In workers compensation, the trends over the past few years have been pointing to declining rates in most states. At the 2019 National Council on Compensation Insurance (NCCI) Annual Issues Symposium (NCCI-AIS), NCCI indicated the 2018 industry private insurer calendar year combined ratio was a record low of 83 percent. I heard comments from many insurers attending the NCCI-AIS that they were very surprised by this figure as it did not reflect what they were seeing on their book of business.
To fully understand the workers compensation marketplace, it is very important to understand what information is included in NCCI and the independent bureau analysis in addition to the different ways they look at data. It is also important to understand the drivers that ultimately impact the costs of workers compensation.
The calendar year combined ratio is not necessarily the most reliable or accurate measure of rate adequacy or the profitability of a book of business. Instead, calendar year combined ratio is essentially an accounting measure that may be materially impacted by things like insurer reserve strengthening or releasing of reserves for all prior accident years. An insurer could be writing unprofitable business, yet still show a calendar year combined ratio below 100 percent if they are releasing prior year reserves. A better measure to understand industry profitability is the accident year combined ratio. For 2018, NCCI indicated that this figure for private insurers was 89 percent.
It is also important to understand what bureau data may NOT include. In general, it does not include any data from self-insured employers. That exclusion omits most data from municipalities, states, and school districts. It also misses a significant amount of data from other industries, such as higher education, retail, and health care.
Bureau data may also exclude information from deductible policies (read those footnotes). It is estimated that the "retention" marketplace, defined as employers that retain risk through self-insurance or high deductibles, covers close to half of the payroll in the United States. If the database does not include information from the retention market, it is missing a very big piece of the overall picture.
You also need to check to see if the data set includes just "private insurer" information. If it does, it is likely excluding data from state funds, which tend to operate at much higher combined ratios.
Also, keep in mind that there is no single source for workers compensation industry data. There are 15 states that have independent bureaus or are monopolistic. These states are not included in NCCI's analysis. For instance, if you take three independent bureau states (California, New York, and Wisconsin), they have more workers compensation payroll than the combined NCCI states.
To further illustrate this point, the NAIC indicated that the 2018 accident year combined ratio was 97 percent. In theory, the NAIC data set includes information from the bureaus around the nation, so it is likely closer to the actual industry figure in the guaranteed cost marketplace for private insurers.
This explains why many insurers may not fully embrace the 83 percent combined ratio figure that was referenced at the NCCI-AIS conference. NCCI data is accurate for what they analyze. But, since they only see a piece of the entire picture, their data may not be a true reflection of what is really going on in the entire workers compensation landscape, and it may not reflect what individual insurers are seeing on their book of business. It is a piece of the puzzle, but not the complete picture.
Changes in Workers Compensation Claim Severity and Frequency
According to data reported at the 2019 NCCI-AIS, over the last 20 years, the cumulative change in indemnity claim cost severity was 100 percent. This was about 20 percent higher than wage inflation. The cumulative change in medical lost-time claim cost severity was 150 percent, which was 89 percent higher than medical inflation. During the same time period, insurers' loss adjustment expenses (LAE) also increased steadily. LAE includes the costs of claims handling, including payroll, benefits, and facility costs, as well as claim-specific expenses such as litigation costs. Data from the other bureaus shows similar trends, although California claim costs did drop after some significant reform legislation.
Given the upward trend in costs over the last 20 years, why have we seen a decrease in rates the last few years? The answer is simple: frequency. NCCI data shows that during the last 20 years, the average annual decrease in frequency was 3.9 percent. That is a significant decrease in the number of claims due to factors such as automation of certain tasks and an increased emphasis on safety and loss prevention. During the last few years, the decreases in frequency more than offset the increases in the average workers compensation claim costs, leading to declining rates in the guaranteed cost marketplace.
The impact of frequency is a very important distinction between the performance of the guaranteed cost market and the retention marketplace. Thousands of small employers in the guaranteed cost market will have no claims. However, in the retention market, all large employers will have claims. Ultimately, it is claims severity (costs), not frequency, that determines the rates and profitability of the retention marketplace.
There has been very little study of the retention marketplace, especially of the larger claims, as those cases tend to be outside the analysis of the bureaus. In September, the New York Compensation Insurance Rating Bureau (NYCIRB) published a study on loss development patterns for claims with incurred losses over $250,000. According to this study, "Large claims can take several years to emerge above the $250,000 threshold. Typically, only a small share of large claims are recognized as such at first report, and that share will grow considerably over the subsequent three or four reports."
The NYCIRB study noted that large claims only accounted for 4 percent of the claim count, but over 50 percent of the ultimate claim incurred losses. The study also illustrated how these larger claims tend to develop over time.
