Recession Will Likely Place Downward Pressure on Frequency, Expert Says

Harry Shuford, chief economist at the National Council on Compensation Insurance, discussed how the macroeconomy influences and drives key financial components of the workers' comp system.

The economic recession has reverberated throughout every industry across the globe, including workers' compensation. Workers' Compensation Report recently sat down with Harry Shuford, chief economist at the National Council on Compensation Insurance, the largest provider of workers' comp and employee injury data and statistics in the country. Shuford discussed how the macroeconomy influences and drives key financial components of the workers' comp system and offered his predictions on how the downturn will impact the areas of exposure, frequency, severity, and investment income.

Workers' Compensation Report: Employment numbers have been falling since December 2007, and further job losses are expected through 2009. We've often heard that workers' comp claim filings increase when employment plummets and workers are worried about losing their jobs. Does this mean we will see an uptick in frequency?

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Harry Shuford: It is fairly clear that, on a net basis, recessions are associated with downward pressure on claim frequency. That often comes as a surprise to people who are closely associated with underwriting or claims management, who are often aware that when a client has a significant number of layoffs, there is a jump in claims.

Our research confirms that an increase in layoffs is associated with upward pressure on frequency, but in a recession, things are different. In a recession, there is a marked reduction in the number of new hires and that dominates. It is what we refer to as the "inexperienced worker effect." Employees who have been on the job less than one year have a much high rate of injury than their more experienced coworkers. Therefore, when the level of new hires drops significantly, it reduces the number of inexperienced employees in the workforce and places downward pressure on frequency. In this recession, we have also seen significant employment declines in more hazardous industries, such as manufacturing and construction.

Conversely, when the economy begins to recover and companies begin to actively hire employees, this will put upward pressure on frequency.

WCR: Since changes in indemnity benefits are often tied to the movement in wages in many states, how will the current slow growth in wage increases impact workers' comp?

Shuford: What we have seen is that severity has grown year after year, sometimes at a faster rate and sometimes slower. The only time we have seen a drop in severity is in the early 1990s when many states were enacting reforms. So the real question is not whether severity will drop, but what happens to its rate of increase.

On the indemnity side, you typically see that its rate of increase drops dramatically the year after the start of a recession. This is primarily because the average weekly wage is the key driver in indemnity payments, and the growth in the average weekly wage eases dramatically in a recession. Benefit levels are typically linked to the average weekly wage in the preceding year, so this is the lag effect you see in indemnity severity.

WCR: How does this impact medical severity?

Shuford: With respect to medical severity, some of our recently published research shows that macroeconomic factors play a limited role in medical costs. The primary driver remains utilizations, which is measured by treatments billed by medical providers. Our expectation is that medical severity will likely grow at roughly the same pace.

What we've seen in terms of the average cost of medical transactions is that it moves fairly closely with the medical Consumer Price Index. There might be a little easing, but the medical Consumer Price Index doesn't seem to be impacted by the macroeconomy.

WCR: With the fluctuation in the stock market and the Federal Reserve lowering interest rates to a record low, what effect will these factors have on investment income in the workers' comp world?

Shuford: For most property and casualty insurance companies that provide workers' comp coverage, the stock market is not a particularly significant factor in their investments income. However, this will have an impact in changes in surplus. That is because unrealized gains and losses in stock portfolios go directly to surplus. If the market is down significantly, even if there isn't a large holding, the value of the stocks will have a dollar-to-dollar impact on surplus.

WCR: Any other predictions on where this volatile economy may take us?

Shuford: Our analysis suggests that there tends to be some hardening of the marketplace after recessions, due to the lowering of interest rates. In the last two significant recessions, we saw a hardening of the market and an increase in the residual market share of the total market. Therefore, you may see a modest increase in the role of the residual market in the next year or two.

April 6, 2009

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