AFTER enduring several consecutive years of deterioratingresults, the workers compensation insurance system is showing signsthat it may be on the mend. The industry's calendar-year combinedratio, after rising for five straight years to 122 in 2001, droppedto 111 in 2002, according to figures released last year by theNational Council on Compensation Insurance. Estimates of reserveinadequacy also took a turn for the better, dropping to anestimated $18 billion in 2002 following a seven-year climb thatpeaked at $21 billion in 2001. In light of rate hikes that wereapproved last year in many jurisdictions, there is reason to hopethat this spring, when NCCI releases its 2003 estimated results,they will show continued improvement.

Not that all is well with workers compensation insurance. NCCIreported that in 2002 the line suffered a 0.1% pre-tax operatingloss (following a horrendous 7.7% loss in 2001). And given the weakinvestment climate, an NCCI report last year stated that “manycarriers may need a combined ratio of less than 100% to returntheir cost of capital.” Uncertainties also abound, ranging from theeffects of OxyContin on the workers comp system to whether theTerrorism Risk Insurance Act will be renewed in 2005.

To get an idea of what may lie ahead for workers compensation,we recently contacted the NCCI, as well as two prominent workerscomp insurers and two intermediaries. Following are theircomments.

National Council on Compensation Insurance
(www.ncci.com)

As the workers compensation insurance system moved into 2004,Peter Burton, senior division executive for state relations atNCCI, sounded cautiously optimistic. Burton called the stateassigned-risk plans, which provide coverage for businesses thatcannot obtain insurance in the voluntary market, a “barometer” ofindustry profitability. In 2002, the volume in the 20 or soassigned-risk pools that NCCI administers rose to an estimated $1.2billion from $632 million in 2001, according to a report NCCIreleased last year. But Burton said growth has started to flattenin recent months. “The residual market may have peaked,” he said,which would presage better times ahead for workers compensationinsurers.

NCCI files advisory loss costs and, in a few cases, advisoryrates for workers compensation in 38 states. Its filing cycle runsfrom July 1 to June 30. As of last month, NCCI had made 28loss-cost filings, Burton said. Of them, 15 were for increases, 11for decreases, and two for no change. Burton said the pattern offilings was similar to that of 2002. In the current cycle, NCCIsought-and was granted-a 21.2% loss-cost increase in Alaska. Asimilar filing in Kentucky, for about a 20% increase, was scaledback to 13.1% by state regulators. Burton said most of the otherincreases NCCI sought were in the single-digit range. “In mostcases, the recommendations we've made with state regulatoryauthorities have been approved as proposed,” Burton said. “Theyrecognize that the market is changing, that cost pressures.”

Chief among the cost drivers are medical expenses. Years ago,Burton said, they were relatively small compared with indemnityexpenses. “Now it represents as much as 54% nationally of what ispaid out in benefits to injured workers,” Burton said. He addedthat NCCI recently conducted a study of what's driving medicalcosts and determined it to be prescription drugs, particularly suchpotentially addictive and frequently abused pain-killers asOxyContin. “Pharmaceuticals probably represent a little less than10% of the overall cost in medical,” Burton said, “but it's thefastest growing element.” (According to a press release issued inAugust by the National Association of Independent Insurers,OxyContin has become the second-most prescribed drug, in terms ofdollars spent, in the workers compensation system. In the samepress release, NAII's Workers Compensation Committee expressedalarm over the growing abuse of OxyContin, which is said to becapable of producing a heroin-like “high,” and announced itssupport for state legislation “to provide tighter guidelines underwhich the drug may be prescribed and for clearer safeguards once itis prescribed.”)

On the other hand, loss frequency, while leveling out in somestates, continues to decline in others, thanks primarily to acontinuing emphasis on workplace safety. “That's really been thesaving factor for workers compensation costs,” Burton said.

One big unknown on the horizon, Burton said, is the fate of theTerrorism Risk Insurance Act of 2002. The act has helped stabilizethe market by capping the losses insurers could suffer in the eventof terrorist attacks of foreign origin. But TRIA is scheduled toexpire in 2005, and whether Congress will reauthorize it isanybody's guess.

Shortly after TRIA was enacted, NCCI sought and obtainedterrorism loads in all states for which it files advisory losscosts. They averaged roughly 2% of payroll for the voluntarymarket, Burton said, and about a point more for the assigned riskplans. No further loads currently are contemplated, Burton said,adding that NCCI would have to revisit the issue if the TRIAbackstop were removed.

