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Work comp insurers should brace for an 'unsustainable' future


CHICAGO--The cyclical nature of insurance markets means that workers compensation insurers and reinsurers must look beyond today's favorable results so they are prepared to cope with tomorrow's problems, including attracting and retaining skilled employees.

Kathleen A. Muedder, senior vp of casualty underwriting for Branchville, N.J.-based Selective Insurance Co. of America, moderated a lively panel discussion on "Strategies for the Current and Evolving Cycle." It was presented recently as part of the American Society of Workers Comp Professionals Inc.'s conference at Chicago's Aon Center.

Some companies are already making headway by maintaining underwriting discipline, enhancing operations and distribution networks, as well as remaining committed to their long-term goals, panelists said.

Last year, the property/casualty insurance industry posted the best results in more than half a century, Ms. Muedder said.

In 2006, the P/C insurance industry reported a combined ratio of 92% on a calendar-year basis, which is the best since 1949 when the industry recorded an 87.6% combined ratio, she said. In addition, workers comp results are expected to be "excellent," with a predicted combined ratio of 87% for the accident year and 96.5% for the 2006 calendar year, she said.

Keep long-term focus

Such favorable results are considered "unsustainable," though, for several reasons, said panelists who included Robert G. Purdy, the Parsippany, N.J.-based president of Specialty Workers' Compensation, a division of American Home Assurance Co., a unit of American International Group Inc., both of New York.

Also participating in the panel were Karl J. Amidon, senior vp at Chicago-based Aon Re Inc., where he is the workers compensation practice group leader; and Robert H. McFadden, senior vp of Princeton, N.J.-based Munich Reinsurance America Inc. He manages the casualty underwriting department for the reinsurer's broker market division.

"It's very clear that it is unsustainable in the long run," Mr. Purdy said.

There have been recent workers comp rate reductions in some states, which result in lower prices and make written premium growth more difficult, he said. "We will certainly be profitable for a few years," assuming no catastrophic events.

"Carriers seek to take advantage of a problem market by growing," he said.

In addition, "there are several indicators that the workers comp market is more disciplined," Mr. Purdy said. Those indicators include the impact of the Sarbanes-Oxley Act, enhanced technology, better information from management reports, more template underwriting, better-controlled reserves, improved investment income and stronger ethics.

"Carriers also are riding the tail of a hard market," Mr. Purdy said. "I do hope the industry doesn't go back to the destructive tactics of underpricing and cash flow underwriting," he said. "That would be disastrous."

Mr. Amidon concurred that the workers comp market is more disciplined, but said that is because those who had been less disciplined are no longer around.

He said there are three characteristics that successful insurers have that enhance their operations and distribution networks. First, is efficient and effective technology to enhance communications. Second, producer relations are "tremendously important," Mr. Amidon said. Third, quality service, such as issuing policies correctly, is very important.

Other strategies

Other strategies that companies can use to successfully navigate the current soft market conditions include managing their portfolios on an underwriting-year basis instead of a calendar-year basis, Mr. McFadden said.

In addition, "management should stay true to your long-term goals, even though you have very short-term pressures," he said. Management also needs to focus on specific goals and work toward them diligently, while avoiding the pitfall of joining a new market because competitors are going there, he said.

"There are also some cultural lessons to be learned," Mr. McFadden said. Companies need to be open and encourage diverse opinions; if top management issues a directive with no ability for others to discuss it, it can make team members rationalize their actions and ultimately lead to a lack of accountability.

On the underwriting side, companies need to be wary of "an instinctive optimism bias" that surfaces during soft markets, which causes both brokers and insurers to focus on the brighter side when evaluating a risk, Mr. McFadden said. As a reinsurer, which is one or two levels removed from the risk, "you really have a tendency to get it very wrong" if you don't discount such market-induced optimism, he said.

Finally, insurers and reinsurers must not let competitive pressures make them adjust their fundamental approach to projecting losses because they will lose control of the underwriting process and the numbers will become meaningless.

Mr. Amidon said the fact that numbers are important--even to brokers--demonstrates the enhanced level of discipline in the current market.

Mr. Purdy said the big lesson learned from previous soft markets is: "Don't chase price."

Reinsurers also need to develop strategies to respond to current market pressures, Ms. Muedder and the panelists said.

Reinsurers "need to be very realistic about broad market movements," and step outside their own particular lines of coverage, said Mr. McFadden of Munich Re. "The supply and demand imbalance and capital management pressures are byproducts of calendar-year results, raised expectations and growth initiatives. Those don't necessarily translate into prudent underwriting-year growth initiatives."

To meet the needs of a better-informed industry, "reinsurers need to operate in a much more open-minded and informed manner," he said.

Reinsurers generally have returned to writing quota-share reinsurance coverage, and "I think that is a very positive move," said Mr. Amidon of Aon Re. That is because reinsurers feel losses more quickly under a quota-share agreement than under an excess-of-loss agreement, which may require them to wait three years for losses to appear, he said.

Another strategy that workers comp insurers and reinsurers are using is predictive modeling, which is moving into commercial lines from personal lines, Ms. Muedder said.

"I think it will become a very big part of commercial lines underwriting," especially for small and midsize risks, Mr. Amidon said. It is less meaningful for large risks such as a major department store chain, he said.

Predictive modeling is "a discipline whose time is now and I think it will be very beneficial," he said.

AIG's Mr. Purdy, who described predictive modeling as "evolutionary," said he expects that every insurer will use the workers comp data they collect to do predictive modeling at least by 2010. "It's now moving to a higher level of sophistication," he said.

Effects of M&A activity

In addition, mergers and acquisitions among workers comp insurers may also be a factor, especially among insurers with strong balance sheets, Mr. McFadden said.

However, Mr. Purdy said it's his opinion that mergers and acquisitions do not necessarily add much strength.

Attracting and keeping capable staff is an issue for many companies, Ms. Muedder said. "Some 64 million skilled workers will be able to retire by the end of this decade, according to the Conference Board."

"It's a timely issue," Mr. McFadden said. In Munich Re America's Princeton, N.J., office, the company has about 1,000 employees whose average age is 47. Companies should focus on the recruitment, development and retention of skilled employees, he said.

Replacing aging workers with members from the so-called Generation Y--those between the ages of 12 and 30--will bring new challenges, Ms. Muedder said. She cited predictions by Bruce Tulgan of Rainmaker Thinking Inc., a New Haven, Conn.-based management consulting firm, that those technically savvy workers will be "the most high-performing" but also "the most high-maintenance" workforce.

The next generation

With younger applicants, it's hard to get them into the insurance industry to begin with and to make the work seem exciting, Mr. McFadden said.

"I do think it is a critical issue, especially for large employers and especially in the reinsurance industry," he said. Some companies previously had comprehensive training programs, but they are no longer offered.

Mr. Amidon said Aon has a "fairly intense" training program for recent college graduates. In contrast to others' sentiments, new employees are willing to work long hours, perform well and are "not high-maintenance," he said.

Mr. Purdy disagreed and said he considers younger workers to be high-maintenance. Yet research has found those workers to be ambitious, demanding and "to question everything." They also are interested in money, primarily because they have a lot of debt from their educational expenses, he said.

An insurer has to marry the energy and focus of the younger worker to the experience and judgment of the older worker, Mr. Purdy said. "It's really a great balancing act," and companies that can do that will do well.

Ms. Muedder, an AMCOMP director, substituted for scheduled moderator Donald T. DeCarlo, a New York-based attorney with the Law Office of Donald T. DeCarlo. He is AMCOMP chairman and president.