Issues that comp insurance firm executives must deal with to ensure that the line remains healthy include:

o Medical cost increases. Medical costs continue to put upward pressure on costs.

o Interest rate levels. While short-term interest rates have increased significantly in the last two years, longer-term rates remain at near historically low levels. This puts pressure on the combined ratios needed to earn an adequate return on capital.

o State-specific issues. Some individual states have workers' comp systems that are in disarray due to rapidly escalating benefit costs resulting in poor results and market disruptions.

o Challenges to reforms. Challenges to recently enacted benefit reforms have been mounted or are being discussed in several states, either through the political process or the courts.

o Persistent residual market issues. Although many states are seeing some depopulation of the residual markets, the overall volume remains too large and in some states remains at unacceptably high levels.

o Terrorism risks. Even though the Terrorism Risk Insurance Act of 2002 (TRIA) was renewed for two years, there is still no permanent solution in sight for managing this catastrophic exposure for workers' comp.

o The cycle. The current underwriting cycle is likely at or near its cyclical peak.

Given the 2005 results, participants might well have an optimistic short-term view of the workers' comp line. But the ongoing concerns outlined above demand that a longer view remains cautious.

Current Financial Results Positive

In the immediate term, however, the market is enjoying good financial results.

The workers' comp calendar-year combined ratio stands at 102 percent for 2005, a five-point improvement from 2004–and the best result since 1997. The accident-year combined ratios remain in the low 90s for both 2004 and 2005–nearly a 50-point improvement from the 1999 high.

NCCI's estimates of the loss reserve position of private carriers also improved. The deficiency, which peaked at $21 billion at year-end 2001, declined to $9 billion at year-end 2005. After consideration of the allowable discounting of lifetime pension cases, the deficiency has declined to a manageable $3 billion.

The investment gain associated with workers' comp insurance transactions is up a point to about 12 percent. This is still down dramatically from the late 1990s, when interest rates were higher and the stock market produced large gains. Still, it has begun to creep up a bit the last two years after bottoming out at 10.4 percent in 2003.

When the investment gains are combined with the small underwriting loss, the result is a pretax operating gain of about 10 percent. NCCI's modeling indicates that, after including the investment gain on surplus and paying taxes, the industry came close to earning its cost of capital in 2005 in this line for the first time since 1998.

Recently enacted reforms in several states, including California and Florida, also appear to be positively impacting the results in those jurisdictions as well as the countrywide numbers. The California reforms, in particular, are having a significant impact on costs and the insurance marketplace in that state.

Drug Costs Appear To Be Moderating

While workers' comp medical costs continue to be a major concern, the nation's drug cost acceleration is finally moderating. In 2004, nationwide prescription drug spending for all payers–including group health and workers' comp–increased 8.2 percent. This is down from the 10.2 percent increase in 2003 and 14 percent increase in 2002.

The Centers for Medicare and Medicaid Services, Office of the Actuary cites several contributing factors to this slowing growth in prescription drug spending, including:

o Rapid growth in the use of lower-priced generic drugs through tiered benefit plans.

o Increased over-the-counter use of antiulcerants and antihistamines.

o A shift toward greater mail order dispensing.

o Reduced consumption of certain drugs due to concerns about their safety.

Despite a slowing trend, the prescription drug issue remains at the forefront of political and media attention. Current hot topics include the importation of prescription drugs from foreign countries, Medicare's coverage for prescription drugs, and the potential for additional health risks from formerly popular drugs such as Celebrex, Vioxx and Bextra.

Medical average claim cost trends have also moderated slightly but continue at near-double digits–rising 8.5 percent in 2005. Workers' comp medical costs continue to grow much faster than average wages and the Medical Consumer Price Index.

Utilization increases are a significant contributor to this growth. Workers' comp is increasingly becoming a medical management business as policy makers, employers and carriers strive to control these costs.

On the indemnity front, NCCI estimates that the change in the average cost of workers' comp indemnity claims rose a modest 2 percent in 2005. This continues a moderation in the increase in indemnity claims costs seen since 2002.

Some of the rapid increase in costs witnessed from 1997 to 2000–and the moderation seen recently–appear to be related to changing claim frequencies.

Claim Frequency Continues To Decline

Based on a preliminary analysis of data in NCCI states, the frequency of lost-time claims declined another 4.5 percent in 2005. This continues the pattern that has persisted since the early 1990s. The cumulative decline in frequency is in excess of 45 percent over that time period. The decline in frequency has been reasonably uniform across all industry groups.

The incidence rate of manufacturing injuries (specifically, the number of cases per 100 full-time equivalent employees) has been declining since the mid-1920s.

NCCI recently completed a frequency turning points research study (viewable online) that suggests that among other factors, changes in workplace practices by U.S. businesses to enhance productivity in response to increasing global competition may be an important factor in explaining the downward trajectory of injury incidence rates since the early 1990s.

Other factors, however, may create some upward pressure on injury incidence rates. In particular, the latest economic forecasts call for continued economic expansion through 2009, with unemployment rates stabilizing at about 4.8 percent–down slightly from the 5.2 percent average in 2005–and real GDP growth continuing at roughly its 3 percent trend rate.

At the same time, the share of younger workers is projected to stop declining and to be essentially unchanged at 14 percent.

Both of these factors suggest some upward pressure on injury incidence rates.

Global competition, meanwhile, is likely to remain intense (continuing to place pressure on U.S. industry to increase productivity) suggesting ongoing improvements in workplace safety and downward pressure on incidence rates.

An estimate of the impact of these various forces on the future direction of manufacturing incidence rates indicates that the decline in incidence rates is likely to continue at least through 2009, albeit at a somewhat slower rate than in 2002-2005.

A Guarded Outlook

Even with the current positive financial condition, moderating drug costs and reduced claim frequency, NCCI's examination of the fundamental changes taking place in the workers' comp market lead to the conclusion that while the short-term results are positive, the long-term outlook remains guarded.

Obstacles such as rapidly escalating benefit costs, ongoing challenges to recently enacted state benefit reforms and volume that remains uncomfortably high in many states' residual markets all remain as significant market concerns.

In recent years, industry stakeholders (including insurers, regulators, trade associations and others) have worked together cooperatively to identify and implement long-term market measures and solutions that have led to the current overall stability in workers' comp.

While cooperation and management efficiency alone cannot withstand another terrorist attack or an ongoing expansion in medical costs, the industry is well positioned today to withstand normal and ongoing market concerns–and to plan for extraordinary challenges.

Stephen J. Klingel is president and chief executive officer of NCCI Holdings Inc. in Boca Raton, Fla.