AIG Specialty Workers Compensation
(www.aig.com)

Jim Roberts, president of AIG Specialty Workers Compensation, adivision of American International Group, said he expects 2004 tobe another year of growth. Roberts' division primarily serves smalland midsize businesses looking for guaranteed-cost, first-dollarcoverage. In the year ahead, Roberts said he expects growth to bein the 15% to 20% range, adding that it likely will be fueled moreby increasing payrolls than by continued rate hikes. For theindustry overall, he said he expects workers compensation rateincreases to average 3% to 5% in 2004.

“I think there has been some recognition that the insuranceindustry in general under-priced workers compensation in the late1990s,” Roberts said. As regulators saw some carriers go out ofbusiness, causing hardships for mainstream businesses, manyacknowledged the need for rate increases, he said, benefiting themarkets in their states. He added, however, that there are somestates, “particularly those that will not allow rating flexibility,either up or down from standard rates,” that will continue to bedifficult for carriers to serve. “They are the states that have thecapacity problems,” he added.

Roberts said he doesn't anticipate any downward pressure onrates for the foreseeable future because he doesn't see a lot ofnew capital entering the market. He noted that workers compensationinsurance is a labor-intensive line, due to the significantregulatory data-reporting requirements insurers face. “Quitefrankly, we think first-dollar workers compensation insurance isnot an easy market to enter,” he said.

Until recently, many observers have characterized the currentbusiness expansion as a “jobless recovery,” but Roberts said he hasseen indications of a change. Through 2002 and the first half of2003, his division's workers compensation premium auditscollectively resulted in a return of premium to employers, Robertssaid, a sign of shrinking payrolls. But in the past few months, thecompany has noticed a small but definite change in the outcome ofpremium audits. “We've gone from returning money in aggregate tocollecting it,” he said.

Job growth is not always an unalloyed blessing for workerscompensation insurers, Roberts noted. While it definitely increasespremium volume, it also can lead to higher claim costs. “We seefrequency of claims increasing when you are running unemploymentrates of less than 5%,” he said, adding that he thinks that'sbecause the most marginal workers, who are involved in adisproportionately high number of accidents, are the first laid offwhen the economy falters and the last to be hired when it picks upagain.

Roberts also noted that when an economy gets booming, newbusinesses are established-but not always by people with thenecessary skill and experience. “An inexperienced manager generallywill have more workers compensation claims,” he said. “So in agrowing economy, we generally are a little bit tougher when lookingat new entities.”

Roberts advised agents and brokers to be circumspect whenevaluating such prospects in the year ahead. He also said agentsand brokers should stress the value of early return-to-workprograms to clients and, perhaps not surprisingly given AIG'sfinancial position, to emphasize the importance of placing theirbusiness with top-rated carriers.

Zurich North America
(www.zurich.com)

Continued medical inflation will be one of the major factorsaffecting workers compensation insurance in the year ahead,according to Bob Rheel, senior vice president and director ofworkers compensation for Zurich North America. Like NCCI's PeterBurton, Rheel cited concerns about the increasing costs ofpharmaceutical drugs, especially OxyContin and similarpain-relievers. He also noted that assigned-risk plans in somestates, like New Jersey, are continuing to repopulate. “Basically,rates need to continue to rise to cover inflationary costs,” hesaid.

Rheel said it is hard to characterize the overall regulatoryenvironment. On the positive side, he cited reform efforts inFlorida and California. “But then we're also seeing certain statejurisdictions that are not passing reforms and are beginning tosuppress rates,” he said. Rheel said he doesn't expect anysignificant changes in workers compensation capacity next year,except perhaps for certain areas with above- average exposure toterrorism-related losses. “In particular, in several cities we'reseeing a general pullback from (businesses with) highconcentrations of employees,” he said. “We suspect it will continuein 2004.”

Zurich North America writes workers compensation insurance inall segments of the market. “I would characterize it as a stablebook,” Rheel said. “We're not looking to make changes next year andwe expect to continue to grow.” He said the carrier'srisk-engineering and claims services, along with its extensive PPOnetworks in many states, will enable it to compete effectively.

In the year ahead, Rheel advised agents and brokers to continueto encourage their clients to be proactive in regard to safety andto manage their loss costs. “In particular, those customers thatare active in utilizing PPOs for medical care will attract more ofthe market than those who do not,” he said.

