The Effect of a Hardening Workers Compensation Market
In the insurance world, modest year-over-year rate increases have led many to declare the soft market to be over. In fact, according to the National Council on Compensation Insurance (NCCI), workers compensation writers have been able to implement substantive rate increases over the last two years. As a result, loss ratios and combined ratios have responded accordingly. By the end of 2012, the calendar year combined ratio stood at 109, down from 115 the prior year. Yet neither insurers nor investors are overly confident regarding their respective market rebounds, and overall industry profitability is still anemic due to historically low investment yields.
Of further concern for the industry, any margin of error that had been maintained has long since been eroded. Across all commercial lines (of which workers compensation represents a sizable portion), this year’s loss development and reserve releases have transformed a $4.1 billion reserve redundancy into a $900 million reserve deficiency (a $5 billion swing), according to a recent study by Aon Benfield Analytics.
However, workers compensation insurers have released an even greater amount of reserve redundancies during the soft market. According to the NCCI, their reserve position actually worsened for the fifth year in a row, ending 2012 with a $13 billion deficiency. Given that neither the workers compensation line of business nor commercial lines as a whole have any remaining redundancies, there is virtually no chance that redundancies from other lines of business will be available to carry workers compensation results in the coming years. The question is, can workers compensation as a line of business stand profitable on its own results?
The answer to this question, for the first time in a long while, is very likely “yes.” The workers compensation industry is, in fact, entering a new and hopeful era with the potential for future profitability. A recovering economy could reduce claim frequency in the coming years. As people return to work, new fraudulent and borderline claims will tend to decrease in number. During the economic downturn, for example, workers who had sustained minor injuries were not at all reluctant to file a claim if they lost their job. With a modestly expanding job base, there should be fewer of these types of claims in the coming years.
Further, implementation of the Affordable Care Act, or “Obamacare,” could lead to a permanent change in claim frequency in the industry. Imagine if all workers had health insurance coverage: denial of a workers compensation claim would simply mean the worker’s primary health insurance coverage would apply. Any borderline claim would likely go first to the health insurer, simply due to the ease of filing a claim. Loss costs would go down and loss adjustment costs would diminish, as many disputed claims would be removed from the system.
This scenario is actually supported by industry research. A RAND Corporation study found that the 2006 Health Care Reform Act may be responsible for the entire 16.7% drop in workers compensation claims between 2005 and 2009. Further, the American Academy of Orthopaedic Surgeons reported that workers compensation costs decreased precipitously in Massachusetts due to the Massachusetts Health Care Reform Act.
Yet, these results are not conclusive and there is considerable downside potential for the industry. Renewed efforts at “coordination of benefits” will certainly cause an increase in loss adjustment expenses as health insurers will try to put costs back to the workers compensation carrier. Further, the cost-saving measures of exchanges (for example, the potential use of a discounted schedule for reimbursement) could also adversely impact workers compensation carriers.
According to managed care blogger Joe Paduda, Obamacare’s impact will be felt in two primary ways: cost-shifting and access to care.
Workers compensation is currently the highest payer around, coming in well above Medicare—though somewhere below the unlucky uninsured who walks in for a checkup. There is continued risk that providers will push to bypass primary coverage and tap into the higher-paying workers compensation system when they are only entitled to the primary insurer’s reimbursement scale. Offsetting this concern, in certain instances, providers (especially hospitals) will now be receiving some reimbursement where nothing was previously available.
In fact, as providers begin to soak in these new revenues, there may be less of an incentive for them to push the envelope in seeking reimbursement. At the same time, insurers will have a great deal of incentive to reduce their medical reimbursement amounts by identifying lower cost providers to handle workers compensation cases. As a result of these competing dynamics, cost-shifting may not become an overbearing concern for workers compensation insurers.
Access to care is also impacted by the fact that workers compensation is already the highest payer for most procedures. This higher cost structure may serve to solve any access issues for workers compensation claimants. While it is easy to envision shortages arising from the addition of 30 million new insureds to the system, it is much harder to imagine that providers will not bend over backwards to accommodate the payer with the biggest checkbook.
If the changes made by the Affordable Care Act or by other recent trends cause a permanent downward shift in workers compensation losses, risk managers should be working in close concert with their third party administrators to ensure these savings are not thrown away at the claim level. Tools such as three-point contact, case management and verification of second injury fund coverage should be second nature. In addition, TPAs will need to redouble their effort to identify situations where primary coverage is liable—with so many new insureds, this should be well worth the effort.
Further, risk managers need to gain a clear understanding of prior-year loss experience and discuss positive trends with their broker and insurer. Whether their coverage is first dollar, a high-deductible plan or high-level excess, they need to keep a close eye on loss development. Just as insurers have never been shy about informing insureds when losses are trending upward, risk managers should keep a watchful eye to determine if and when their losses begin to trend the other way. These trends may provide significant savings at renewal.
For example, the insured may be able to realize some immediate savings through scheduled rating credits, provided it can demonstrate above-average efforts at loss control. In addition, a favorable loss history as compared to other insureds within a specific class code will eventually be reflected in the experience modification factor, but this takes over three years for the full effect to be felt. Finally, if all losses are going down, the savings will eventually be captured by lower overall rates but this takes time as well.
In the meantime, if the risk manager is not satisfied that its improved loss position is being properly reflected in premiums, it may be time to revisit the structure of the program, change to a high deductible or high-level excess program, or consider self-insurance options, including captives.