Impact of Financial Crisis on WC Expected to Stretch Into 2010

The economic recession took a significant toll on profitability in the workers' compensation market in 2008, and experts believe the impact will linger well into 2010.

According to a recent report by A.M. Best Co., a global full credit rating organization, challenging market conditions, regulatory issues and reforms are continuing to affect workers' comp and bring turmoil in terms of pricing, competition, loss costs, frequency, severity and profitability. Edward Keane, senior financial analyst with the firm, said the workers' comp market has not been immune to the unprecedented events that have impacted the overall U.S. property/casualty industry over the past 18 months.

"The report hits on what we have been seeing with regard to premium decreases in the market," he said. "The significant decline in premiums that we have had over a three-year period are like nothing we have seen before. Premiums had increased every year since the 1970s. Obviously, the market has been impacted by declining payrolls and the rising unemployment rate. However, those are only two factors that are at play."

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Keane said competitive markets in states such as California, Florida and New York, and increases in medical costs are also behind falling premiums and profitability. Medical-related expenses, he said, have outpaced the decline in claims frequency and reform-related pricing adjustments in recent years, causing the workers' comp industry to record an underwriting loss in 2007 and 2008.

"The reforms in California and Florida, for example, have opened these areas to greater competition, and it's having an effect on the total line," he said.

Study highlights. Among the highlights of the A.M. Best's report, researchers found that:

Calendar-year combined ratio up slightly. The workers' comp line reported a calendar-year combined ratio of 104.4 in 2008, up only slightly from 103.6 in 2007. However, researchers said this was up sharply from the low of 98.5 reported in 2006.
Comp market income dropped sharply. According to A.M. Best's workers' comp composite, which consists of 103 groups and unaffiliated single companies (including state funds), net income in 2008 deteriorated by $1.4 billion to $0.9 billion -- a 62 percent decline from 2007 data. 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.
Premiums fell to lowest level in nearly a decade. Net premiums written in the workers' comp line of business fell for the third consecutive year in 2008, declining about 12 percent. Researchers said this was significantly faster than the 2 percent decrease for the overall property/casualty industry in the U.S. Net premiums written in 2008 were at the lowest level since 2000, down approximately 30 percent from the composite's high of $20.9 billion in 2004.
Frequency continued its decline, but severity climbed higher. Despite widespread expectations to the contrary, Keane said the frequency of workplace injuries continued its descent in 2008. However, the report noted that data from the National Council on Compensation Insurance found that the severity of claims rose again last year, due primarily to increasing indemnity and medical cost trend. The average indemnity cost of a claim increased 5 percent to $21,000 in 2008, while the medical portion of the average claim increased an estimated 6 percent to $26,000.
AIG fell from top spot. According to the report, the top five workers' comp insurance groups/companies by net premiums written were Liberty Mutual Insurance Companies, American International Group, Travelers Group, Hartford Insurance Group, and the State Compensation Insurance Fund of California. After years of maintaining the top spot, researchers said AIG fell to second place with net premiums written declining by nearly 25 percent as the conglomerate "sought to reestablish itself in the market."

Market predictions. Keane predicted that the workers' comp market will continue to see some deterioration through the end of the year and into 2010.

"Long term, it is hard to tell right now," he said. "We don't know how high the unemployment rate will go or if it will peak at 10 percent. However, I believe you will see the factors that are impacting the market stretch well into the coming year."

According to the report, A.M. Best Co. expects net premiums written in the workers' comp line to decline approximately 6 percent in 2009 and the combined ratio to deteriorate above 108. Researchers said these results could quickly erode further should management "turn its back on underwriting and pricing discipline and prudent reserving."

"The ability to react quickly to the dynamics of this cyclical market will distinguish those companies that survive the latest round of demands on the industry relatively unscathed and those that face ratings pressure over the near term," the report noted.

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October 19, 2009

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