Workers' compensation cover is becoming increasingly hard to find in the private market. By Phil Zinkewicz.

Three years ago, California had a thriving workers' compensation insurance marketplace, one in which competition was fierce among voluntary market insurance companies. Today, there are only two or three insurers actively writing workers' compensation insurance in the state, and workers' compensation risks are swelling the state fund residual market. That scenario apparently reflects what is happening in other parts of the US as well.

When the soft market in the US began turning in the year 2000, it was doing so pretty much on a line-by-line basis. Workers' compensation was among the few lines to see rate increases and coverage restrictions. Had this situation run its natural course, today workers' compensation insurance would be an expensive proposition, but there likely would still be many markets available. However, the terrorist attacks of September 11 exacerbated the position of an already troubled workers' comp market.

Peter Burton, of the National Council on Compensation Insurance (NCCI), said the NCCI has been monitoring weekly residual market activity in the 20 states where the Council manages residual markets since September 11. (Residual markets are set up by state law to write compensation business when exposures can't obtain coverage in the private market.)

"In the first three quarters of 2001, the premium bound in the residual markets that we manage grew by 90%," said Mr Burton. "That pattern continued in the three months after the September 11 terrorist attacks. However, a significant increase is now becoming apparent in the premium bound for coverage from applications submitted on and after 1 January 2002. In six out of the first eight weeks of 2002, NCCI has bound more than $10m in assigned risk premium each week. In 2001, NCCI bound more than $10m in one week only once during the entire year, including the time after September 11. This premium increase is being funded by larger accounts seeing coverage in the residual market."

Difficult coverage
In other words, employers are finding it difficult, and in some cases almost impossible, to obtain workers' compensation coverage in the private marketplace. But why? Is it the result of September 11 or general market conditions? The answer is probably both. September 11 brought home to workers' compensation insurers the reality of having a significant number of workers in a given area. The industry is not only receiving workers' compensation claims from people injured in the World Trade Center attack, but also from people in surrounding places of employment. Many of the claims being submitted cite extreme trauma as the complaint.

"September 11 will result in a significant number of workers' compensation claims for both death and injuries incurred in this catastrophe," said Burton. "It is estimated that workers' compensation losses directly attributable to September 11 range from $3bn to $5bn. The scope of this catastrophe impacts the entire workers' compensation system, including workers' compensation bureaus and insurance providers worldwide. These attacks, including the recent anthrax biochemical incidents, raise many issues, which are not yet resolved."

In addition, both large and small workers' compensation insurance companies are experiencing unsettling challenges to their business thanks to the lack of reinsurance coverage in the wake of September 11. The National Association of Independent Insurers (NAII) has warned that the lack of reinsurance and the fact that workers' compensation policies are not permitted by state law to have terrorist exclusions could lead many companies to re-evaluate their strategies for offering workers' compensation cover, causing some to drop the business altogether.

"Without federal backstop legislation, all insurers are facing the problem of reinsurance unavailability, and smaller and medium-sized companies certainly face the same problem" said Nancy Schroeder, NAII assistant vice president, workers' compensation. "A major chemical, nuclear or biochemical attack could put any company in financial jeopardy without the protection of reinsurance. Some of the smaller and medium-sized companies may simply be hesitant to put their own surplus at risk. These companies will take great precautions and could even withdraw from the market if they feel it necessary to protect their own financial health."

Schroeder added that other "twists" in assessing new risks have emerged since the war on terrorism began. "Before September 11, most people thought of employees in factories or on construction sites as the most likely workforce to sustain injuries, and therefore generate losses," she said. "Today, the major concern is about white-collar office workers in large urban areas where a terrorist attack would have the greatest impact."

But it would be a mistake to attribute all of the workers' compensation industry's woes to the terrorist attacks. That horrific tragedy only added to an already dire situation. For example, the NCCI reports that as of 1 June 2001, five pool participating companies of the NCCI with aggregate obligations of $105m were insolvent. Another carrier, with obligations of $74m, is currently under regulatory supervision and rated E by AM Best. In addition, federal black lung regulations, currently being contested in federal court by the American Mining Association and the insurance industry, hold the possibility of adding an additional $170m in unfunded liabilities to the workers' compensation pooling mechanism.

High service standards
While the residual markets are right now nowhere near historically high levels, NCCI is acting to ensure that policyholders, producers and insurers continue to receive the best possible service, according to Burton. For example, state agent trade associations and insurance regulators are increasingly using the NCCI's online residual market application, RMAPSSM Online Application Service. The online system is intended to bring considerable savings to the residual markets by streamlining the submission of applications and speeding up application processing. Also, where permitted by state regulation, NCCI provides online access to assigned expiration lists. Producers and carriers can view expiring account lists to find coverage for these accounts in the voluntary markets.

