The study, published in the September/October issue of "Public Health Reports," looked at the variables surrounding premiums from 1973 to 2007 and found that on average, as the number of lost-time injuries and medical costs increased, workers' compensation premiums did increase. But the study also found that as the Dow Jones Industrial Average and inflation-adjusted interest rates on U.S. Treasury Bonds increased, premiums decreased, and vice versa.
J. Paul Leigh, PhD - Economics, lead author of the study, told WorkCompCentral that he is very confident with the findings. He said in running the numbers through a number of different regression models, there was a strong correlation between investment returns on premium rates that was not seen in other variables such as claim frequency or severity.
"We know, as students of the field, these rates of return are important and predicative of premiums," he said in a phone interview with our reporter Greg Jones. "But the public at large doesn't understand that. The public thinks rates go up because workers are lying and cheating, and fraud on the part of recipients of workers' compensation benefits."
Indeed - Dr. Leigh hits on a very important aspect of the public perception of workers' compensation: workers' compensation is a cash flow industry dependent on investments for profits. In most states an underwriting profit is an aberration. Carrier profits come from net investment returns.
That's why, in a perfect climate, the industry shoots for a 100% combined ratio - meaning that for every dollar that comes in as premium, a dollar goes out in expense. This is why most states have a "state fund" - they act as a stabilizing factor in the industry since they are not supposed to make a profit. State fund "profits" are returned to policyholders in the form of dividends.
The 100% combined ratio mark is very hard to achieve.
When the pure premium ratio goes too far north of the 100% mark carriers sweat because net cash return has to work really hard to make up for operating losses. And when the mark goes well south of 100% carriers get pressure from departments of insurance and the public to lower their rates.
I see nothing wrong with admitting that investment returns are more predictive of premiums than actual cost of claims - that's a basic financial element of the insurance business. And the public's knowledge of this pattern is, in my opinion, actually good public relations for the workers' compensation insurance industry.
The average Joe Employer has no understanding of, nor the desire to understand, the financial underpinnings of his premium bill. To Joe it is just a cost of doing business and one he attempts to control with good risk management practices.
And for the most part that is good employer behavior.
But Joe Employer, if he is operating in a "businessman-like manner", is going to have an annual budget. Understanding how economic conditions affect his business is part of the budgeting process and understanding what the economy means to his cost of insurance is an important realization for Joe.
When the insurance industry tells Joe that unfortunately the economy means that his premium is going up, then that's a fact that Joe will have to factor into his budgeting, just as much as when the economy is humming along and carriers can pass along reduced premiums because investment returns were robust.
Most states have a competitive workers' compensation insurance industry - and the market for the most part keeps the cost of insurance in check. The bench mark is the state fund, which is not supposed to be making a profit. If the competitive carrier can not beat the state fund's premium declaration then the for-profit carrier goes out of business.
That the national, heck international, economy is in the tank is not news to anyone. That premiums need to go up when investments can not generate sufficient returns is not rocket science.
The only thing I really retained from business school was the first thing my finance professor said.
"If you don't learn anything else in business school, the one thing you must take away with you is this very simple fact: cash is king," he said. "You can have all the assets you want, but unless it is readily liquidable to pay the bills RIGHT NOW you're out of business."
Workers' compensation, as I said, is a cash flow industry. Cash goes in as premiums, some of it is set aside (reserved) for claims, some of it is spent on operational expenses, and the rest of it is invested hopefully to return net cash later on down the road to pay shareholders or policy holders.
What we have seen, and what we are currently seeing, in the financial news does not bode well for premiums or the health of the industry. Hopefully those smart mathematical types that figure all this stuff out with their sophisticated financial models can keep this industry afloat until the economy recovers.