Standard & Poor’s Says Comp Profitability Unlikely:

By Greg Jones, Western Bureau Chief

Despite rate increases in some states and talk of a hardening market for workers’ compensation insurance, international credit-rating agency Standard & Poor’s said it remains “bearish” on the industry because of the sluggish economy.

Siddhartha Ghosh, a credit analyst with S&P in New York, wrote a report published on Monday that warns of continued years of poor profits for workers’ compensation carriers and possible downgrades of ratings for some insurers with a heavy concentration in the workers’ compensation line.

The title of Ghosh’s report sums up the rating agency’s outlook: “For the U.S. Property/Casualty Industry, Making Workers’ Compensation Profitable May Be Mission Impossible.”

The report says the industry has had a poor track record for underwriting results in the past 20 years. The industry has posted combined ratios below 100% only three times — 1995, 1996 and 2006 — between 1991 and 2010. The national combined ratio will reach at least 115% in 2011 and could stay there until 2013, Ghosh writes.

But not everyone agrees that carriers have to keep their combined ratios at 100% or below to earn a profit. When rejecting a proposed increase in the pure premium rate in 2007, California Insurance Commissioner Steve Poizner said that a combined ratio exceeding 100% does not necessarily indicate a carrier is losing money, because the ratio does not include investment income. Part of the decision written by Senior Staff Counsel Chris Citko said based on a set of assumptions that includes an estimated 6.72% yield on invested assets, a carrier could operate profitably at a combined ratio of 112%.

“To put it another way, the shortfall of 12% above the amount necessary to pay for claims and expenses is handily covered by investment income and should leave enough left over for a healthy profit,” Citko wrote at the time.

Ghosh agreed that a combined ratio in excess of 100% doesn’t necessarily indicate a carrier is operating at a loss. Because each insurer’s portfolio will determine the impact of investment income on performance, S&P doesn’t look for a magic number, but it is not possible to be profitable in the current economic environment with a combined ratio of 115%.

“If underwriting results are expected to be at least 115% or 116%, we need 10% to 12% return to get to a break-even scenario,” Ghosh said.

With the struggling economy, Ghosh said he does not expect to see double-digit investment returns.

A stagnant economy creates additional problems because workers’ compensation profitability is sensitive to payroll, Ghosh said. The market analysis predicts the national unemployment rate, which fell to 8.5% in December, will not change much over the next two years.

The analysis from S&P predicts an average unemployment rate of 8.7% in 2012, improving to 8.6% in 2013.

Ghosh said he also feel strongly that industry reserves are inadequate, noting in his report that the property and casualty industry prematurely released $2.8 billion in reserves from the workers’ compensation line between 2006 and 2008. Ghosh writes that because of the long tail of workers’ comp, it is almost impossible for an insurer to have a high level of confidence in initial reserves. He expects to see carriers reporting adverse reserve developments for accident years 2007 through 2010.

Ghosh told WorkCompCentral that the various factors, such as the economic conditions and reserving, are not equally weighted, and economic performance is more significant.

“But the combination of all of that is staggering in terms of any kind of profitability in the near future,” he said.

Some insurance experts have commented that recent trends suggest that the workers’ market is hardening — a hard market being the condition where demand for insurance exceeds supply — which would bring more profitability to carriers.

A survey by the Council of Independent Agents and Brokers found price increases of 4.1% and 2.6% in the first two quarters of 2011, Ghosh reported. Another survey from the Risk and Insurance Management Society found average renewal prices declined a modest 1.7% in 2010, compared to larger declines of 3.8% in 2009 and 3.5% in 2008.

Ghosh called these signs of improvement evidence of a trend going in a favorable direction, but he isn’t convinced the market is actually hardening.

“It’s just too early to know whether the trend will continue,” he said.

In California, Insurance Commissioner Dave Jones reported on Jan. 19 that insurers filed for an average rate hike of 2.8% for 2012.

Ghosh said the increase in California isn’t sufficient to overshadow combined ratios of 130% reported by the Workers’ Compensation Insurance Rating Bureau for 2009 and 2010. He also said rates filed by carriers do not indicate what is ultimately charged to employers after discounts and credits are factored in.

“Even if charged prices increased — that’s good news because it’s been a while — there is a question about sustainability and whether it’s wide scale or national,” Ghosh said.

Mark Gerlach, a consultant for the California Applicants’ Attorneys Association, said the Golden State is in a unique position because of profits generated in the years after reform legislation was enacted.

Information from the Rating Bureau showed combined ratios of 57% in 2004, 55% in 2005 and 69% in 2006.

With substantial profits, California carriers were able to put more into investments. The result, Gerlach said, is that excess investment income earnings continue to subsidize higher combined ratios, which explains why insurers increased rates an average of 2.8% in light of a combined ratio of 130%.

“The situation is unusual, and can’t be sustained for the long term, but it is a situation where California insurers are making rational decisions based upon their level of investment income,” he said.

Gerlach said he does not expect to see significant rate increases in California, because he doesn’t think carriers are under significant pressure. He expects to see increases of about 3% as the economy improves over the next few years, but that is about it.

Gerlach has not seen the S&P report, but did note that the agency looks for greater profits than he thinks is necessary. S&P looks for profits of 15% to 20%, while Gerlach said he thinks 10% is appropriate for insurance carriers.

Ghosh said S&P is “bearish” on the workers’ compensation market, and the idea behind his report was to explain why it thinks performance will continue to struggle over the coming years.

“On the pricing side, in order for things to improve materially, there has to be a wide scale rate improvement across the board,” he said. “A countrywide rate increase would benefit a great deal of companies and make the line more attractive.”

Ghosh also cautioned that if some insurers strengthen their reserves, causing their operating earnings to fall below S&P’s expectations, the agency would consider lowering some ratings.

Karen Oxman, owner of GNW-Evergreen Insurance in Encino, Calif., said the she doesn’t think a downgrading by S&P would have a significant impact, because employers mostly look to A.M. Best for ratings of insurance companies. She added that A.M. Best looks at S&P’s report, so there could be some impact there.

“Unless it’s a real severe change, I don’t think most people are impacted,” she said. “People get a quote and if it’s the best quote, I think they’re inclined to take it.”

Oxman said her official position as president of a brokerage firm is that clients should go with the company that has the best rating, but that is not always what customers are looking for.

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Source: WorkComp Central

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