The guaranteed cost industry standard is to use 7–10 years of data to determine an experience rating. Thus, those insurers generally stop looking at loss data past 10 years postaccident. In the retention marketplace, things are very different.
According to one large national retention market insurance company, at 10 years postaccident, only 70 percent of the claims that will ultimately breach the retention will have been reported to the insurer. This is because the most severe catastrophic claims that will exceed the retention are reported quickly, usually in the first 12 months. But the majority of remaining claims that will eventually breach the deductible/self-insured retention are not catastrophic injury claims at all but instead are slow-developing claims that take years to reach required reporting thresholds. Because of this slow development of retention claims, at 10 years postaccident, the actual claim case incurred is approximately 40 percent of the expected ultimate claim costs. So, when the first dollar marketplace stops looking at the data, the retention marketplace is still actively seeing new claims, and significant additional incurred development is expected.
As an example, consider a 30-year-old claim involving a now 62-year-old worker that recently necessitated a $1 million incurred increase. The claim had been reserved appropriately based on then-known information, but the exposure worsened as the injured workers' condition now requires 24/7 attendant care. The cost of 24/7 institutional attendant care can run as high as $300,000 or more a year. The bureaus and the guaranteed cost marketplace are not looking at a development like that because it is occurring long after they stop monitoring such things. This is only one example of the extremely long claims tail in the retention marketplace. Because of this long tail, insurers in the retention market are impacted more by increasing claims costs as they handle and pay out such long duration claims for up to 60 years or more.
There has been much publicity around the "shock losses" being seen in the general liability, auto, and property marketplaces, with insurers seeing claims creep higher than they have ever seen before. Factors such as excessive jury awards and runaway wildfires are contributing to insurers having to redefine what their worst-case exposures may be in these lines.
The significant cost increases currently being seen in liability and property coverage are also being seen on catastrophic workers compensation injuries. Although catastrophic injury claims are only a tiny percentage of the total claims count, these injuries are a significant percentage of total workers compensation claim costs. Catastrophic injuries include spinal cord injuries, brain injuries, severe burns, major amputations, and other severe traumatic injuries.
Reasons for Increasing Costs
There are several reasons for these rapidly increasing costs. First, it is important to consider that, unlike group health insurance or Medicare, there is no policy limit nor excluded treatments in workers compensation. The insurer is responsible for any treatment deemed reasonable to "cure or relieve" the injury without limitation. On workers compensation catastrophic injuries, it is common for the insurer to have to pay for things like attendant care, prosthetics, home and auto modifications, skin grafts, or new housing, transportation, and even experimental treatments.
Standards of care for seriously injured individuals are constantly evolving. What was the norm 5–10 years ago is not the standard today, and in 5 years, that standard will be even more different. Think of all the medical innovation you see in the news regarding spinal cord injury recovery. The medical technology is evolving at a pace never seen before.
To illustrate the evolution of medical technology, consider Christopher Reeve, the actor who suffered a spinal cord injury in 1995 that left him a quadriplegic. He was 43 years old at the time of the accident. Reeve received the best care money could buy from experts around the world. He lived less than 10 years after the accident. More than 15 years after his death, medical science has advanced to the point that a quadriplegic can live a near-normal life expectancy because physicians are able to prevent the complications that lead to shortened lifespans.
Accident survivability is another factor affecting the increasing costs of catastrophic injury cases. Due to advances in emergency medicine, both on the scene of accidents and at Level 1 trauma centers, many patients who died shortly after their injuries will now live. According to the American College of Surgeons, from 2004 to 2016, the fatality rate for the most-severe traumas declined over 18 percent. Every one of those cases likely results in millions of dollars in medical care. For example, I saw a severe burn claim that would have likely resulted in death within days 10 years ago. That person survived for 3 months, and during that time, that individual received over $10 million in medical treatment.
These rapid advances in treatment for catastrophic injuries are saving lives and significantly increasing the function and life expectancies of seriously injured patients. But they have also resulted in costs that have never been seen before by the workers compensation industry. When I started handling claims 29 years ago, $5 million individual claims were rare. Today, the workers compensation industry has seen numerous individual claims with incurred exposures over $5 million, and losses in excess of $10 million and even higher are becoming more frequent. These claims are likely to get even more costly as new, increasingly expensive medical advances come along.
Conclusion
To understand the big picture in workers compensation, it is important to take a close look at the data you are relying on. Pay careful attention to understand what this data includes and what it does not. It is also important to distinguish between the guaranteed cost market and the retention market because the retention market has an extremely different developmental tail; rate trends are very different than in the guaranteed cost market. Claim frequency trends in the guaranteed cost market are fairly predictable and significantly influence rates. However, in the retention marketplace, rates are driven by severity, which is evolving to levels never seen before in a world of rapid medical advances.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.
