The Market Is Dynamic

At the upcoming Workers' Compensation Research Institute 2014 Annual Issues & Research Conference in Boston next week, National Council on Compensation Insurance's chief economist, Harry Shuford will present "How the Economy Drives Workers' Compensation."

I don't know what Harry is going to present. But I've heard Harry in past NCCI events and he always does a masterful job of explaining how economic issues affect workers' compensation underwriting.

Harry would probably criticize my explanation of the economy's relationship to workers' compensation, but here's my elementary school version.

When employment is high, and payrolls increase, workers' compensation premiums go up. That's because workers' compensation premiums are based in large part on how big the work force is, and the best indicator of the size of a work force risk is how much money the work force is being paid, which is then modified by what kind of jobs that work force is doing.

Smart guys with lots of computing power (in the old days it used to be really fast slide rules) figure out what kind of jobs are risky, and which are not so risky, and ascribe a modifier to the payroll number to determine the ultimate premium cost.

When investment yields are low and claim exposure is high, workers' compensation premiums go up, of course depending usually on whether the state insurance commissioner agrees that these circumstances were not of the carrier's making.

And visa versa - when fewer are employed and payrolls decrease, premiums go down, and when investment yields are good and claim exposure is controlled, premiums don't go up (but usually don't go down appreciably).

Generally the industry doesn't expect to make much money, if at all, on an underwriting versus expense basis - a measurement called the combined ratio.

A combined ratio of 100 means that for every dollar coming in the door, a dollar goes out the door. If the combined ratio is higher than 100 then there is more cash going out the door in claims and expenses than is coming in from customer's premiums. And if the number is less than 100 then there is more cash coming in and less going out.

Workers' compensation is a cash flow mechanism. Carriers bet that the cash flow spread, what is parlayed into investments, yields enough money to generate a profit over time. The old adage that a dollar today is worth ten cents more tomorrow is what drives work comp profit margins.

As an investment, workers' compensation is not a great business. There are a lot easier and less risky ways to make more money than the general profit margin in work comp. But it's not a bad line if one can stomach the ever changing statutory and regulatory framework one must work within, and the consequential changing assumptions regarding the risk of investing in the market.

There is still a good appetite for workers' compensation risk however, as market statistics demonstrate.

Today it was reported that Travelers Group surpassed Liberty Mutual Group as the nation’s top workers’ compensation insurer in 2013, reporting direct written premiums of $4.14 billion to Liberty’s $3.59 billion, according to figures released Tuesday by the National Association of Insurance Commissioners.

Liberty had been top dog for many years, but the company has in the past let it be known that its appetite for workers' compensation risk, particularly in the ever changing market of California, was waning. So its move to number two is not particularly surprising.

And also not surprising is that the industry’s top 25 companies had a 7% increase in direct premiums written from a year earlier with a combined $51.4 billion in 2013.

The numbers reflect the 2.1 million new jobs nationwide, a modest increase in payrolls “and rate increases being pushed through as well,” said Robert Hartwig, president of the Insurance Information Institute.

Hartwig also told WorkCompCentral that “some of the most unprofitable business is being shed into the state funds,” predicting that the trend may continue for a while.

The private carrier appetite for risk must not be too healthy in New York, as that state's fund, New York State Insurance Fund, was sixth on the list, even ahead of big economy California's State Compensation Insurance Fund, which moved down the scale to twelfth. 

Apparently there is a lot of unprofitable business in New York that the private carriers don't want to touch.

Here are the Top 10 in direct written premium in 2013 and their change since 2012:

• Travelers Group, $4.14 billion, up 8.9%.
• Liberty Mutual Group, $3.59 billion, down 14.2%.
• Hartford Fire & Casualty Group, $3.35 billion, up 1.7%.
• American International Group, $2.85 billion, down 3.5%.
• Zurich Insurance Group, $2.53 billion, down 8.6%.
• New York State Insurance Fund, $2.28 billion, up 17.4%.
• Berkshire Hathaway Group, $1.76 billion, up 39.9%.
• AmTrust NGH Group, $1.67 billion, up 82.0%.
• Old Republic Group, $1.20 billion, up 7.9%.
• WR Berkley Corp. Group, $1.16 billion, up 17.4%.

California’s State Compensation Insurance Fund was No. 12, with direct written premiums of $1.11 billion, a 23% increase.

Texas Mutual Insurance Co. held its No. 13 ranking with direct written premium of $1.03 billion, a 13.8% increase.

Shuford will probably tell us at the conference next week that some of the big premium drivers, the riskiest categories with the highest payroll, haven't quite recovered completely from the 2008 recession - such as the construction and trucking industries.

But then we have new growth in the health care sector with its related sub-industries and it's trillions of dollars in payroll as the roll out of the Affordable Care Act continues over the years. The health care sector is generally low risk and high payroll - an attractive combination if you're an underwriter.

In the meantime the investment returns remain below inflationary rates because of the Federal Reserve's monetary policy which has kept interest rates artificially low, and historically anemic.

Which is to say that the overall workers' compensation underwriting market is particularly dynamic right now.

In the past couple of years the economists that follow this market have generally opined that the current trend of low investment yields, increasing payrolls, and an ability to pass along some of the risk onto policy holders will continue for a couple more years.

So far it looks like their forecasts are accurate.

See you in Boston.