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.
Mark Walls is vice president of Communications
& Strategic Analysis for Safety National. See his full bio.