Swiss Re: Challenges ahead for workers' comp market
An array of potential headwinds and risks have surfaced (or re-surfaced), meriting caution and scrutiny by re/insurers.
After a decade of extended profitability, the U.S. workers’ compensation re/insurance (WC) market faces emerging challenges, a Swiss Re analysis shows.
This market has been a bright spot in an often tough environment for casualty re/insurers, with the National Council on Compensation Insurance (NCCI) recently highlighting continued strong performance in 2023 that saw a 10th consecutive calendar year of underwriting profitability for private carriers.
Even so, discipline is necessary. While the WC market continues to exhibit some favorable characteristics, our analysis from the perspective of a reinsurer that is engaged in this market indicates the need for a heightened level of diligence. A variety of potential headwinds and risks have surfaced, or in some instances, re-surfaced, meriting caution and scrutiny by re/insurers as they work to protect and reinforce the performance of their portfolios.
Based on Swiss Re’s analysis of information from multiple sources:
- While there continues to be significant reserve redundancy, reserve releases in recent years have served to mask underlying deterioration of Accident Year combined ratios (CoR).
- Fierce competition in states such as California has led to significant premium rate reductions and a softer market, raising pricing concerns and increasing loss ratios.
- Medical inflation, relatively benign in recent years, has resurfaced, with hospital costs the main driver, as well as increased post-COVID utilization.
- A tight job market with low unemployment often results in hiring less experienced workers, potentially resulting in more first-year injuries in select industries.
- Safety gains that have buoyed the market in recent decades by reducing frequency of workplace injuries may be moderating, potentially limiting future upside in this area.
After prolonged pressure on premium rates amid a favorable environment, emerging challenges for the industry suggest that pricing discipline is necessary to avoid unsustainable developments. Re/insurers that have benefited from the workers’ compensation insurance market as a source of consistent profit for an extended period should consider a more cautious approach as they aim to minimize negative impacts. Disciplined underwriting to ensure pricing is matched appropriately with the evolving risk landscape will be paramount.
Current marketplace overview
Workers’ compensation insurance is generally mandatory for most U.S. businesses. The purpose of this heavily regulated form of insurance is to protect employees by providing them with resources for necessary medical treatment and compensation for lost wages should they suffer an on-the-job injury.
Annual premiums for the market total an estimated $55-$60 billion, according to S&P Global, with primary insurers ceding a portion of premiums to reinsurance (around 20% of premiums).
Given this market’s consistent profitability, however, some primary insurers have chosen to instead cede significant premium to their own captives to retain what has long been seen as favorable risk on their own books. Hence, free cessions to the reinsurance market are smaller.
The WC reinsurance market is predominantly an excess-of-loss market. While capital relief considerations can be a motivation to cede business on a proportional basis, most reinsurance purchases are motivated by volatility management. Excess of loss policies are characterized by longer tail risk, including exposure to prospective medical inflation. It is therefore not surprising that loss ratios for the reinsurance WC market have performed on average two percentage points worse than those of the primary market over the last 10 years.
In contrast, WC Cat covers have profited from a prolonged absence of large-scale catastrophic events. While profitable over the last two decades, Cat covers require more capital for relatively low margins.
For much of the past 50 years, the U.S. workers’ compensation market exhibited strong cycles driven by not only the macroeconomic environment but also regulation. In the early to mid-1990s, for example, reforms of the workers’ compensation market helped improve loss ratios. States enacted changes including time limits for temporary wage benefits; expanded medical reviews of claims; caps on damages; new time limits for claims filing; and use of medical provider networks as they sought to contain costs.
By the end of the decade, however, loss ratios had climbed dramatically amid a softening market and overcapacity, market features that were exacerbated by less expensive reinsurance. Hardening re-emerged after the 9/11 terrorist attack, which itself had a substantial direct impact on workers’ compensation claims in New York and nearby states. Changes to workers’ compensation insurance laws in places like California also helped to drive loss ratios lower.
What has driven good results in a more stable market?
For more than a decade, loss ratios within the workers’ compensation insurance market have developed more evenly amid an improved risk landscape. In fact, the stability of the last decade has helped produce the longest period of profitability for US workers’ compensation insurance, as reductions in loss ratios compensated for falling premiums linked to favorable business development.
Workplace safety improvements have reduced accidents. Moreover, better claims handling including the use of managed care networks, programs to assist injured workers in returning to their jobs more swiftly, and efforts to target appropriate treatments have all played a role in these positive developments.
Reserve releases have supported results over this period. Buoyed by this, Calendar Year combined ratios have remained below the 100% threshold since 2015, with the most recent six-year period averaging less than 90% (see figure 2). Amidst the COVID-19 pandemic, social-distancing measures including work-from-home policies also contributed to lower frequency of WC claims. Since then, working from home, “hybrid models” and virtual meetings in lieu of business travel have become the new normal, positively impacting loss frequency.
