February 7th, 2012

January 2012 Reinsurance Renewal: Workers Compensation

Posted at 1:00 AM ET

jan2012cover_gcci1A difficult market for workers compensation in 2011 is likely to extend into 2012. Deteriorating results in the primary market over the last few years have also had implications for reinsurers, which are under pressure from global property-catastrophe losses. Reinsurance rate declines were not the norm for the January 1, 2012, workers compensation renewals, as in past years. Factors ranged from sluggishness in the job market to the likelihood of reinsurer profit in other lines of business.

Primary Insurance

The rating process and workers compensation rules and regulations vary from state to state. However, there are negative factors in today’s market that have an impact across state borders. Specifically, key components of investment returns, medical inflation, employment statistics and overall economic conditions in the United States (and globally) are challenging the profitability of the primary workers compensation market nationwide. Nationwide results for workers compensation insurance have deteriorated for several years, with the composite combined ratio projected to exceed 120 percent for 2011. Overall premium has dropped, because of rate decreases, competition and job losses, more than 30 percent since 2005. Rating agencies have responded to the poor results with negative rating actions outpacing positive rating actions by a ratio of more than two to one. During 2011 and going into 2012, primary rates have been increasing on average in the mid-to high single digits. However, there are rate increases indicated in a number of states, and for the first time in several years, the number of states with proposed rate increases has exceeded the number of proposed decreases.

Poor workers compensation results have had an effect on M&A activity, which was below normal levels in 2011. Between the deteriorating results and depressed interest rates, the current workers compensation market isn’t conducive to transactions. When pricing and profitability improve for this line, M&A activity will rebound.

In the new year, we anticipate that dedicated workers compensation carriers will refine underwriting standards, with “casual” workers compensation carriers reexamining their strategies for the line. We would also expect to see some realignments within the MGA segment as carriers reduce their workers compensation partnerships due to deteriorating market results. Residual market carriers and facilities should see a premium uptick from both new employers (in a job market that is recovering but still struggling) and established employers with poor loss experience. The latter group of employers is likely to find limited options for workers compensation coverage in the standard market.

Unemployment-related payroll shortfalls and decreasing primary rates in the last few years have reduced premium from a high of USD49 billion in 2005 to just under USD34 billion in 2011. Expense ratio pressures and subsequent actions by carriers have likely increased their net risk profiles via increased reinsurance retentions and reduced spends for services and loss control services that mitigated loss volatility. Increased rates and a recovering job market may provide a slight uplift for accident year 2012. However, as the 2008 to 2010 years continue to develop, overall profitability in 2012 will be a challenge.

Reinsurance Market

With the possible exception of 2001, in which the terrorist attacks of September 11, 2001, added loss ratio points to already poor market results, the workers compensation reinsurance market is not driven by catastrophic workers compensation events. Rather, workers compensation losses are more a function of unbudgeted loss development and insufficient pricing, which typically produce calendar year losses on top of unprofitable accident year experience. Reinsurers in this sector are affected by the same factors that impede profitability in the primary market.

There is no shortage of uncertainty in the workers compensation reinsurance market today, with a number of continuing conditions set to create a difficult 2012:

  • Primary loss ratios and combined ratios are approaching 1999-2000 levels in the 115 percent to 120 percent range
  • There was an uptick in loss frequency last year for the first time in roughly a decade
  • Job growth has been sluggish, because of a stagnant economy
  • Investment rates remain dismal
  • Threats of inflation remain
  • Reserve creep continues
  • Increasing estimates of market reserve deficiency
  • Competition in the primary market and the use of discounts is offsetting any bureau rate increase recommendations

A majority of the reinsurers providing reinsurance capacity for workers compensation are global companies that will have been posting loss reserves for the excessive catastrophe losses in 2011, which adds strain to the space.

For loss-free catastrophe excess of loss programs, rates on line look to be flat to down 5 percent at the January 1, 2012, reinsurance renewal, compared to average declines of 5 percent or more through 2011. While there were no catastrophic events impacting the workers compensation space specifically, the panel of reinsurers providing capacity did share in worldwide catastrophe losses of above USD100 billion in 2011. Several clients have estimated subject premium increases for 2012 resulting in a pure rate decrease for programs where rates on line were renewed as expiring.

Per risk or working layer pricing followed individual company loss experience and exposure rating (driven off of loss ratios). There were very few rate reductions in the working layer renewals at January 1, 2012. A more complete study of rate changesfor both working layer and catastrophe layer renewals will be available after a comprehensive evaluation of finalized terms.

Terms and conditions remained fairly consistent for the 2012 renewals - typical maximum any one life (MAOL) warranties remained at USD10 million. From the ceding companies there is increased interest in reinsuring single claimant losses excess of the current reinsurance market standard limits of USD10 million. We expect to see ceding companies, intermediaries and reinsurers all working to develop products and treatments to cover expanded single claimant limits.

Model changes and economic conditions did impact cedent decision making. Decreasing covered employee populations, expense ratio pressures and updates to earthquake models in 2010 (reducing projected loss at lower return periods) had a continued ripple effect for 2012 with some cedents reducing overall catastrophe limits. The lowering in Terrorism Risk Insurance Program Reauthorization Act of 2007 attachment points (because of declining premium) reduced the terrorism limits ceding companies secured to buy down their deductibles.

Current market conditions and profit opportunity in other lines have led some reinsurers to decrease their appetite for workers compensation catastrophe business. At the same time, other reinsurers looking to diversify their portfolio or anticipating an improved market with the new primary rate increases have increased their quoting activity. Although the net impact on capacity has been a lower level of oversubscription than last year, bound capacity was sufficient for programs to be fully signed for 2012 renewals.

Despite no shortfall in traditional catastrophe reinsurance capacity, a new multi-year catastrophe bond for workers compensation was placed in 2012. The earthquake-only recovery is based on post-event modeled output. The bond was not placed because of a shortfall in traditional reinsurance capacity.

In summary, despite the profitability challenges in the primary workers compensation market, there is balanced, diversified and dedicated reinsurance capacity to address reasonable risk solutions for ceding companies.

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