Workers’ Compensation Rate Redundancy

  • It appears that although rate reductions countrywide have been at historic levels and combined ratios for the carriers that service the business were at the second best is the last 50 years in 2018. While these are generally signs that the market will be corrected, it is anticipated that due to claims reserve redundancy, the end of the soft market is not in sight. from
Friday, March 29, 2019

Healthy Reserves May Help Extend Comp’s Profitability, Analysts Say

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The workers’ comp industry had excess loss reserves estimated at $4.7 billion at the end of 2018, according to new report from A.M. Best, and some analysts say that will provide a cushion to help extend the insurance line’s streak of profitability.

Robert Hartwig

Robert Hartwig

The workers’ comp reserve excess, which analysts refer to as a redundancy, is in contrast to some other insurance lines detailed in the report that are experiencing a reserve deficiency. Those include commercial auto liability, with a $2.2 billion deficiency, and a products liability category, with a $5 billion deficiency.

The figures represent the “undiscounted” reserve, which includes factors such as the amount of interest the money will earn.

While $4.7 billion might sound like a hefty sum, it represents less than 3% of the workers’ comp net loss and loss adjustment expense reserves, which total about $165 billion, according to Thomas Mount, a senior director for A.M. Best rating services and author of the report.

Still, the extra $4.7 billion is nice to have for an insurance line that’s known for its volatility, said Robert Hartwig, director of the Center for Risk and Uncertainty Management in the Darla Moore School of Business at the University of South Carolina. As recently as 2011, workers’ comp was running a combined ratio of 115%, representing an underwriting loss, and reserves were deficient, Hartwig noted.

Hartwig said the reserve redundancy should be viewed as “a prudent cushion in an inherently volatile line — a line in which reserves can transition from redundant to deficient quickly relative to shorter-tail lines.”

When insurers feel comfortable that a portion of reserves won’t be needed, that amount can be released and applied toward earnings, something that Hartwig said has been happening gradually in workers’ comp. Hartwig said he expects to see “continued modest releases” over the next few years.

“The $4.7 billion redundancy makes it highly likely that reserve releases in this line will continue, bolstering the WC line’s underwriting performance and its overall profitability,” Hartwig said.

Reserves are set based on projections of the amount that will be needed to pay claims into the future. As time goes on, it may turn out that the estimate is too low to cover actual claim costs, resulting in a reserve deficiency, or too high, producing a reserve redundancy.

Timothy Mosler, a director and consulting actuary with Pinnacle Actuarial Resources, said a decline in claim frequency is one contributor to the workers’ comp reserve redundancy. Even after claim frequency falls, he said, insurers will take a cautious approach to reducing reserves. That’s because it’s not immediately known whether frequency has fallen for low-cost claims or high-cost cases.

Another factor is that medical severity has been increasing at a slower rate, according to Mosler, who attributed the trend to insurers’ implementation of cost containment measures.

Workers’ comp has experienced four straight years of underwriting profitability, and the reserve redundancy likely means “the good times will continue a bit longer,” Mosler said.

“With reserve redundancy, it’s reasonable to expect a postponement to the unprofitable times,” he said.

According to A.M. Best, workers’ comp reserve development has been favorable each year since 2011, ranging from $300 million in 2011 to about $2 billion in 2015 and 2016. Favorable reserve development then more than doubled in 2017, to $4.3 billion.

Mount, at A.M. Best, said the workers’ comp reserve redundancies are spread across most WC insurers.

He said that “only time will tell” what ultimately happens to the current $4.7 billion redundancy. And for each insurer, the answer may be different.

“Some insurers may release it into earnings in lieu of taking rate increases, thereby keeping the calendar year results profitable while the accident year deteriorates,” Mount said.  

In another possibility, Mount said, multi-line insurers might use the workers’ comp redundancy to bolster reserves in a line that has a reserve deficiency.

And if claim costs turn out to be higher than what was estimated in calculating the reserve, some of the redundancy could be used to cover the higher-than-estimated liabilities, he said.

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