Rising medical and legal costs, payrolls threaten comp profits: Best

Workers compensation has been a profitable line of business in recent years, unlike many other property/casualty lines, but that profitability is threatened by rising medical costs, payrolls and legal expenses, according to a report by A.M. Best Cos. Inc.

Workers compensation insurers have effectively combatted declining rates attributable to an overall market softening since the beginning of 2015 and continued generating profits in 2017 and through the first half of 2018, according to the report released on Wednesday by the Oldwick, New Jersey-based rating agency. Workers comp had a favorable performance in 2017 compared with many other commercial property/casualty lines, particularly property catastrophe-exposed lines, which experienced deteriorating results. 

But non-pricing-related headwinds for the comp segment include rising medical loss cost severity, the declining benefit from prior accident year reserve redundancies and high average settlements on cases stemming from attorneys’ growing involvement and litigation, according to the report.

“AM Best’s outlook for the workers compensation segment is stable, as is our outlook for the commercial lines segment, of which workers’ compensation is the largest component,” Best said in its report. “Current market conditions for workers comp represent a definitive change since the 2008 financial crisis after which the workers’ compensation insurance market hardened, payroll base and premiums shrank, rates rose and the number of workers compensation writers declined. That changed around 2013, when the post-recession recovery began to take hold (and) rate increases began to decline, leading to rate decreases soon becoming the norm two years later. This trend has continued into 2018 and will likely cause profit margin compression over the near term, possibly as soon as 2019.”

Workers comp insurers “still face additional economic, regulatory and legal issues that will continue to challenge and reshape the market,” but the “leveraging of technology is benefitting these companies’ bottom lines from an expense standpoint and the decline in loss frequency owing to loss control and risk management improvements should help offset competitive market pressures to some extent,” Best continued.

In 2017, workers’ compensation insurers reported $55.8 billion in direct premiums written, 4.7% below the record $58.5 billion reported in 2016, reflecting a consistent decline in comp rates overall, according to the report.

Workers compensation premiums have an inverse relationship with the unemployment rate and since rates have decreased on average since 2015, the level of top line premium is attributed primarily to an increase in the payroll base. Payroll growth had a 4.4% positive impact on direct premium growth for private insurers as U.S. unemployment continued its decline since 2010, according to the National Council on Compensation Insurance.

“However, the U.S. has not recorded a consistent decline in the unemployment rate longer than nine consecutive years since it began tracking the unemployment rate in 1929,” Best noted. “Historically, long declines have typically been followed by sharp spikes in unemployment, which may serve as forewarning for workers compensation writers to expect payroll growth, and any resulting premium growth, to cease sooner rather than later, unless wage growth accelerates. However, in September, the unemployment rate hit its lowest level since the Vietnam War and remained at that level through October. At this time, economists are stating that there is little indication that it will shoot back up anytime in the near term.”

In 2017, net premiums written declined by 6.6% to $45 billion, which was attributable primarily to the decline in direct premiums written and to larger cessions to reinsurers by individual insurers, including offshore cessions, according to the report. The property/casualty industry overall has increased its use of reinsurance for workers compensation since the 2008 financial crisis, ceding nearly 50% more of this business than before the recession, according to Best.

The workers comp sector’s combined ratio continued to improve, with insurers reporting a 92.4 combined ratio in 2017, mostly due to $6.6 billion in reserve releases – $3.4 billion more than in 2016, when the sector’s combined ratio stood at 95.5, according to the report.

But Best expressed continuing concern over the deficiency of reserves in the sector, which it estimated at about $16.8 billion as of year-end 2017.

“Loss reserve adequacy is especially important for the workers compensation business because of the long-tailed nature of the line’s liabilities,” Best stated.