The fallout of the debacle of the Unicover workers' compensation reinsurance pool will force primary writers to “eat more of their own cooking”, but a broad and sustainable market hardening looks unlikely. Ron Frank reports.
Deteriorating loss trends, years of aggressive pricing and the looming evaporation of cheap reinsurance paint a bleak picture for workers' compensation results. However, while some of the most egregious competitive behaviour seems to be receding, a dramatic hardening is not yet in sight.
Workers' compensation is the largest US commercial insurance line, but total premiums contracted at a compound annual rate of 5.3% to $23 billion during the five year period ended in 1998. A number of factors contributed to the premium decline: 1) increasing use of large deductibles; 2) migration to self-insurance by certain large employers and group purchasers; and 3) price competition spurred by reducing loss costs.
An absence of claims cost inflation since 1991 reflected moderating increases in medical care costs and declining frequency during much of that period. The rate of occurrence is down substantially from its 1990 peak and continued to improve in 1997, the most recent available data. Declining work related injuries and illnesses coupled with heightened anti-fraud measures have contributed to a decline in claims frequency, and a greater emphasis on workplace safety has had a direct impact. That said, a near term flattening or reversal of this trend, if not already in place, would not be surprising, in our view, given the greater numbers of unskilled workers being employed in a strong economy.
However, other signs are somewhat troubling. The data appear to suggest that incremental benefits from workplace safety and anti-fraud efforts are behind us. Medical care inflation has increased for the first time in eight years, which confirms a trend evident throughout the healthcare industry; it has become increasingly difficult to wrong costs out of the system.
In 1998, the calender year pure loss ratio deteriorated for the first time in seven years, and we believe that loss costs are not likely to improve near term. Severity in both the medical and indemnity (wage loss) components, if not increasing, is flat at best. Average indemnity costs in 1996 returned to their 1991 peak and increased again in 1997, the last year for which data is available.
Partly offsetting this was a continued contraction in frequency, at least through the 1997 accident year. However, the National Council for Compensation Insurance (NCCI) is painting a bleak picture of ultimate accident year combined ratios: 108%, 115% and 121% in 1996, 1997 and 1998 respectively.
Meanwhile, the fallout from the now notorious Unicover, workers' compensation reinsurance facility continues to spread. Three reinsurance pools, managed by Unicover Managers, Inc. allowed life/heath reinsurers to “carve out” risks relating strictly to the health portion of workers' compensation insurance. In theory, this renders what is essentially a casualty product suitable for the life/health market.
The story broke when Cologne Life Re last year announced it was taking a $275 million charge to cover potential losses in its US workers' compensation business, which are generally assumed to arise primarily from Cologne Re's participation in the Unicover facility. Its announced loss, and its pool percentage of 17.5% imply that total core pool losses may ultimately exceed $1 billion and, perhaps even approach $1.5 billion.
The fallout continues to expand. This includes lawsuits, returned premiums, policy recisions actions, suspected claims payments and loss reserve strengthening. Barring a universal settlement, it is likely to be years before this incident is fully resolved.
Prospectively, primary workers' compensation writers will be forced to “eat more of their own cooking” once the first of these multi-year contracts expire, which may be as early as January 2000. However, we continue to question whether an event such as this is sufficient to produce a significant turn in workers' compensation market conditions.
Our reasons: 1) with total projected pool losses approximately only a few months of property catastrophe losses, a broadly based and sustainable market hardening would seem something of a stretch; 2) the property/casualty reinsurance market is still awash in capital and, by all appearances, anxious to write business; and 3) the alternative markets are eagerly waiting in the wings to capitalise on any backlash to price firming in the traditional market.
Ron Frank is property/casualty insurance analyst with Salomon Smith Barney, New York. E-mail:firstname.lastname@example.org.