Friday, May 11, 2012

NCCI - "Conflicted"


NCCI's president and CEO, Stephen Klingel, is famous for his single word descriptors of the industry that he has been doing since he began delivering the State of the Line address at the NCCI Annual Issues Symposium, and I think this carefully chosen adjective is a good and accurate one for the industry at this juncture.

I opined that I thought Klingel would tell us that the industry is still perilous, but that stability is coming into play as the economy, albeit tepid, appears to be improving. That appears to have been an accurate view.

Klingel said that the fundamentals have stopped declining and are improving and while other fundamentals are either not to a desirable or are at a neutral level, are nevertheless improving.

Here's what's good:

Lost time claim frequency - While 2010 saw the first increase in 13 years, this appears to have been an anomaly. For the past 2 decades there has been a prominent negative trend in claims frequency. Last year's numbers were up 3% which was considered "significant" and challenged the long held belief that the decline would continue. 2011 data shows that the downward trend is continuing, albeit at a lower pace than in previous years.

Net written premium increased for first time in 5 years, and by 8% - Dissecting that number shows that what drove it was not wage increase (contributing a very small factor to the premium increase) or prices. The increase was an audit return premium phenomenon meaning that payroll audits showed more payroll than originally reported by employers.

Accident year combined ratio improved by 2 points - However this third positive is tenuous depending upon overall economic improvement.

Finally, medical inflation is stabilizing growth, with no high spikes noted in medical inflation.

Here's what's bad:

Calendar year combined ratio of 115% for 2011 - This was troubling because, while it is the exact number as the prior year, 3 points in 2010 was attributable to one carrier adding so much to their reserves, so actual;ly this represents an overall deterioration in industry combined ratio.

Reserve deficiency - Each of past 4 years the industry reserve deficiency has increased and it is now 5 times higher than in 2007. While this number does not set off any major alarm, the trend could be problematic if it continues.

Residual markets in the first quarter of 2012 saw the premium grow 47% - This not a positive, said Klingel, because the major growth was seen in the premium sector exceeding $100,000, and as residuals grow there is tendency that they become less self-sustaining, and it becomes difficult to maintain pricing differentials to meet the growth in risk inherent in a growing residual market.

Finally low interest rates and investment income is not there to support underwriting. Net profit of carriers this past year was the product of capital gains realized on bond sales. While this produced some investment profit, the downside is that these bond positions are being replaced by bonds with lower returns which may serve to depress net investment income in the future.

As I predicted in yesterday's column, California distorted some of the statistics about the health of the industry, but I was surprised that the influence was not as outsized as it had been in the past.

One part of the various presentations that I thought was interesting was the analysis of the economic recovery. Several speakers all agreed that manufacturing is returning to the United States - in a big way. Manufacturers have discovered that it is now costing more to make things in China, because of Chinese wage inflation, shipping, distribution and other costs, than it would just to manufacturer in the United States.

But, US manufacturers have learned to become so efficient in the manufacturing processes that this return to American soil is not resulting in increased jobs.

I take that essentially as a very good thing. Sure, employment isn't jumping right back up post recession because of the return of manufacturing, but what this means to me is that we are building a much tougher, more resilient economy that we had in the past, and much less susceptible to base employment export.

In other words, the jobs that are being created now by the return to manufacturing are going to be here for quite a while, and this base will continue to expand as the US returns to being the world's largest manufacturer (we're not that far behind China at this point anyhow). Imagine living in China and looking at the Made In The US tag on the product! That likely is not that far off into the future as China goes through its current socio-economic transformation.

And of course the construction sector, usually a major contributor to premium, remains in the doldrums. There is growth in industrial construction (see increase in manufacturing!) but residential construction and municipal/state construction continues to contract.

One area of observation that was interpreted differently by NCCI than my interpretation was the return of growth to the residual market. I said that this was a positive attribute, because the base for residual markets are new employers and businesses that are high risk (e.g. construction). So an uptick in residual markets means that the base employment numbers are going up which reflects positively on the economy. Several underwriting executives that I talked to agreed with my interpretation - time will tell which prognostication proves correct.

For those who are concerned about the impact of the AMA Guides on indemnity, for the first time there has been an apples to apples comparison between the 5th and 6th editions (the 5th and 6th editions of the AMA Guides have been adopted in 15 states since introduction, while 14 states don't use any edition).

In a pre-recorded video by Jeff Eddinger of NCCI, displayed during NCCI's Chief Actuary Dennis Mealey's presentation, a comparison was done for Montana, Tennessee and New Mexico. NCCI data showed that impairment ratings consistently dropped between 25 and 30 percent across the board when states moved from the 5th to the 6th edition.

Oklahoma was mentioned in passing, and NCCI acknowledged that there are many states looking closely at what happens in Oklahoma with great interest in bringing a non-subscription model to legislatures if there is success there. There was not much conversation though about what could happen to the comp market should a wave of non-subscription start spreading across the states. 

Those close to the work comp industry derided the Oklahoma plan because it circumvents the "grand plan" since there would be no protection for workers over the long term - if an injured worker leaves the employ of an ERISA planned employer medical benefits would then cease. I am not sure this is really the case, as this in my opinion would be a violation of the Oklahoma compromise which requires that a non-subscription system match what would be available under work comp.

There was acknowledgment, however, that if the Oklahoma plan bears fruit and spreads to other states that the industry would face significant obstacles in the same manner that were predicted with the invention of large deductible policies - the difference being however that large deductible policies still are workers' compensation policies bringing in premium revenue to support claims and operations. Non-subscription would wholesale remove that premium base.

Vermont also got honorable mention as that state continues to look at including workers' compensation in a single payer medical system.

In the end, it was noted that the work comp market is on the upswing, demonstrating the largest line increases out of all property/casualty lines, demonstrating the cash flow stimulation that the insurance industry craves.

Now if the investment market would just cooperate to deliver returns to take advantage of all that incoming cash...

There's more in this morning's WorkCompCentral story by Senior Editor Jim Sams.

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