Another area that is helping results is improved data and analytics in underwriting and claims.
Headwinds on the horizon?
Given its strong performance, the U.S. WC market has performed better than other casualty segments. In its most recent “State of the Line” publication, for instance, the National Council on Compensation Insurance highlighted the market’s continued positive hallmarks: Premium increased 1% in 2023, NCCI has reported, adding the Calendar Year combined ratio was 86% for private carriers while lost-time claim frequency has seen larger than average decreases.
Nonetheless, some potential challenges have emerged amid this seemingly robust picture that merit increased scrutiny, according to Swiss Re analysis. For instance, favorable WC results that marked the last decade mean there is continued pressure on premium rates due to increased competition and new players entering the market.
WC insurance rates have decreased for ten consecutive years. Most of that impact has been offset by continued frequency declines. Even so, cumulative rate decreases have reached an inflection point in recent years, resulting in Accident Year combined ratios creeping up; they now exceed 100%. This development has been masked by reserve releases that keep Calendar Year results positive. Research institutes indicate a continued reserve redundancy for the WC line of business in the range of $15-$18 billion. This is likely to continue the downward pressure on premium rates with the risk of the actual underlying performance becoming unsustainable.
While favorable accident year loss ratio developments have benefited the industry since 2012, the positive trend appears to have peaked. Loss ratios are still developing favorably but the latest years show the smallest favorable development in recent history after 24 months.
Medical inflation is also projected to increase significantly in the near future, in particular compared to the low-inflation, pre-pandemic years. Some anticipate wages in the healthcare sector to rise amid a shortage of workers, pushing up costs. While medical fee schedules do help contain this, severities are still expected to rise, potentially substantially. To date, workforce payroll has outpaced WC medical severity, providing a net benefit to performance. However, with increasing medical severity, this benefit may soon fade.
The unemployment rate remains low. With the labor market tight, however, the hiring of unskilled workers or employees in construction or service industries with less experience can lead to temporary frequency increases. According to a study by the Workers’ Compensation Insurance Rating Bureau of California (WCIRB), employees in their first year of tenure are more than twice as likely to have a claim compared to the state-wide average.
Workplace safety improvements that have contributed to lower accident rates in recent years are also seen plateauing (see figure 3.3). While we see the impact of workplace safety improvements moderating, we still anticipate frequency decreases. Moreover, potential gains from new technologies that rely on artificial intelligence to provide workplace safety insights could reignite momentum on safety.
With these developments, Swiss Re is taking a cautious approach going forward to help sustain the commercial success achieved in this line of business over the last decade.
Different states, different market dynamics
The U.S. workers’ compensation insurance market is heterogeneous and highly dependent on state legislation. WC is a state product, with rates and benefits varying by state. Four states deliver protection to workers against injury through state funds; others have adopted a mixed approach, allowing flexibility to companies to provide workers’ compensation insurance via a private insurer, self-insurance or a state fund. The vast majority allow private insurers to write business.
The cost of workers’ compensation insurance, typically paid for by employers, also varies by state and industry, with regulators setting advisory rates and insurers often competing with one another within markets via discretionary credits, a premium discount that isn’t mandated by regulators to reduce the cost of a policy for employer.
The performance of workers’ compensation insurance portfolios and trends that affect them differs substantially, as well. Some states with large populations and economies including California, the largest US WC market, as well as New York and New Jersey, exhibit some of the most challenged loss ratios in the country (see figure 5), with fierce competition among insurers exerting continued downward pressure on premiums. For instance, the average charged premium rate in California has decreased by 50% from 2015 to 2023.
Market outlook
While the overall U.S. WC market has the potential to continue to reward re/insurers as it fulfills its essential purpose for both workers and their employers, changing market dynamics call for caution. Whilst improved data and analytics in underwriting and claims have enhanced risk assessment, reduced fraud and promoted safer work environments, there are signs of a continued deterioration of underlying Accident Year combined ratios due to the exogenous factors we explored in preceding chapters. The market has been cyclical before and might be moving closer to an inflection point.
Riding on favorable prior year development and tailwinds from a higher yield environment, we expect the current soft market to continue. Consequently, margins are expected to decrease in the near-term, although this may moderate in the mid-term as re/insurers intensify scrutiny on risk vs return considerations. This is particularly true for re/insurers doing business in states that are already facing unfavorable combined ratios.
Any projection of the current market environment and its future development is subject to a significant amount of uncertainty. Downside potential exists side by side with the potential for more optimistic outcomes. This uncertainty demands a cautious underwriting approach that acknowledges each state’s individual characteristics.
This article first published on the Swiss Re website and is republished here with permission.
Laure Forgeron is chief underwriting officer casualty with Swiss Re.
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