The voluntary reduction in exposure to the workers' compensation line by the two largest comp insurers—Liberty Mutual and AIG—at a time when there is increased appetite for business in other property and casualty insurance lines is an ominous development. Does this signal that a crisis is imminent for the U.S. workers' compensation insurance system? Are there measures that could forestall an impending crisis?
Because workers' compensation insurance is mandatory for most employers in most states, the businesses rejected by the largest U.S. carriers will need to find coverage. This is likely to increase the size of assigned risk pools and state insurance programs. Already, California and New York—the state governments, that is—are among the nation's top workers' compensation insurers by premium volume.
The premium share of the residual market decreased from 13% in 2004 to 6% in 2008. One factor in this decrease is the state of the economy, particularly the housing market. Construction businesses represent the largest segment of the residual market. The National Council on Compensation Insurance (NCCI) has also worked very hard, utilizing reinsurance and credits, to reduce the size of the residual market, which has a combined ratio of 115%. A pull-back in workers' compensation underwriting from the two largest private carriers could undermine these efforts.
In New York, the percentage of the workers' compensation market by premium volume held by the New York State Insurance Fund increased from 38.5% in 2008 to 41% in 2009. The California State Insurance Fund has long been the largest provider of workers' compensation insurance in California. In the midst of a budget crisis and various issues with the state insurer, then-governor of California Arnold Schwarzenegger proposed selling a portion of the workers' compensation insurer. The state funds face the same investment return and other issues as the private carriers. Additional increase in the number of businesses covered by the various state-funded workers' compensation insurers would likely also increase budget pressures at a time when states are already severely financially constrained.
Death Rattle or Just a Hiccough?
Despite all of the issues confronting the workers' compensation insurance market, premium rates continue to decrease. Consistent with the overall soft market in the property and casualty insurance underwriting cycle, workers' compensation premium rates declined an average of 5.3% in the third quarter of 2010. A portion of the capacity that is driving the prolonged soft market includes reserve releases. A typical risk of such soft markets is that the remaining reserves will not be adequate for the exposures underwritten. An increase in insurer insolvencies can occur under those conditions.
These factors all provide pressure on the state system of workers' compensation that has been in existence for more than a century. The system cannot adequately function without a robust private insurance market. Especially during these difficult economic times, state budgets could probably not withstand any additional funding pressures for workers' compensation benefits. Can anything be done to prevent the market that NCCI has called "precarious" from entering a crisis?
If we could get a sustained economic recovery, some of the conditions facing the workers' compensation insurance market would improve. Premiums, which are based on payroll, would increase as hiring picked up. If the unemployment rate were to decrease, transitional and permanent return-to-work opportunities should increase. Christopher J. Colavita, senior vice president of NJM Insurance Company, says that his company weathers economic storms and cyclical underwriting phases by practicing fundamental underwriting and claim discipline.
The proverb that opportunity coexists with crisis also presents possibilities for the workers' compensation system. This may be the time for innovation in areas such as rehabilitation of injured workers, ergonomics in the workplace, and employer-sponsored wellness programs. Although these types of programs are often the first to be cut during lean economic times, investments in these areas may provide both short-term solutions and, more important, a more stable long-term foundation for the current state-regulated workers' compensation system.
Judith Vaughan, CPCU, AIC, is director of Content Development for The Institutes.
