Thursday, May 17, 2012

On the Street Corner - Do You Need a Beer?

Yesterday I smelled a rat.

Bill Cobb, VP Business Development for CompMetrics, has helped ferret out that rat in a blog post he put together along with cool charts, graphs with numbers and things that help explain the madness of the California rate making process.

What Cobb's report tells us is why carriers still write business in California despite all of the "sky is falling" rhetoric year after year (or in this case, mid-year) - because they make money even if their expense ratios are deplorable and investment returns are pathetic for professional money management. More on that below.

I asked yesterday what the big deal was about cost containment expenses. To me that is an internal operational issue and should not be cause to raise rates and premiums on employers. If a carrier can not exercise the discipline to keep its costs under control then that is the carrier's problem - that's a cost of doing business.

Cobb confirms this. Note in his analysis that medical expenses have essentially remained flat since the last "reform". The big cost driver for carriers is how much they spend keeping those medical costs down.

Bill Mudge, president of the Workers' Compensation Insurance Rating Bureau (WCIRB) blamed some of the increases on the difficulty of establishing and maintaining medical provider networks. I don't buy that - MPNs have been around since 2004. Why all of a sudden are they costing more? The MPN industry in California is now mature with known entities and players.

Mudge also postulated that some of the cost increase could be blamed on an increase in continuous trauma (CT) claims - where are the statistics to support that? And why do CT claims cost more to cost-contain? Again, I don't buy that. This does not seem logical to me. CT claims have been around since the beginning of [workers' compensation] time.

The WCIRB seeks a rate increase on ESTIMATED increases in costs. Is this not a self-fulfilling prophecy?

I know that reserving requires a bit of art to perform properly and much of this art involves the skillful estimation of future expenses. But I'm wondering why projections of cost-containment services can't go DOWN.

I said yesterday that the numbers don't make sense to me, but that is not unusual because when it came to math I was not gifted with the right set of genes to develop those skills.

But even I can see when numbers don't appear to add up.

For instance, Cobb has a three great graphs demonstrating accident year increases in Estimated Ultimate Costs of an indemnity claim, increases in Indemnity Costs per indemnity claim and Allocated Loss Adjustment Expense Costs (ALAE) per indemnity claim.

In the first two instances it is absolutely clear that since 2008, after the system adjusted to the 2004 reforms, there essentially was stabilization in both medical costs and indemnity costs.

What continued to inflate, well past wage basis levels, is the ALAE costs, with a inflation rate of 11.9% per year. ALAE, as a percentage of combined costs, rose from 23% in 2004 to 46% in 2011.

Now as to those profits. According to Cobb's analysis, by the end of 30 years, due to the magic of modern day finance and the power of compound interest, carriers still put over thirty cents of every premium dollar in their pockets even after paying out 100% of claim costs. This can explain why Tokio Marine was interested in Delphi Financial and Delphi's workers' compensation holdings, including Advantage Insurance.

Compared to the average publicly traded company, workers' compensation insurance has a poor rate of return - but it's that long term cash flow that keeps the clocks ticking and why carriers won't flee California. The world's seventh largest economy just has too much available opportunity to abandon.

I don't have a problem with carriers making a profit - even an outsized profit (I'd invest!). Profitability of the line is necessary for carriers to participate and for a health distribution of the risk (we saw what happened when capacity dried up and the State Fund ended up with nearly half the market).

However, lack of transparency when the hand is out creates mistrust and uneasiness. Kind of like the homeless person on the street corner - are you going to give your money to the person whose sign says they can get a job, or the one that says "Let's be honest, I need a beer"?

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