Nevertheless, despite these efforts, it appears that there is definitely a retrenchment on the part of workers' compensation carriers. Recently, the Pasadena, Cal-based PAULA Financial announced that its underwriting subsidiary, PAULA Insurance Co, has voluntarily ceased writing workers' compensation business. Debbie Maddox, vice president of investor relations for the insurer, said that the company will no longer write the coverage in the nine states in which it had been operating - California, Arizona, Oregon, Idaho, Alaska, Florida, Texas, New Mexico and Nevada. She said the decision to cease writing business was more a function of conditions in the California marketplace than of September 11.

California comp
In making the announcement, Jeff Snider, PAULA's chairman and chief executive officer, said the decision came as a result of reserve developments primarily from claims relating to accident years 1997-1999 on California's workers' compensation business.

"PAULA Insurance would be a remarkably attractive platform to complement the company's agency and TPA businesses, save for its small capital base," he said. "Steps taken in recent years to work with quota-share reinsurance partners have been very effective, reducing leverage and protecting infrastructure as pricing normalises and underwriting margins return to positive territory."

Mr Snider said that the company began actively seeking new financing starting late summer 2001 in anticipation of sustainable improving underwriting trends, particularly in California. "Our poor underwriting results for prior periods, not surprisingly, have had the effect of reducing outside confidence levels in what we believe to be exciting current and prospective patterns in core underwriting classifications." However, Mr Snider added: "Reinsurance instability following September 11, uncertainty about the California environment and its largest writer of workers' compensation - the State Fund - the apparent ripple effect of Enron on actuarial conservatism, and a significant change in legislated benefits for injured workers in California, all equate to very expensive, scarce new capital.

"We have worked hard to maintain a great deal of transparency regarding the condition of the insurance company with regulators in California, rating agencies and our reinsurers," continued Mr Snider. As a result, the company decided "to exit underwriting."

PAULA Insurance Co will post an increase to prior year reserves of $37m for the fourth quarter of 2001, consistent with the best estimate selection of the company's outside actuaries, said Mr Snider. This reserve increase will cause the company's risk-based capital to fall into the "mandatory control level." For the time being, the company will be permitted to administer claims settlement run-off of PAULA Insurance. Rating agency AM Best is expected to "take appropriate steps" to adjust the rating of the company to reflect this current development, according to Mr Snider.

The PAULA Insurance Co scenario reflects in microcosm what was happening to the workers' compensation industry prior to September 11. In times past, when the buyers of workers' compensation insurance faced tightening markets, they turned to alternative risk mechanisms such as self-insurance and/or the formation of captives. These approaches are likely to resurface in the current hard market. However, it should be remembered that the current hard market, which mirrors the last one of 1984-1985 in its intensity, is different in that much of it is due to a single and very unexpected event.

Keith T. Bateman, vice president and director of workers' compensation and health for the Alliance of American Insurers (AAI), speaking recently before an NAIC hearing on workers' compensation, put the matter into perspective in terms of both insurers and buyers of workers' compensation products and services. "Even before September 11, the insurance industry was struggling with how to deal with an environment in which the severity of indemnity and medical costs was increasing significantly," said Mr Bateman However, he added, "the aftermath of the events of September 11 have compounded the difficulties faced by the industry, and the full cost of the tragic events of September 11 for workers' compensation insurers may not be known for years. Carriers are concerned that claims for mental injuries or latent diseases may be filed for years into the future. And, to the extent that foreign nationals are victims of the World Trade Center or of similar attacks, insurers may face pressures, not only from domestic agencies, but foreign governments as well."

Mr Bateman said that the most immediate concern for workers' compensation insurers is what is happening or "not happening" in the reinsurance market regarding coverage for acts of terrorism or war. He said that reports range from those stating that catastrophe coverage for workers' compensation is drying up, with reinsurers excluding all coverage for such acts, to others who say that some coverage is available for much lower limits.

Rewriting the rulebook
Moreover, Mr Bateman said that the "normal underwriting rules" for workers' compensation are being rewritten in light of September 11. It has become difficult to determine what an employer's obligations are before an event occurs. "Employers are obligated to cover workers' compensation liabilities arising out of and in the course of employment. But that meaning varies from state to state," Mr Bateman said. "Moreover, the industry cannot be sure that the case law that exists the day before a terrorist act will continue to apply after such an attack. Employers are being asked to cover things they never thought about, such as covering testing and prophylactic treatment for workers alleging exposures to anthrax who have no symptoms of the disease." He said it would take time for insurers to adjust to the changed environment. So the workers' compensation situation in the US today is an enigma. On the one hand, problematic market conditions can work themselves out in time and in the past generally have done. On the other hand, September 11 has changed all the usual rules that apply to market cycles.

By Phil Zinkewicz
Phil Zinkewicz is a re/insurance journalist based in New York City.