May 7th, 2009

Workers Comp Rate Trends Call for Discipline and Reveal Opportunities

Posted at 1:00 AM ET

p_sidebar_iaxsEmil Metropoulos, Senior Vice President
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January 1, 2009 reinsurance renewal rates for workers compensation stabilized after steady annual decreases since 2002. While this certainly compares favorably with other lines of reinsurance, key underlying components of workers compensation insurance are not cooperating. Medical expenses constitute more than 50 percent of overall workers compensation costs and are increasing at nearly twice the pure medical inflation index. Add the effects of the financial market turmoil, increased unemployment, mixed rate actions within the various jurisdictions, and reform push-back, and we are faced with a new level of uncertainty for workers compensation results. Efficiently priced working layer reinsurance — which has typically been the hedge against frequency losses — is not as readily available as it once was, and insurers will have to find new ways to manage their capital effectively.

Guy Carpenter’s Reveal®, a leading-edge severity model is now available on the i-aXs® platform and can help you identify the states and classes in your portfolio with the greatest risks of excess or catastrophic loss, resulting in better capital management, a smoother path to profitability, and the creation of shareholder wealth.

From Capital Strength to Underwriting Savvy

A year ago, the insurance landscape was much different. Carriers sought strategies for making excess capital productive. Dividend payments and share buybacks were common. The industry operated from a position of capital strength … which is the reason it was able to weather the financial catastrophe so well. Insurers were able to absorb the financial losses sustained last year, but they entered 2009 with leaner balance sheets. Without the crutch of excess surplus, underwriting discipline has only gained in importance. For the remainder of this year — and likely next year, as well — carriers will need to optimize existing capital, rather than assume that they can raise more with ease.

The workers compensation space may not have been affected as profoundly as other lines of business by the worldwide financial crisis, but it nonetheless has challenges that did not exist a year ago. Medical inflation trends have not eased and realized as well as unrealized investment losses have thinned balance sheets to the point where the continued slide of risk transfer pricing was brought to a halt. Flat reinsurance pricing may signal that capital is not as plentiful as it used to be.

Before applying a dollar to a risk, careful analysis is necessary to ensure that the investment is value-accretive. From the granular evaluation of how a particular policy is likely to perform to the broader company-wide impact of a capital management strategy, the shortage of capital relative to last year means that insurers will have to do more with less.

Risk Selection Advantages

While the use of reinsurance is an important component of any risk management plan, it is not the only alternative available. In fact, risk transfer is only effective when it constitutes part of a broader view of the portfolio. To optimize the deployment of capital, it may make sense to assume some risks when they can be priced and managed, even if access to reinsurance is limited or not priced effectively. Mixing retention analysis with reinsurance purchases and the judicious selection of risks to cover can maximize the value of the capital put to work in the marketplace.

The importance of underwriting discipline was underscored in 2008. The realized and unrealized investment losses that pushed through the insurance industry impaired earnings, but many carriers were able to generate underwriting profits. The core risk management skills on which insurers rely was demonstrated to be sufficient. This effectiveness becomes crucial to success in a capital-constrained environment. With reinsurance rates steadying, underwriting prowess will be magnified this year and in 2010.

The goal, consequently, is to balance risk, retention, reinsurance, and return — with insurers assuming the risks that can be managed most effectively through retention and risk transfer techniques to generate the largest return possible. In this environment, optimizing your capital may not follow the path it did last year.

Assuming high levels of risk that can’t be transferred effectively via reinsurance for an adequate price — while avoiding the assumption of other insufficiently priced risks — is the definition of solid underwriting. And, it could bolster top and bottom line results.

It seems counterintuitive, but analytical and technological developments can make the stubborn risks that cannot be pushed from your portfolio sources of consistent earnings. By identifying the circumstances (e.g., specific underwriting criteria, loss control, pricing, and claims handling), carriers may be able to develop niche markets that have long been underserved. Early movers that execute well are likely to be rewarded with a long-term competitive advantage, a steady source of underwriting profitability, and an unparalleled growth opportunity.

Reveal(ing) Your Results

Guy Carpenter Reveal makes your analysis of risk and subsequent allocation of capital more effective. Using 1,600 class code categories, workers compensation insurers can take a more granular approach to assessing the marginal impacts of specific classes of business on its portfolio. Rapidly calculating loss likelihoods and impacts based on years of historical data, Reveal unlocks hidden opportunities for niche market entry and the judicious deployment of capital.

The recent hazard group expansion has been a major improvement in excess loss rating, still enough heterogeneity in the underlying injury distribution remains. Reveal is particularly effective at identifying excess loss exposure for classes of business with disproportionate amounts of catastrophic claims. Using Reveal, you can locate these threats to your balance sheet — which otherwise would be nearly impossible to find — and take informed, decisive risk and capital management action. This may include exiting a particular state or segment of the market because the risk is too high … or writing a difficult class of business because Reveal can help you determine the thresholds at which enhanced underwriting, loss control, claims handling, and pricing can make troublesome policies profitable.

For example, looking at class code 7229 (Long-Haul Trucking) within the challenging USD4 million XS USD1 million layer, Reveal identifies this class as being approximately 3 percent to 8 percent more hazardous than its hazard group proxy in half of the states this sample carrier writes in. In North Carolina, this class is 10 percent higher and represents the carriers’ largest in-force premium-weighted class deviation. This knowledge is essential to carriers seeking to underwrite and service this class adequately. In other states, such as Arizona, the deviation is even higher at 15 percent.

Source: Guy Carpenter Reveal® v1.1

Source: Guy Carpenter Reveal® v1.1

Ultimately, Reveal’s robust risk identification and evaluation capabilities support the decision-making processes that can expand margins, elevate return on equity (ROE), and bolster shareholder value. Sometimes, the best courses of action are obscured by an inability to access or process targeted, granular data effectively. Reveal removes this barrier, opening new opportunities and making every dollar invested in risk more effective.

New Tools, New Results

Damage to the asset sides of insurers’ balance sheets has led to a change in the cost of risk transfer, as evidenced by the end of double-digit reinsurance rate declines for workers compensation reinsurance. Inexpensive capital is no longer the norm, requiring carriers to develop new underwriting alternatives for preserving capital and achieving overall financial objectives.

Reveal’s ability to identify individual state class codes exhibiting a propensity to produce higher (or lower) frequency and severity losses has a variety of applications that a workers compensation carrier can find useful. In addition to being able to identify the key drivers of excess loss in their portfolios, insurers can use Reveal to facilitate superior retention analyses, claims administration, loss control, profitability, anticipated claims emergence, and strategic portfolio growth. Now fully web-enabled via our expanded i-aXs Workers Compensation data management platform, carriers can have fast and easy access to it on their desktop.

Reveal allows risk managers to garner more intelligence from their workers compensation data. Keener insights lead to improved capital allocation and a financial performance that will be felt throughout the company … all the way to shareholders. Earnings success is magnified in market capitalization. Reveal can help you maximize the effect.

Download the i-aXs Reveal Fact Sheet >>

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