If workers' compensation insurance were priced and insured at the national level, the continuity and stability of such long-term declines in accident frequency would exert a profound, stabilizing impact on the workers' compensation insurance system. But, of course, it is not.

Accident frequency rates in states such as Arizona and New Jersey have declined appreciably over the past six years, with Arizona recording an impressive 27 percent decline in its frequency rate for all private employers. At the same time, appreciable accident frequency improvement has been elusive in states such as California and Vermont. Indeed, Vermont's accident rate actually increased some 13 percent, on balance, between 1996 and 2002 (latest data available).

At the industry level, the trajectory of accident frequency can be especially pronounced, even within those states recording overall improvement in frequency.

For example, New Jersey experienced considerable deterioration in construction industry accident frequency over the 1996-2002 period, even though the corresponding all-industries' accident frequency measure declined.

In Vermont, the increase in aggregate accident frequency over the 1996-2002 period was 0.4 injuries per 100 full-time workers, but the surge in the accident frequency rate for manufacturing workers was five times that, roughly 2.0 injuries per 100 full-time workers. Due to the backward-looking, aggregate process used in workers' comp rate making, pronounced upswings in a major industry's accident frequency such as that recorded for Vermont manufacturing can adversely affect underwriting experience for a set of industry-related class codes for a number of years before the higher accident frequency is fully manifest in the class-level rate structure.

While many factors can influence the observed accident frequency rate, one of the most important and most cyclically variable is the pace of business activity in a given industry. Construction and manufacturing, due both to their impact on system-wide ratemaking and their volatility, are especially relevant examples.

The extent of state-to-state and period-to-period variability in construction activity is illustrated in Chart 3, using the growth of construction employment, which is a good proxy for the pace of economic activity in the sector.

Over 1999-2000 (now the central part of the loss experience time span for states' workers' comp ratemaking), California's construction employment expanded at an exceptionally strong 19 percent annual rate almost twice the national average growth. While this growth subsequently slowed, California has maintained positive growth over the entire 2001-2004 period, while nationally, construction employment has been flat.

In contrast with California, construction employment growth in New Jersey never reached such lofty heights in the late 90s. However, it has continued to grow through the recent recession and is forecast to expand at a 2 percent rate over the next three years. Vermont, on the other hand, has paralleled the national average by dropping to a negative growth status in 2001 and is projected to remain soft through 2006.

In construction, as in other sectors, rapid production growth often exerts a detrimental influence on occupational accident frequency, and through it, on incurred workers' compensation loss experience. This negative impact flows through a number of employee characteristics and working condition factors.

Consider, for example, that to meet the increased demand in periods of strong growth, employers will hire from a more shallow pool of workers who often lack experience, or rely more heavily on overtime both known contributors to workplace accidents.

In Vermont, for example, the fraction of construction employees on the job for less than a year jumped markedly in 1997 from less than 10 percent to more than 25 percent as construction activity surged, and it remained quite high through 2000. The construction industry in New Jersey, however, experienced a modest decline in the fraction of new job entrants falling from around 19 percent to roughly 13 percent despite continued strong construction activity.

Periods of strong construction activity can also produce an increased use of overtime hours. Vermont's construction industry recorded much higher than normal overtime hours in the late 1990s, (more than 35 percent in 1996, compared to 20 percent in New Jersey) perhaps in part due to the state's more limited and geographically isolated workforce. Since then, overtime utilization in Vermont has moderated somewhat, but still remains well above the national average for the construction industry.

Expanding construction activity also influences a state's workers' comp system through its tendency to spawn large numbers of new, smaller construction firms. These firms tend to employ less experienced workers and to have weaker accident prevention programs, and as a result, to have higher than average accident frequency rates.

In Vermont, for example, smaller firms (non-employers and small commercial) accounted for almost 90 percent of the state's total construction employment in 2002, while smaller firms made up only about 65 percent of construction employment nationally. With respect to a carrier's underwriting results, increasing numbers of these smaller firms tend to intensify the impact of deteriorating accident frequency, since they are too new and small to be experience rated.

While in-depth analysis of employee characteristics and working conditions might yield a more granular understanding of the factors driving deteriorating accident frequency, substantial insights and practical value can be gained simply by monitoring industry growth rates.

Over the 2004-2006 period, construction industry employment growth is forecast to be quite muted for the United States as a whole, averaging only one-half percentage point growth annually. Yet employment in New Jersey's construction industry is forecast to average about 1.7 percent annually over this period, placing it in the ranks of the fastest growth states for construction exposures likely with adverse development along with the likes of Nevada and Arizona.

In most cases, it is not possible for carriers to eliminate the lagged adjustment process that characterizes current workers' comp ratemaking. However, the rise and fall of the business cycles causing the problem are: (1) state-specific, (2) industry-specific and (3) readily forecast with substantial accuracy. As a result, carriers can use knowledge of anticipated business cycle phenomenon to reduce their exposure to workers' comp classes in specific states that are having or are forecast to have adverse development in accident frequency.

Fritz Yohn is the developer of “MarketStance,” a market analysis tool for U.S. commercial property-casualty insurers and is a registered trademark of IntelliStance, LLC, in Middletown, Conn.

Reproduced from National Underwriter Edition, April 30, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.