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The soft property casualty insurance market, in combination with vanishing low interest rates, has been a historic aberration over the last six years. Insurers will usually make their money on high premiums or high interest rates. They have had neither for half a dozen years. But that may be changing.

Travelers, always a solid bellwether of the property casualty insurance realm, recently announced via their CEO Jay Fishman that they are not going to count on interest rates rising any time soon. Rather, they are going to start to escalate premiums. Or as Fishman terms it, "we will continue to seek improved pricing." Workers' compensation and commercial auto will be the lines seeing the most rate increases by Travelers.

Another data point recently revealed is that Florida, the fourth largest workers' comp market in the country behind California, Texas and New York, announced that it is raising workers' comp administrative rates by 6.1 percent. Kevin McCarty, Florida Insurance Commissioner, made that announcement on October 26. This follows increases of 7.8 percent in January 2011 and 8.9 percent in January 2012. California also issued a recent rate increase advisory. The Workers Compensation Rating and Inspection Bureau recommended an average base rate of $2.68 per $100 of payroll for workers' comp policies renewing or starting on January 1. That works out to an increase of 12.6 percent more than the average base rate of $2.38 filed by insurers as of July 1.

"Recent premium rate increases in workers' compensation are an encouraging sign that the market has reached a cyclical bottom," said James B. Auden, Fitch Managing Director in a July article in Risk & Insurance®. However, "Fitch estimates that it will be difficult for the workers' compensation market to have a combined ratio of 110 percent or better in 2012 or 2013 without significantly more price improvement," due to rising medical severity.

So essentially, although workers' comp rates are on the way up, they are still insufficient to keep the industry from witnessing a probable 119 percent combined loss ratio for 2012.

A side effect of the gradually increasing workers' comp rates is growth of the residual market. As long as premiums were low over the last half dozen years, the residual market had basically shrunk to irrelevancy. However, the markets of last resort such as competitive state funds are now beginning to see more business, as employers are either quoted substantial premium increases by their insurance carrier (which encourages them to go elsewhere), or are simply turned away as being undesirable risks.

According to the NCCI, residual market growth in the first six months of 2012 accounted for an 89 percent increase in premium volume of that market segment. Admittedly, the residual market was rather small to begin with, but premium in that area almost doubling illustrates another data point that workers' comp rates are generally on the move.

Of course, with workers' comp being state specific, not all jurisdictions are experiencing rate increases. For example, the state of Washington (a monopolistic jurisdiction) has not raised rates, nor has Kentucky. But there are enough areas where rates are gradually increasing to signal an incipient general reversal of the six-year soft premium market.

Increasing premiums in the workers' comp arena may augur well for the domestic economy, as this development should point to a slow improvement taking place. The health of the workers' comp insurance market is but one indicator in that puzzle, but one that must be acknowledged.

Is Traveler's announcement a signal that workers' comp underwriting principles are generally starting to be rigorously applied across the industry? Usually when a Top Five workers' comp insurer makes a declaration of that manner, it encourages a similar strategy of the other top carriers in like fashion. But what is more cogent is that underwriting workers' comp insurance at increasing losses for the last six years is an unsustainable business plan for any insurer.

The art of underwriting (rather than pricing) is the salient underpinning of a financially vital insurance company. Economic history is replete with the wreckage of venerable insurance companies that started practicing a "market share" pricing philosophy (for example: Mission, Reliance, The Home). It makes no sense to consciously write risks at prices below expected loss costs. The choices are simple; raise prices to proper levels or simply withdraw from writing that lines of business. Otherwise shipwreck will eventually be suffered.

The good news is that businesses who take their loss control obligations seriously will be the recipients of lower premium quotes, as they will be desirable risks. Those that ignore their workers' comp risks will experience higher quotes, or not be able to find coverage in the competitive marketplace and be driven into the residual market where higher premium costs will usually result. The choices and consequences are clear. Let's hope the business community understands what is at stake, and the actions they need to take to remain going concerns.

November 11, 2012

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