A workers' compensation marketplace that was already in a tailspin at this time last year continues to try to right itself in the aftermath of the events of September 11. Those catastrophic events have brought new complexities, raised new underwriting issues and generated huge losses for reinsurers. All this has been superimposed on a market grappling with years of adverse experience created by product underpricing. This article will take a look at market conditions and provide some suggestions that might help keep your premium increases to a minimum.
Factors behind the Hard Market
The National Council on Compensation Insurance (NCCI) estimates the 2001 accident year combined ratio to be 127 percent. This ratio (losses and premiums paid in a calendar year) is one of the yardsticks used by the insurance industry to gauge the profitability of workers' compensation insurance for a given year. A combined ratio below 100 percent is indicative of an underwriting profit. Although 127 percent is not a great result, it is an improvement over 1999 and 2000 when the accident year combined ratio was 137 and 133 percent, respectively. On the surface, this figure would indicate that loss experience on the product line is improving, but these statistics do not reflect a couple of important factors that will impact the actual pricing forecast for the line.
According to NCCI, the 2001 accident ratio is likely to go up only 1-4 points as a result of September 11 workers' compensation claims, since the vast majority of the losses were ceded to reinsurers. The future pricing of workers' compensation insurance will certainly be driven in part by reinsurers looking for some way to recoup these losses. Also, both indemnity and medical claim costs continue to escalate and, unless brought under control, workers' compensation costs and ultimately pricing will continue to increase.
In addition to creating large reinsurance losses, the workers' compensation terrorism exposure revealed by September 11 has produced new underwriting concerns that have led to many reinsurance treaties excluding terrorism. Underwriters and reinsurers are looking at their aggregation of exposures at any one site and shying away from employers with concentrated work forces in high-rise buildings.
Unlike some of the other lines of insurance, workers' compensation is statutorily based, and insurers are not free to deviate from what the state statutes require to be covered. The only state whose statute provides a possible exclusion for losses resulting from terrorist activity is Pennsylvania, where Section 301(a) of the Workers Compensation Act excludes losses resulting from "enemy sabotage from a foreign power." On the other hand, some 30 states will not allow workers' compensation terrorism exclusions: Alaska, Arkansas, California, Colorado, Connecticut, Florida, Georgia, Hawaii, Kansas, Kentucky, Louisiana, Maine, Massachusetts, Michigan, Minnesota, Missouri, Montana, Nebraska, New Hampshire, New Mexico, New York, Oklahoma, Oregon, Rhode Island, South Dakota, Tennessee, Texas, Utah, Vermont, and Wisconsin.1 Illinois has approved a terrorism exclusion for use on excess workers' compensation for self-insured employers, but excess workers' compensation insurance is optional for individual self-insureds.
While primary insurers cannot exclude terrorism, their reinsurers can and are doing so. The inability to cede some of the risk to reinsurers has led many insurers to decline to write employers perceived to be especially vulnerable to large losses in a terrorism attack. For example, employers in major cities with large concentrations of workers in high-rises historically, an easy-to-place, low premium and exposure risk are finding renewals problematic for the first time.
Self-insured employers and captives are encountering similar problems with their excess workers' compensation insurance or reinsurance. In some cases, excess insurers are excluding terrorism. In others, they are imposing a policy limit rather than having a statutory benefit limit ( in some cases, a statutory benefit limit is offered but at high premium cost). This may drive some self-insureds back into the voluntary or residual markets where statutory limits can be procured at a more reasonable price.
As with other lines, workers' compensation pricing is up. How much of an increase an insured can expect is driven by type and location of risk, and by loss history. Increases are in the 10-50 percent range, with the majority at 20-30 percent. Those accounts with excellent loss histories can expect a lesser increase, and those with a poor loss history will be at the high end if the insurer chooses to offer renewal at all. Some insurers have made deductibles mandatory.
When the workers' compensation market has hardened in the past, employers have explored alternate ways to handle their risk. For the most part, this market is no different. However, self-insurance, normally one of the more common alternatives selected, is not as desirable this time because of problems in obtaining adequate excess workers' compensation insurance and a tight market for the surety bonds often used to satisfy state requirements to collaterize self-insured retentions.
Thus, employers are exploring captive insurance programs in various configurations, including individual, association and broker-sponsored groups. Some of the more successful programs have exit provisions making them look, smell and feel more like an insurance company. Many offer coverage without risk of assessments should the experience of the group deteriorate. One problem with captive approaches is that reinsurance costs, and especially fronting fees, have gone up dramatically, so there isn't as much of a price advantage as there once was. However, these alternate risk mechanisms do offer employers the opportunity to exert more control over the various facets of their risk management programs.
State residual market mechanisms are at the other end of the continuum of options. Residual market premiums began to rise in 2000. That trend has accelerated this year and will likely continue for the foreseeable future since the residual markets must offer statutory limits to policyholders. Consequently, they offer a refuge of sorts not only to employers who have been declined by the voluntary market, but also those who have been unable to secure statutory coverage through an excess policy for a self-insured program and have decided to return to the traditional marketplace.