Applied Underwriters
(www.applieduw.com)

Recent turmoil in the workers compensation markets should givestable insurers more opportunities to write business in 2004,according to Carl DeBarbrie, senior vice president of AppliedUnderwriters Inc., a San Francisco-based financial services companyoffering workers compensation insurance and variousemployer-related services through independent agents and brokersacross the country. Applied Risk Services, one of its subsidiaries,is an MGA that underwrites workers comp on behalf of VirginiaSurety, rated A IX by A.M. Best.

DeBarbrie noted that in the past year, a number of workerscompensation insurers, as well as multiline carriers withsignificant workers comp books, have been downgraded by A.M. Bestand other rating agencies. Some have merged with others insurers orhave sold their books of business. DeBarbrie said he expects suchdevelopments will lead to a lot more marketing of accounts in 2004,as producers react to the consolidation and attempt to ensure theirclients are placed with financially secure carriers. Thedowngrades, along with what has been a lackluster investmentclimate, also have obvious implications for insurers, he said. “Ithink the consolidation will really emphasize the necessity ofunderwriting to a profit,” he said.

Even with the economy picking up steam, DeBarbrie said AppliedUnderwriters plans no major changes in its approach to business.Rather, he said, the company views the improved economic outlook as“an opportunity to strengthen our core business” and to focus on“controlled, profitable growth.” He said the company will continueto emphasize the need for agents to provide accurate data oncurrently valued losses and historical payrolls, and in some casesto furnish financial statements.

In general, the company focuses on small and midsize businesses,DeBarbrie said. One of its programs is geared toward companies thatare paying up to $100,000 for workers compensation insurance. Itcan accommodate a broad array of risks, including some of the moredifficult ones, like construction, transportation and certainmanufacturing classes. Another program, which providesprofit-sharing opportunities to clients in a position to sharerisks and control losses, focuses more on large fixed-locationrisks paying $150,000 to $1 million in annual workers compensationpremiums.

DeBarbrie said he doesn't expect the reinsurance market forworkers compensation insurance to soften, as it might for theproperty line, and believes it is likely to remain fairly stable in2004. “In general, the regulatory environment seems a little bettertoo,” he said. “In California, we believe there has been someexcellent movement toward reform. I think you're going to continueto see that in other jurisdictions too.”

PMC Insurance Group
(www.pmcinsurance.com)

“I'm feeling very optimistic,” Greg Malloy, chairman and CEO ofPMC Insurance Group, said when asked about the outlook for workerscompensation insurance in 2004. PMC is a wholesaler that writesworkers compensation insurance exclusively. It operates on anationwide basis, although it derives a quarter of its businessfrom New England and upper New York.

Malloy said he attributed his upbeat outlook to an improvingeconomy, which should result in higher workers comp premiums asemployers begin hiring again, and a workers comp market in whichrates, while perhaps still not adequate, are at leaststabilizing.

“I don't see rates changing much, only minor changes up ordown,” he said. “I also don't see any use of schedule credits ordeviations.”

With the industry's negligible return on surplus, Malloy saidhe's not looking for a lot of additional capital to enter theworkers comp market. But on the other hand, barring unforeseencircumstances, he doesn't expect to see comp carriers leaving themarket in great numbers. “I think we've seen that already,” hesaid. He added, however, that the disappearance of more multilinecarriers could contribute to a contraction in the workers compmarket.

Captives and other so-called alternative markets should continueto prosper in 2004, Malloy said, since most standard carriers stillare not offering options like retrospective rating plans ordividend plans to insureds in the $500,000 to $1 million premiumrange-as they were several years ago.

Malloy said PMC is expanding its staff and putting more peoplein the field in its core New York/New England territory inanticipation of writing more business in 2004. PMC also will lookfor opportunities in other areas where it can bring a new productto the market or otherwise offer workable options. “For example,”he said, “we do a really good job in Florida for those accountsthat are larger and are willing to go on a consent-to-rate basis.”(Under consent-to-rate regulations in the various states, a largeinsured can file an application with state insurance regulators inwhich it consents to a rate that is higher than one the state hasapproved.) He said PMC also recently obtained a retrospectiverating plan with a minimum $150,000 premium that it can offer toqualifying insureds. He added, however, that it remains difficultfor PMC to do business in certain states, including California,Florida and New Jersey, and that he has trouble placingprofessional employer organizations, regardless of where they arelocated.

Malloy said he expects the residual markets to continue to growin 2004. But before agents give up on finding voluntary coveragefor their clients and place them in an assigned-risk plan, Malloyadvised them to contact a wholesaler, which might have access tomarkets that the agent can't otherwise reach. Such an alternativecan mean a lower premium for the insured and a higher commissionfor the agent, he noted.