In workers compensation, the trends over the past few years have been pointing to declining rates in most states. At the 2019 National Council on Compensation Insurance (NCCI) Annual Issues Symposium (NCCI-AIS), NCCI indicated the 2018 industry private insurer calendar year combined ratio was a record low of 83 percent. I heard comments from many insurers attending the NCCI-AIS that they were very surprised by this figure as it did not reflect what they were seeing on their book of business.
To fully understand the workers compensation marketplace, it is very important to understand what information is included in NCCI and the independent bureau analysis in addition to the different ways they look at data. It is also important to understand the drivers that ultimately impact the costs of workers compensation.
The calendar year combined ratio is not necessarily the most reliable or accurate measure of rate adequacy or the profitability of a book of business. Instead, calendar year combined ratio is essentially an accounting measure that may be materially impacted by things like insurer reserve strengthening or releasing of reserves for all prior accident years. An insurer could be writing unprofitable business, yet still show a calendar year combined ratio below 100 percent if they are releasing prior year reserves. A better measure to understand industry profitability is the accident year combined ratio. For 2018, NCCI indicated that this figure for private insurers was 89 percent.
It is also important to understand what bureau data may NOT include. In general, it does not include any data from self-insured employers. That exclusion omits most data from municipalities, states, and school districts. It also misses a significant amount of data from other industries, such as higher education, retail, and health care.
Bureau data may also exclude information from deductible policies (read those footnotes). It is estimated that the "retention" marketplace, defined as employers that retain risk through self-insurance or high deductibles, covers close to half of the payroll in the United States. If the database does not include information from the retention market, it is missing a very big piece of the overall picture.
You also need to check to see if the data set includes just "private insurer" information. If it does, it is likely excluding data from state funds, which tend to operate at much higher combined ratios.
Also, keep in mind that there is no single source for workers compensation industry data. There are 15 states that have independent bureaus or are monopolistic. These states are not included in NCCI's analysis. For instance, if you take three independent bureau states (California, New York, and Wisconsin), they have more workers compensation payroll than the combined NCCI states.
To further illustrate this point, the NAIC indicated that the 2018 accident year combined ratio was 97 percent. In theory, the NAIC data set includes information from the bureaus around the nation, so it is likely closer to the actual industry figure in the guaranteed cost marketplace for private insurers.
This explains why many insurers may not fully embrace the 83 percent combined ratio figure that was referenced at the NCCI-AIS conference. NCCI data is accurate for what they analyze. But, since they only see a piece of the entire picture, their data may not be a true reflection of what is really going on in the entire workers compensation landscape, and it may not reflect what individual insurers are seeing on their book of business. It is a piece of the puzzle, but not the complete picture.
Changes in Workers Compensation Claim Severity and Frequency
According to data reported at the 2019 NCCI-AIS, over the last 20 years, the cumulative change in indemnity claim cost severity was 100 percent. This was about 20 percent higher than wage inflation. The cumulative change in medical lost-time claim cost severity was 150 percent, which was 89 percent higher than medical inflation. During the same time period, insurers' loss adjustment expenses (LAE) also increased steadily. LAE includes the costs of claims handling, including payroll, benefits, and facility costs, as well as claim-specific expenses such as litigation costs. Data from the other bureaus shows similar trends, although California claim costs did drop after some significant reform legislation.
Given the upward trend in costs over the last 20 years, why have we seen a decrease in rates the last few years? The answer is simple: frequency. NCCI data shows that during the last 20 years, the average annual decrease in frequency was 3.9 percent. That is a significant decrease in the number of claims due to factors such as automation of certain tasks and an increased emphasis on safety and loss prevention. During the last few years, the decreases in frequency more than offset the increases in the average workers compensation claim costs, leading to declining rates in the guaranteed cost marketplace.
The impact of frequency is a very important distinction between the performance of the guaranteed cost market and the retention marketplace. Thousands of small employers in the guaranteed cost market will have no claims. However, in the retention market, all large employers will have claims. Ultimately, it is claims severity (costs), not frequency, that determines the rates and profitability of the retention marketplace.
There has been very little study of the retention marketplace, especially of the larger claims, as those cases tend to be outside the analysis of the bureaus. In September, the New York Compensation Insurance Rating Bureau (NYCIRB) published a study on loss development patterns for claims with incurred losses over $250,000. According to this study, "Large claims can take several years to emerge above the $250,000 threshold. Typically, only a small share of large claims are recognized as such at first report, and that share will grow considerably over the subsequent three or four reports."
The NYCIRB study noted that large claims only accounted for 4 percent of the claim count, but over 50 percent of the ultimate claim incurred losses. The study also illustrated how these larger claims tend to develop over time.
