The Twists and Turns of Workers’ Compensation Profitability

images-1Profitability is a sensitive subject in workers’ compensation. That is because, with a smattering of exceptions, workers’  compensation is mandated. As heavily-regulated social insurance, its profitability cycles have often been compared to roller coasters — and for good reason.

For a fresh look at workers’ compensation underwriting cycles and their historic causes, check out Workers’ Compensation Insurance Industry Underwriting Results in 2011 (which is also posted at the bottom of this blog). Published in the Workers’ Compensation Resources Research Report, its author, John F. Burton, Jr., graciously shared his December 2012 article with me prior to its release.

Burton is not an actuary, but an economist and  retired professor and CompLand’s senior researcher. As the head of the only National Commission on State Workmen’s Compensation Laws, which stemmed from the Occupational Safety and Health Act in the early 1970s, the depth and degree of his influence on workers’ comp cannot be overstated.

Ultimately, Burton takes readers through underwriting figures galore since 1973. He begins by reporting that the overall operating ratio – the most comprehensive measure of insurer profitability because it includes investment income  – went up from 96.7 in 2010 to 99.8 in 2011. This reflects a downward profitability trend for the past several years and partially explains why employers are seeing premium increases.

Using A.M. Best figures, Burton’s article is a veritable time machine,
unfolding the drama of the workers’ compensation underwriting cycle.

An overall operating ratio more than 100 means insurers are losing money even with investment income while an overall operating ratio that is less than 100 means insurers are profitable.  “The overall operating ratio of 99.8 in 2011 means that workers’ compensation insurers made $0.20 of profit per $100 of premiums that year,” Burton said.

Using A.M. Best figures, Burton’s article is a veritable time machine, unfolding the drama of the workers’ compensation underwriting cycle. Insurers have gains and losses and employers’ pay more or less through a parade of political efforts intensifying the twist.

Note that Burton is not using figures from the National Council on Compensation Insurance, Inc. (NCCI), which is the go-to organization for underwriting information in workers’ comp. NCCI tends to stress the combined ratio as a measure of the comp underwriting experience. To Burton, however, the combined ratio alone “represents an incomplete and potentially misleading record” of insurer profitability because it does not include investment income, which averaged almost 15 percent of premium in the seven years from 2005 to 2011.

He insists that he does not want to suggest that $.20 per $100 of premium is an adequate return for workers’ comp insurers. At the same time, he writes,” focusing on the overall operating ratio – and not the combined ratio after dividends — should be the starting point for assessing the profitability of the workers’ compensation insurance industry.”

Maybe so, but how can I resist comparing A.M. Best’s figures with NCCI’s? I’ll post my findings in a future blog after I visit with a couple comp actuaries!

Burton’s piece rightly offers that profitability from investment is an important contributor to overall profitability. He reviews each piece of the overall operating ratio for workers’ compensation and throws in comparisons with other major property/casualty lines.

After demonstrating the true profitability picture, he tries to persuade the reader that there is “little justification” for cutting benefits or tightening compensability now since benefits paid to workers as a percent of payroll have been stable since 2006. This is unlike the period from 1982 to 1992, when the workers’ comp insurance industry saw adverse underwriting results and benefits increases were on the rise.

This of course raises the issues of narrowing compensaibility, which is fodder for another day.

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