The exhibits below are updated to reflect the current economic outlook for factors that typically impact workers compensation. Each exhibit also provides some context for the outlook, relative to the historical data. Forecasts are derived from Moody’s Analytics.
After a robust start to the year, in which private employment grew by more than 200,000 jobs in both January and February, the US economy added only 147,000 jobs in May. Private employment growth averaged 126,000 jobs for the months from March through May, about three-quarters of monthly job growth during 2016.
During May, the most jobs were added in these sectors: education and healthcare; professional and business services; and leisure and hospitality. Employment declined in trade, transportation, and utilities; information; and manufacturing. However, manufacturing lost only 1,000 jobs in May after increases in each of the five previous months.
Real gross domestic product (GDP) growth slowed in the first quarter to a 1.4% seasonally-adjusted annual rate, as compared with 2016’s annual GDP growth rate of 1.6%. Moody’s expects that real GDP growth will pick up during the remainder of this year, forecasting a 2.3% increase for all of 2017, followed by 2.7% real GDP growth in 2018.
While real GDP growth is forecast to accelerate modestly over the next two years, Moody’s predicts that employment growth will slow down, from 1.9% annually in 2016 to 1.4% annually by 2018. The slowdown in employment growth is a consequence of labor market tightness, as the US unemployment rate has recently reached historically low levels below 4.5%. A further consequence of low unemployment is likely to be an acceleration in wages, a topic to which we turn next.
Preliminary data indicates that average weekly wages increased by 1.2% during 2016, down from a 3.1% growth rate in both 2014 and 2015. This is a substantial decrease from last March’s Quarterly Economics Briefing (QEB), where we estimated 2016 average weekly wage growth at 2.5%. March’s wage growth rate for 2016 was an estimate, whereas the wage growth rate in this issue uses actual wage data for 2016. Taking into account last year’s lower-than-expected wage growth, we forecast that average weekly wages may increase by 3.4% this year and accelerate to 4.8% in 2018.
Full employment is a theoretical concept referring to an equilibrium of supply and demand in the labor market with the defining property that wages are neither increasing nor decreasing, but not where all workers who want a job can necessarily find one. The full-employment rate of unemployment reflects frictional unemployment (workers transitioning between jobs) and structural unemployment (matching job skills demanded with those supplied in the labor force). The Federal Reserve, charged with the dual goals of combating inflation while promoting full employment, estimates that the US economy is at full employment when the unemployment rate is 4.65%. The current unemployment rate of 4.3% in May, its lowest level since 2001 and below the full-employment rate, signals a tight labor market and suggests that wage growth is likely to accelerate. The exceptionally low unemployment rate can also help to explain the recent slowdown in employment growth, which makes it more difficult for businesses to find qualified workers.
With the US economy now at—or above—full employment, near-term payroll growth is likely to be more heavily weighted toward increases in wages, and less weighted toward increases in employment. The prospect that wage growth will outstrip employment growth suggests that workers compensation indemnity severity may increase relative to medical severity. However, this conjecture presumes that growth in medical costs remains relatively stable as wage growth accelerates. In fact, the near-term outlook for medical costs looks more uncertain, as we discuss in the following section.
After jumping to 3.8% in 2016, Moody’s forecasts that inflation in the medical Consumer Price Index (CPI) will slow this year to 2.8% before picking up again to 3.3% in 2018. Moody’s current forecast for 2017 medical CPI inflation is down from last March’s forecast of 3.4% because recent data shows a slowdown in the rate of price growth for prescription drugs. During the second half of 2016, prescription drug prices grew 6% to 7% year-on-year as measured by the CPI, but comparable price growth dropped to 3.1% as of last April. Since prescription drugs make up 17% of the medical CPI index, a 3.5% drop in price inflation for prescription drugs produces a decline of 0.6% in medical CPI growth.
The recent slowdown in prescription drug prices may be due, in part, to several drugs going off patent. Patents for Crestor, a cholesterol-lowering drug, and Benicar, a blood pressure medication, expired in late 2016. Vytorin, another cholesterol medication, and Tamiflu, a flu medication, both went off patent this year. However, none of these are important drugs in workers compensation claims.
Notwithstanding the downward revision since March, Moody’s expects that the medical CPI will go up faster than general inflation, which it forecasts to run at 2.2% in 2017 and 2.4% in 2018.
Medical cost changes over time can be decomposed into price changes and changes in utilization. Forecasts for the medical CPI speak to the price component. In Accident Year 2016, medical severity for workers compensation claims in NCCI states increased by an estimated 5%. Netting out 3.8% for price inflation, as per the medical CPI, leads to the conclusion that medical utilization per claim increased by 1.2% last year.
Last year’s increase in medical severity follows a surprising estimated decrease of 1% in medical severity for Accident Year 2015, which implies that medical utilization per claim dropped in that year. Recent research by NCCI concludes that a decline in physician services per claim was the major driver for lower medical utilization in Accident Year 2015. Although not yet substantiated, 2016’s experience suggests that decline in medical utilization during the previous year may have been an anomaly.
In sum, medical price inflation could accelerate to above 3% annually by 2018. Medical utilization per workers compensation claim, after a surprising drop in 2015, rose in 2016. Taken together, these observations suggest that medical costs in workers compensation may grow faster in the next few years than in the recent past.
Investment income has been constrained by a low interest rate environment for many years. However, the expectation that price inflation will return to more normal levels of 2% or above means interest rates should rise.
After increasing the target range of the federal funds rate by 25 basis points at their March meeting, the Federal Open Market Committee again boosted rates by 25 basis points to the range 1.00%–1.25% in June. The Fed’s projection following the June meeting indicates that it expects to raise the target rate once more this year. As it shifts to a stance of gradual monetary tightening after many years of easing, the Fed also indicated that it plans to start shrinking its asset holdings of Treasury and mortgage securities later this year by allowing these assets to roll off without repurchases.
Interest rates on 10-year Treasury notes as of June of each year have been below 3% since 2012. Interest rates fell in 2016, perhaps due to uncertainty surrounding the British vote to exit the European Union.
Moody’s forecasts the 10-year rate to rise to 2.4% in the second quarter of this year before increasing to 3.4% next year. Next year’s 10-year interest rate above 3% is in line with expected inflation at 2.4% and with the Fed’s stated intention to continue raising short-term interest rates.
With continued low interest rates, investment income is likely to remain muted this year. However, nominal investment returns can be expected to increase as inflation picks up and the Fed continues to tighten credit conditions.
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Note: Analysis and charts prepared in May and June 2017.