The hardening market for workers' compensation cover is focusing risk managers' and insurers' minds.

After years of declining prices in a feeding-frenzy market, risk managers and workers' compensation insurers have realised that inadequate rates – and the unacceptable financial results that they produce – cannot continue.

The end of the 1990s saw a return to combined ratios exceeding 120% for workers' compensation, a repeat of the results of the late 1980s when the line was frequently described as being in a state of crisis. A hardening market is now replacing the days of intense price competition, when many insurers cut prices below cost to maintain market share and when risk managers saw average premium decreases of 7% per year.

New market conditions require risk managers and insurers once again to focus on the basics – controlling the true cost drivers of workers' compensation through effective underwriting, superior loss prevention and aggressive claims and managed care (see figure 1). Understanding trends in each of these areas will help risk managers effectively manage risk in the new workers' compensation market.

Recent history
The workers' compensation market of the late 1980s was a crisis for both insurance buyers and writers. Prices rose dramatically in response to rapidly increasing loss costs, particularly medical inflation. At the same time, benefits expanded in reaction to increased reliance on the workers' compensation system, and the residual market grew quickly, placing a huge burden on the voluntary market. As a result, workers' compensation insurers saw profitability deteriorate quickly as rate increases within the highly regulated system did not keep pace with rising costs.

The early to mid-1990s saw an improvement. The cost of workers' compensation began to fall in response to deregulation of prices, effective state reforms, slower growth in claim costs, decline in claim frequency, and aggressive adoption of managed care tools and techniques.

Improving results led – once again – to intense price competition. Pricing discounts sprang from the overcapacity in the industry, as an abundance of capital chased a relatively stable demand. This intense price competition led to declining financial performance for many insurers.

The past 18 months have seen a gradual hardening of the market. In a softer workers' compensation market, with employers enjoying rock-bottom pricing, the core disciplines of risk management sometimes deteriorated.

Today's harder workers' compensation market is returning risk managers and insurers to solid underwriting, loss prevention, and claims and managed care practices. Understanding trends in each of these areas will help risk managers deliver solid results in this new market.

Underwriting trends
At the end of the last decade, most companies did not have an incentive to update their workers' compensation programs. Prices had been decreasing or flat for many years, and coverage was easy to come by. Today, however, workers' compensation has changed. Risk managers are noticing the following underwriting trends:

  • continued hardening – the factors that led to the softening of the workers' compensation market in the early 1990s have either run their course or are moving in the opposite direction. Efforts at state reform have finished, and there are few new reforms pending. Claims costs are growing as the cost of workers' compensation medical benefits and the average age of the workforce have increased. Managed care initiatives have become more common, but some of the medical privacy issues may make it harder to effectively manage claims;

  • increasing use of alternative programs – a hardening market has renewed employers' interest in higher retention levels. Demand for higher dollar deductible programs and other alternative risk financing mechanisms are increasing in response to higher premiums. Companies are reexamining their risk programs to find the right level of risk to retain. Risk managers are finding middle excess layers and moderate aggregate limits more appropriate solutions to all-or-nothing risk positions. As organisations retain greater levels of risk, they tend to more effectively manage that exposure, dropping costs;

  • growing interest in integrated disability management – all sizes and types of companies are looking at these programs, which typically include two distinct components; workers' compensation coverage combined with a short-term and long-term disability program that includes proactive disability management for both occupational and non-occupational illness and injuries. When implemented effectively and for the right organisation, risk managers may see improved claim results, some administrative efficiencies, consolidated reporting, improved return-to-work outcomes, and elimination of claims double-dipping.

    As recognition of the real cost of employee absence has grown, there has been an increasing demand for programs that comprehensively manage this issue. Integrated disability management programs will continue to expanded to manage federally mandated Family Medical Leave Act and sick time.

    Loss prevention trends
    Most companies want to eliminate injuries and provide their employees with a safe working environment. The common goal is to prevent the human and financial costs of workplace accidents. The hardening market is placing even greater emphasis on workplace safety.

    Several emerging loss prevention trends include:

  • . Benchmarking – Employers are starting to compare safety performance against other companies in their industries. Employers are looking to insurers and brokers for benchmarking data. Recently, the Liberty Mutual Workplace Safety Index provided the first-ever ranking of the leading causes and costs of workplace accidents. The index provides a valuable tool to help compare performance and to focus employers on those workplace safety accidents that have the greatest potential impact (figure 2).

    In addition, Liberty Mutual provides its middle market policyholders with detailed reports that track loss performance, outline ways to improve that performance and compare the company's loss results to the aggregate performance of other Liberty Mutual policyholders with the same standard industry code.

  • Changing workforce demographics – The aging workforce is impacting how companies manage risk.

    To some degree, older employees are less likely to take risk. In addition, they tend to work with lower physical stress and more efficiently. However, if an injury does occur, the extent might be greater and the length of disability longer. Employers will need to plan safety and health services to meet the needs of an older workforce.

    At the same time as the workforce is aging, new employees entering that workforce are given responsibility at an accelerated pace, causing them to change jobs more often. One recent study showed that employees are 40% more likely to be injured in the first year of a job. Accordingly, training programs will play an even greater part in employers' safety programs.

  • More non-traditional employee relationships – The relationship between employees and the companies that hire them continues to change. Companies and individuals are shifting from the traditional model of full-time employees with long-term careers with the company. Part-time, contract and vendor-provided employees will continue to grow as a percentage of the workforce. At the same time, more employees are working away from a company's facilities, including at home. Both of these trends are challenging companies to provide safe working conditions.

  • Increasing role of professional safety management – With changes in employee demographics and relationships, the need for advanced safety management is greater than ever. Engaging the participation and insight of employees is critical to the evaluation, analysis and control of workplace hazards. Safety programs must solicit and support employee involvement as well as provide feedback on performance.

    Claims and managed care
    Risk managers are experiencing changes in claims and managed care as insurers leverage technology, medical inflation grows, and the protection of medical privacy becomes an issue. Four of the major trends in claims and managed care are:

  • Managing claims based on severity – All claims are not created equal. The largest dollar exposure comes from a very low percentage of lost time cases. Increasingly, claims are segmented by severity and sent to the professional talent best suited to manage the specific claim. Insurers are using loss profiles to identify those claims likely to be severe and strategically applying advanced claim techniques to control these losses. Such an approach reduces both the financial and human cost of workplace accidents.

  • Rising medical and pharmaceutical costs – Recent increases in medical costs are likely to continue in the near-term, potentially impacting the medical loss portion of workers' compensation programs. During the 1990s, medical cost increases hovered around 0% to 3%. In the last few years, increases have been in the 7% to 10% range.

  • Continued investments in technology – Technology is critical to support effective workers' compensation claims management. Risk managers can expect insurers to provide increasing access to more detailed and customised claim information that will help them evaluate their internal programs and better manage risks.

  • Protecting individuals' medical privacy – Potential improper use of and access to an individual's medical record has become a growing concern. As federal and state governments try to develop rules and laws to protect medical privacy, there is a risk that the workers' compensation system will be harmed, particularly integrated disability management programs, which combine workers' compensation and short-and long-term disability.

    The hardening workers' compensation market provides risk managers with many challenges and opportunities. Successful risk managers will partner with insurers to develop risk management programs based on the realities of the new market. The most successful of these programs will leverage trends in underwriting, loss prevention and claims and managed care.