The Coming Crisis.
Like the so-called "millennium bug," some crises can be averted. Now another one is threatening the insurance industry and its business customers, this time in the workers' compensation line.
To understand the scope of the problem, we first must recognize it as we did with Y2K. That means looking at numbers. The National Council on Compensation Insurance projects that the combined ratio of the worker's comp line for accident year 1998 is about 122. The early estimate for the 1999 combined ratio seems to exceed that.
This would prove disastrous for a line that traditionally loses money when the combined ratio--after tax and including investment income--surpasses 112. Investment income can go only so far to offset inadequate underwriting.
The situation looks worse going forward. We'd gotten comfortable with declining loss costs, but now both indemnity and medical costs are rising at about 7% or 8%. Workers' comp rates have been virtually flat, although they are beginning to rise. Without dramatic change, accident year 2000 could approach a combined ratio of 130.
If that isn't a crisis, I don't know what is.
Some insurers may have been shielding themselves from the full impact of the line's deterioration by booking reserves far lower than expected claims. Good margins permit companies to do this for a while.
But rising medical and indemnity inflation and excruciatingly low rates for workers' comp are not temporary situations, so reserve margins will not buffer them for much longer. The National Council on Compensation Insurance says prior-year loss reserves have dropped by an average of $2.1 billion a year for the past four years, equal to a 13% aggregate reduction on the industry's $66 billion loss reserve base.
Some companies need to replace those reserves, and insurers' failure to adequately address actual loss costs presents a skewed picture to the world that makes it more difficult to obtain adequate rates.
Today's combined ratio is at or even higher than insurers experienced in the late 1980s and early 1990s, when the industry used words like "death spiral," "disaster" and "Armageddon" to describe workers' comp.
The drivers for today's crisis, though, are different. Unlike that earlier period, loss cost inflation has been relatively low. The economy has been booming. Residual markets are virtually nonexistent. Rate indications have been fairly stable. And legislative reforms won in that last crisis have been holding.
This time, the drivers are simply excess capacity and extreme competition. Too many companies chasing too few customers have driven prices down 25% or more below filed rates or loss cost levels, particularly for midsize to large employers. For small employers, insurers have developed more aggressive dividend plans and rate deviations. And there are more niche players than ever before.
In short, as cartoonist Walt Kelly once said, "We have met the enemy and he is us."
The industry is starting to revise prices upward. Many insurers are taking earnings hits on their balance sheets, citing workers' comp as a major driver.
Operating losses in this line are hurting the share prices of our industry. Some companies are acting to change that, but it's painful. A company that dropped prices 50% below published rates to gain business must now increase prices 100% to get back to square one. Factoring in inflation, an adequate rate increase could be as much as 110%.
In workers' comp, we need to refocus our attention on indemnity and medical data each quarter--perhaps each month--and make appropriate rate and underwriting changes immediately. This is where technology, especially data warehousing and data mining, can provide current information at a very detailed level and help us isolate problems and address them quickly. Technology also can help improve our ability to identify fraud.
We also need to work with trade associations and rating bureaus to educate policyholders and lawmakers about the scope of this problem, making it easier for us to take steps to remain a healthy industry and keep markets open.
Finally the industry must resolve to set and keep prices where they need to be, despite efforts by some groups to thwart this. For example, the California Applicants'Attorneys Association, a workers' comp plaintiffs attorney group, accused insurers of hyping the need for rate increases and urged its members to shop around for deep discounts from insurers wishing to "bump up premium" revenue irrespective of risk.
Just as we averted a computer crisis as 2000 began by recognizing it and taking action, we must act now to prevent a workers' comp crisis. We can fight a skirmish now--or a war later. It's our choice.
Richard J. Quagliaroli, a Best's Review columnist, is president of Hartford Commercial, Hartford, Conn.
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|Title Annotation:||workers' compensation insurance|
|Author:||Quagliaroli, Richard J.|
|Article Type:||Brief Article|
|Date:||Apr 1, 2000|
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