threat of a terrorist attack remains a real issue." The report noted that insurers "have few mechanisms to protect against terrorism loss" because employers in all states except Texas are required to provide workers' comp coverage for their employees, with no exclusions permitted for terrorism. "The potential for large losses and the uncertain probability of such a catastrophic event make it critically important for insurers to buy workers' compensation catastrophe reinsurance or to limit exposures to large employers and aggregations within cities," the report recommended.
* Reserves. Reserve inadequacy is a third potential problem. "Because of its long-tail nature, persistently high medical inflation and the possibly disruptive impact of periodic reforms," the report said, "Standard & Poor's believes reserve and pricing risk remain, albeit at lower than usual levels for this line." Overall, the research indicated workers' comp will be profitable for most carriers in 2005 and 2006.
"However, rate softening will most likely cause some slight deterioration in 2006, and the risk of mispricing in California, Florida and Texas will increase if savings from reforms are lower than expected," it said. With increasing competition, carriers could be pressured to lower premiums in advance of actual reform-generated savings. "In other words," the report said, "2005-2006 may be as good as it gets."
May 1, 2006
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