The Work Comp Bubble

July 18, 2018

Do you remember the housing bubble of the early 2000's that ultimately triggered the landslide of a financial crisis in 2007? That “bubble” started because residential loans were crazy cheap and credit-underwriting standards had become extremely loose. Demand for houses, and thus loans, were high with interest rates so low, all the while home values peaked at a crazy pace. Underqualified buyers received incredibly low interest rates and favorable terms, but as interest rates increased, the demand for houses and loans dried up. Subsequently, home values decreased as much as 40%, and millions of foreclosures occurred over the next several years as people had no means to pay back at the newly inflated rates. After getting bludgeoned for the role they played in pumping air into the bubble, lending institutions got much more disciplined in their underwriting of residential mortgages. Getting a home loan after the bubble burst was pretty close to impossible.

The point of describing the housing meltdown is to set the stage for where we are in the current Workers Compensation insurance marketplace. We are currently floating in a happy bubble where rates are at historically low levels and underwriting standards are as flexible as silly putty. No, I don’t believe that a bursting of the Work Comp bubble will trigger a massive-scale financial meltdown, but it will certainly have a ripple-effect in the insurance marketplace that will make this current “buyer’s market” feel like a distant fantasy.

The Air in the Bubble
We marketed several accounts over the last 12-24 months and have found repeatedly that underwriters are happy to apply scheduled credit on a risk that truly doesn’t deserve it. Taking a 25-point increase on your Experience Modification Rating (EMR)? No big deal! We’ll offset it by increasing scheduled credits and moving your program to an insurance company with a more advantageous rating structure. Auto Liability rates going up 15% this year? Don’t worry! We can add some more credit to the Work Comp to make sure the total program premium remains flat.

While this might seem reckless, the current rate environment makes it necessary for underwriters to propose aggressive terms in order to retain business and compete on new opportunities. But the current lack of underwriting discipline is not sustainable and will only contribute to a bigger shock when the losses finally catch up with the low rates. Why do I think this will happen? Here are a few points to chew on:

Medical advances are saving lives after catastrophic claims in ways not previously possible, but these advances are extremely costly with a long-term commitment.
Catastrophic injury claims are happening more frequently in the last decade than they did in the prior four decades.
At the top of the list for catastrophic injuries is motor vehicle accidents. The market has already adjusted by sharply increasing Auto Liability rates. Due to the longer development of Work Comp claims, we have not yet fully experienced the impact these claims will have on loss ratios within the Work Comp segment.
Many of the “preferred risks” continue to opt out of the traditional insurance marketplace to take control of their destiny and experience the benefits of a Group Captive insurance model. This means the pool has less strong performers to prop up and help offset the poorer performers.
The number of jobs are increasing as the economy improves. We saw payrolls increase nationally by nearly 4.5% in 2017. This increase in the labor force means that there are newer and less-trained workers in the marketplace who are statistically more likely to file a Work Comp claim.
All but one NCCI state experienced an overall rate decrease in 2017. Eleven states took double-digit rate decreases.

Still Making Money
Despite all of this, insurance carriers are making money in Work Comp. 2017 represented a record low combined ratio at 89%, when the previous low was 93% in 2006. The combined ratio is a measure to determine if an insurance carrier, or a line of coverage like Workers Compensation, is paying out less money than it is receiving. At an 89% combined ratio, this indicates a very healthy margin for insurance carriers.

Something Doesn’t Add Up
When you combine all of these factors, how are carriers still making money? Rates are down, while severity claims are up. Underwriting discipline is waning, while the “best in class” risks are testing the waters of Group Captives and alternative risk finance (i.e. self-insurance).

The question isn’t “if” this bubble will burst… but when?

When Will it Burst?
The current cycle we are in is the longest declining rate cycle we have seen in 20 years. Over the last 20 years, a “reset” typically happens around year 5. Simply based on this, we can venture a guess that we are due for change soon.

Because of the length of time it takes for Work Comp claims to develop, the amount of premium collected today has to be sufficient to potentially cover 30 years of losses. Many factors contribute to Work Comp claims having a longer tail including the inflation of medical care costs, more permissive claim reopening provisions, and an aging workforce. Carriers haven’t seen what the financial impact of many claims will be on their loss ratios yet because these claims haven’t developed in meaningful ways. I can’t predict exactly when we will start to see this shift, but I believe it is visible on the horizon.

How Can You Prepare?

Stay best-in-class. A continued emphasis needs to be put on Safety, Loss Control and Claims Prevention so your insurance broker can advocate for the best pricing, terms and conditions. Underwriting scrutiny will get more intense, and giving us the ability to shine the best light on your organization will matter. Our Loss Control team provides custom-built strategies that help make our clients safer, stronger and more attractive to the insurance marketplace.
Consider a captive program or alternative risk finance. If your Safety and Claims are already best-in-class and your organization has a fairly significant spend on Work Comp premium ($150,000+ annually), let us review risk finance strategies that have sustainability and rewards. One way to avoid the effect of the bubble bursting is to take your destiny into your own hands and avoid the volatility of the insurance marketplace altogether.
Focus on employee wellbeing. This might seem unrelated, but there are plenty of statistics to back-up that a more healthy workforce equals a safer workforce with highly engaged employees that are less likely to file a Work Comp claim. We spend time educating our clients on these statistics and advise them on practical initiatives to positively impact not only their health insurance spend, but to also positively impact Work Comp loss performance.

Air continues to be pumped into the Work Comp bubble. Let’s enjoy this buyer’s market while it lasts, but be aware that it can’t be sustained. History will repeat itself, and the pricing bounce is likely to happen sooner than later. Is that a hissing sound I hear?

By: Adam Balentine
Associate Partner and Director of Insurance Operations
Thomas McGee Group
abalentine@thomasmcgee.com