This article looks at analyst call highlights, and whether rates are keeping pace with loss cost growth net of payroll growth.
Property casualty insurers mostly managed to deliver strong numbers in the Q3 earnings season however the one area that garnered discussion for some executives was workers’ compensation (“WC”).
In calls with analysts, executives at The Hartford, Cincinnati Financial, and WR Berkley faced pointed questions about loss ratios and pricing in the workers’ compensation segment. The focus comes amid a tight labor market, with the U.S. unemployment rate having remained at or just below 4 percent over the past six months. Employees are taking on more hours, adding to the risk of workplace injury, and an uptick in claims.
One analyst asked whether workers’ compensation could be a “material problem” for The Hartford. In the middle-market portion of The Hartford’s commercial book, increased WC frequency led the combined ratio to rise by 3.2 points to 100.2 percent. “Although workers’ compensation 2018 frequency trends are elevated from expectation, it’s a modest change in trend that we’re addressing,” Christopher Swift, Chairman and CEO, said during the call.
Workers’ compensation also came up for Cincinnati Financial. During the firm’s earnings call, CEO Steve Johnston said loss-cost trends are “being recognized.” He also noted pressure on pricing because of the “aggressive marketplace.”
In another call, WR Berkley’s CEO, Rob Berkley, said there had been a “lot of chatter” around rating bureau actions moving rates down, referencing workers’ compensation. “At the same time, I would caution people not to overreact to this rate activity or rate action,” Berkley said.
The key issue is “are rate changes keeping pace with loss cost growth net of payroll growth?”
With respect to the loss costs trends and the economic strength in the U.S. right now, there has been some concern expressed by analysts about a possible uptick in frequency. I believe the economic upturn is, as a whole, good for WC carriers; mainly because payrolls are growing more than they have in recent years and premiums are boosted by increased growth in payrolls. Premium growth has been dampened in recent years by anemic payroll growth in the U.S., but that is changing now.
It is worth noting that, in contrast, Commercial Auto uses a non-inflationary exposure base number of vehicles, so they don’t get the same uplift. Also, the property casualty industry is predominantly invested in fixed income investments, and the increasing yield rates as the economy strengthens boosts investment income on bond portfolios in which capital supporting WC is largely invested.
Many recent years of benign cost inflation (both frequency and severity, and both indemnity and medical) has contributed to an industry WC combined ratio well below 100%. Indeed, some have called the last four or five years “the golden age of workers’ compensation,” and all at once, calling out how good times have been and suggesting the good times are coming to an end. Going forward, the big issue is that these benign loss cost trends, combined with heightened competition, are causing the rate environment to soften considerably. Filed loss cost decreases by the rating bureaus, increased certainty about the effectiveness of reforms, perceived success from managed care and claims settlement strategies, and the emergence of a robust runoff market have allowed carriers to better focus their capital and their resources on active business, and have all been contributors.
There are many offsetting drivers on WC costs due to changing economic employment and inflationary forces. One important driver is a favorable one, and that is workers will tend to languish on the WC payroll when there are no other jobs to return to. In a growth economy, workers tend to be eager to get back to work as generally the wage replacement from WC is below the pre-injury wage. This is increasingly true as you go up the wage scale to higher wage earners due to the maximum weekly benefits state WC acts impose.
“The median and mean duration of temporary disability on permanent disability has continually decreased since 2008. Several Working Group members noted that the trend is largely related to an improved economy with rising salaries, increased number of hours worked, good job opportunities and other factors which encourage claimants to return to work.” – WCIRB of California 9/4/18 Actuarial Committee Meeting Agenda.
Conversely, studies show that less experienced workers tend to have a higher frequency of claims due to lack of safety awareness and experience. This is likely a driver of what is being reported by The Hartford. Of course, rising economic tides increase medical inflation as well. In addition, indemnity benefits, of course are linked to wages, so rising wage levels lead to rising average weekly benefits.
One important fact is that claims are generally closing quicker across the country, and quite significantly so in some jurisdictions, in California for example. “Permanent and temporary disability claims continue to close at faster rates. Permanent disability claim closures have also accelerated in recent periods.” – WCIRB of California 9/4/18 Actuarial Committee Meeting Agenda.
Many carriers have developed and implemented analytical tools to enable claims adjusters to better identify the right amount to settle a claim for; as well as, those claims which have the most uncertain outcomes which are the ones that should be focused on from a settlement perspective. An increase in closure rates enables claims employees to focus more of their time on the newer claims, which still have the best chance to be favorably impacted by claims handling best practices.
One of the reasons the rate environment has softened notably relates to the cloud of uncertainty that has been lifted in some key states around legislative reform effectiveness. It has become far clearer due to the very good loss emergence that has been experienced in the last 18 to 24 months that the California WC reform SB683 is working fantastically. Also, the Florida court decisions adversely impacting previous reforms has not proven to be as damaging to long-term cost trends as originally hypothesized. Further, there have been no major adverse state legislative changes or court decisions to cause erosion in costs and cost trends, other than the aforementioned Florida court decisions.
We need to keep on constant watch for changes in system environment, whether they come from court decisions, legislative changes, system participant behavior or economic changes. California, for example, has had a history of reform erosion due to court decisions, participant behavior or a combination of both.
I don’t necessarily see a dramatic change in loss cost inflation in the short term. While the fantastic frequency trend may abate somewhat in the near term, I still see some low cost inflation overall. Carriers need to watch the competitive rate environment. At some point with decreasing rates, we can question whether there is any redundancy in the tail factors being used in the bureau loss cost filings, which tail factors generally are being based on experience from many years ago when the inflationary and utilization and cost containment environment were dramatically worse than they are today. Also the opioid initiatives are proving to be quite effective, and I would expect them to increase geographically throughout the country and in effectiveness.
If you would like more information or would like to discuss these ideas in more detail, please get in touch with your KPMG contact or me.
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