The guaranteed cost industry standard is to use 7–10 years of data to determine an experience rating. Thus, those insurers generally stop looking at loss data past 10 years postaccident. In the retention marketplace, things are very different.
According to one large national retention market insurance company, at 10 years postaccident, only 70 percent of the claims that will ultimately breach the retention will have been reported to the insurer. This is because the most severe catastrophic claims that will exceed the retention are reported quickly, usually in the first 12 months. But the majority of remaining claims that will eventually breach the deductible/self-insured retention are not catastrophic injury claims at all but instead are slow-developing claims that take years to reach required reporting thresholds. Because of this slow development of retention claims, at 10 years postaccident, the actual claim case incurred is approximately 40 percent of the expected ultimate claim costs. So, when the first dollar marketplace stops looking at the data, the retention marketplace is still actively seeing new claims, and significant additional incurred development is expected.
As an example, consider a 30-year-old claim involving a now 62-year-old worker that recently necessitated a $1 million incurred increase. The claim had been reserved appropriately based on then-known information, but the exposure worsened as the injured workers' condition now requires 24/7 attendant care. The cost of 24/7 institutional attendant care can run as high as $300,000 or more a year. The bureaus and the guaranteed cost marketplace are not looking at a development like that because it is occurring long after they stop monitoring such things. This is only one example of the extremely long claims tail in the retention marketplace. Because of this long tail, insurers in the retention market are impacted more by increasing claims costs as they handle and pay out such long duration claims for up to 60 years or more.
There has been much publicity around the "shock losses" being seen in the general liability, auto, and property marketplaces, with insurers seeing claims creep higher than they have ever seen before. Factors such as excessive jury awards and runaway wildfires are contributing to insurers having to redefine what their worst-case exposures may be in these lines.
The significant cost increases currently being seen in liability and property coverage are also being seen on catastrophic workers compensation injuries. Although catastrophic injury claims are only a tiny percentage of the total claims count, these injuries are a significant percentage of total workers compensation claim costs. Catastrophic injuries include spinal cord injuries, brain injuries, severe burns, major amputations, and other severe traumatic injuries.
Reasons for Increasing Costs
There are several reasons for these rapidly increasing costs. First, it is important to consider that, unlike group health insurance or Medicare, there is no policy limit nor excluded treatments in workers compensation. The insurer is responsible for any treatment deemed reasonable to "cure or relieve" the injury without limitation. On workers compensation catastrophic injuries, it is common for the insurer to have to pay for things like attendant care, prosthetics, home and auto modifications, skin grafts, or new housing, transportation, and even experimental treatments.
Standards of care for seriously injured individuals are constantly evolving. What was the norm 5–10 years ago is not the standard today, and in 5 years, that standard will be even more different. Think of all the medical innovation you see in the news regarding spinal cord injury recovery. The medical technology is evolving at a pace never seen before.
To illustrate the evolution of medical technology, consider Christopher Reeve, the actor who suffered a spinal cord injury in 1995 that left him a quadriplegic. He was 43 years old at the time of the accident. Reeve received the best care money could buy from experts around the world. He lived less than 10 years after the accident. More than 15 years after his death, medical science has advanced to the point that a quadriplegic can live a near-normal life expectancy because physicians are able to prevent the complications that lead to shortened lifespans.
Accident survivability is another factor affecting the increasing costs of catastrophic injury cases. Due to advances in emergency medicine, both on the scene of accidents and at Level 1 trauma centers, many patients who died shortly after their injuries will now live. According to the American College of Surgeons, from 2004 to 2016, the fatality rate for the most-severe traumas declined over 18 percent. Every one of those cases likely results in millions of dollars in medical care. For example, I saw a severe burn claim that would have likely resulted in death within days 10 years ago. That person survived for 3 months, and during that time, that individual received over $10 million in medical treatment.
These rapid advances in treatment for catastrophic injuries are saving lives and significantly increasing the function and life expectancies of seriously injured patients. But they have also resulted in costs that have never been seen before by the workers compensation industry. When I started handling claims 29 years ago, $5 million individual claims were rare. Today, the workers compensation industry has seen numerous individual claims with incurred exposures over $5 million, and losses in excess of $10 million and even higher are becoming more frequent. These claims are likely to get even more costly as new, increasingly expensive medical advances come along.
Conclusion
To understand the big picture in workers compensation, it is important to take a close look at the data you are relying on. Pay careful attention to understand what this data includes and what it does not. It is also important to distinguish between the guaranteed cost market and the retention market because the retention market has an extremely different developmental tail; rate trends are very different than in the guaranteed cost market. Claim frequency trends in the guaranteed cost market are fairly predictable and significantly influence rates. However, in the retention marketplace, rates are driven by severity, which is evolving to levels never seen before in a world of rapid medical advances.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.