S&P's Report: What, Me Worry?

So Standard & Poor's (S&P) says that workers' compensation is a bad line of business because it doesn't make an underwriting profit ... big deal. That's nothing new; just part of the cycle.

Siddhartha Ghosh, a credit analyst with S&P in New York, wrote a report published on Monday titled, "For the U.S. Property/Casualty Industry, Making Workers' Compensation Profitable May Be Mission Impossible."

Ghosh warns of continued years of poor profits for workers' compensation carriers and possible downgrades of ratings for some insurers with a heavy concentration in the workers' compensation line.

The industry has posted combined ratios below 100% only three times between 1991 and 2010 Ghosh notes: 1995, 1996 and 2006. The national combined ratio will reach at least 115% in 2011 and could stay there until 2013, according to Ghosh.

Workers' compensation in the private market was not designed for underwriting profit - it is a cash flow mechanism that permits profitability through investments. In most states the private market competes against quasi-governmental insurance units (aka state funds) which are designed by law to operate on the fringe of profitability.

Ghosh sort of gets the cash flow nature of comp when he notes that a stagnant economy creates additional problems because workers' compensation profitability is sensitive to payroll - that's because premiums are based on payroll. The lower the payroll, the lower the premium, the less cash coming in the door, ergo negative cash flow.

The monkey in the closet, though, is reserves. Many states allow claims to be settled by lump sum payment, which terminates future reserve liabilities for the claim and create a more certain future for a carrier's overall reserves. But many other states don't allow lump sum settlements, and this "long tail" nature of claims liabilities can create problems down the road.

Regardless, Ghosh says that industry reserves are inadequate, stating in his report that the property and casualty industry prematurely released $2.8 billion in reserves from the workers' compensation line between 2006 and 2008. He expects to see carriers reporting adverse reserve developments for accident years 2007 through 2010.

Ghosh cautioned that if some insurers strengthen their reserves, causing their operating earnings to fall below S&P's expectations, the agency would consider lowering some ratings. This may or may not be important - S&P ratings are followed by Wall Street, but business owners and risk managers (and their brokers and agents) look to ratings from A.M. Best for a carrier's financial health in paying future claims.

But even a carrier's financial health rarely trumps bottom line premium pricing for the insurance consumer.

Karen Oxman, owner of GNW-Evergreen Insurance in Encino, Calif., told WorkCompCentral that even though she advises her clients to go with the company that has the best rating, that is not always what customers are looking for.

"People get a quote and if it’s the best quote, I think they're inclined to take it," she said.

To people outside of the industry workers' compensation insurance isn't much more than a commodity. So while Wall Street may not like the profitability of the line, Main Street doesn't care ... until the line can't raise capital to finance operations or growth because of S&P ratings, and has to do so by raising rates and premiums.

That's when Main Street starts calling for reform, and the cycle starts anew.

For veterans of the industry, which means you're as old as I am or older, your culture was influenced by the irreverent comedy magazine of our teenage years, Mad Magazine, and the indomitable fictional character Alfred E. Newman's famous quote, "What, me worry?".

So it is with this latest S&P report.workers compensation, work comp, injured worker