There are some drawbacks to using the residual market. For multi-state accounts, there will be the additional administrative burden of working with multiple insurers in various states. The coverages offered by the funds are basic, and the other states coverage (workers' compensation benefits for an organization's employees when they are traveling through or working temporarily in states other than the organization's home state) offered by the funds is not uniform in wording or as comprehensive as that provided by the NCCI policy used in the voluntary market. At least one state, Florida, has an assessable fund that allows policyholders to be charged for deficits the fund may experience.
Even though the insurance industry will be greatly affected over the long term by the financial markets and occurrence or nonoccurrence of man-made or natural disasters during the coming months, the foundation for the next 6-12 months has already been laid. While some slight easing may occur, a generally tight insurance market can be expected well into and perhaps beyond 2003. Thus, risk professionals should prepare for higher premiums, higher deductibles, reduced coverage and less available policy limits.
1 Based on information from reports published by Safety National and the International Association of Industrial Accident Boards and Commissions (IAIABC).
Sidebar: Survival Tips
What can you as a risk management professional do to control the impact of rising workers' compensation costs? First and foremost, you need to get back to risk management basics. Below are some tips that might help you minimize the impact of the tough workers' compensation market.
- 1. If you have a great safety and loss control program, document it succinctly and clearly for your underwriters. If you don't have a great safety and loss control program, get senior management commitment to put one in place.
- 2. Develop a comprehensive database for the past 5 years. Include claims, payroll and other needed underwriting data.
- 3. Review your claims information to assure it is correct and up to date. If there have been frequency or severity problems, describe steps taken (e.g., loss control program) to address the problem.
- 4. Pay particular attention to reserves on open claims. Meet with adjusters to review any that appear questionable. If the activity, reserve or expenses on open claims during the past 12 months have significantly increased during the past 12 months, consider commissioning a claims audit.
- 5. Check your experience modifier calculation to make sure it is correct. Prepare a test modifier well in advance of your renewal.
- 6. Analyze your concentrations of risk by location, and be prepared to show underwriters plans for dealing with catastrophic events that can affect major locations. If a small piece of the company is causing underwriters a lot of concern, consider carving out that particular operation and securing separate coverage or lower limits.
- 7. Prepare a high-quality, thorough underwriting submission using the data and information discussed above. Include a great deal of detail, using it to distinguish your account from others.
- 8. Begin the renewal process early at least 4 months prior to the anniversary date.
- 9. Carefully evaluate the marketplace and approach only those insurers that are most likely to be interested in your risk profile. If you decide to seek quotes from more than one agent, assign markets (insurers) to the agents based on their volume of business with each insurer and the profitability of their book for the insurer (to the extent possible).
- 10. Even though you prepare and submit your renewal submission several months out, be prepared for last-minute quotes. Make sure that you are in a position to quickly analyze the alternatives offered, have a contingency plan in place in case the terms are unacceptable, and be able to access all necessary decision makers as soon as you receive the renewal quotes.
- 11. Analyze your risk retention capability and prepare to assume higher deductibles or move into a loss-sensitive insurance program.
- 12. Determine your minimum liability limits requirements in case you need to reduce limits because of lack of capacity or unacceptable pricing. Don't forget to consider your contractual commitments.
- 13. Communicate, communicate, communicate! Work closely and carefully with your agent. Meet personally with the underwriters and review your company's risk management program, financial position and business plans for the coming year.
- 14. Proactively demonstrate the reliability of your company's financial statements to underwriters, particularly for directors' and officers' liability insurance. Consider involving your CFO in these discussions.
- 15. Explore the feasibility of using a single parent, group, or protected cell captive insurance company to cover your liability exposures.
- 16. Develop a strategy for dealing with terrorism exclusions. Be sure to determine if contracts with lenders, customers or other business partners require you to purchase terrorism coverage.
- 17. Carefully review the financial position of your insurers to assure that they are likely to be around when you need them. At a minimum, review the 3-year trends in A.M. Best's Ratings and Standard & Poor's Ratings.
- 18. Be diligent about obtaining certificates of insurance from all contractors, subcontractors, suppliers, vendors and other business partners.
- 19. Prepare senior management for higher premiums and deductibles. They don't like surprises.
About the author: Christine Fuge is the author of IRMI Workers Compensation Insurance Guide, and is the principal research analyst for IRMI Workers Comp., A Complete Guide to Coverage Laws and Cost Containment. Additionally, she is coauthor of the IRMI Cancellation Guide. She received her BA degree, cum laude, from Southwestern University and her MS degree from the University of Texas at Austin. Fuge is a Chartered Property Casualty Underwriter (CPCU). Before joining IRMI, she served as a risk manager for a Fortune 200 corporation and held the position of assistant vice president with an international insurance broker where she coordinated service delivery to large multinational accounts.