At NCCI’s Annual Issues Symposium 2019, a video shown on the underwriting market cycle discussed the ebbs and flows of the workers compensation industry and how the market has changed since the 1990s.
Soft market typically refers to periods when coverage is widely available and insurance companies lower prices to actively compete for market share. During a soft market, industry reserve deficiencies may build as companies release reserves to offset increasing underwriting losses. On the other hand, hard market generally describes periods of relatively higher prices, tightening underwriting standards, and reserve strengthening.
Today’s workers compensation environment is healthy and competitive. However, industry stakeholders have described the current market as atypical, displaying a hybrid of both SOFT-market and HARD-market characteristics.
Furthermore, NCCI’s estimate of the calendar year workers compensation combined ratio has been less than 90% for the most recent three years. The Calendar Year 2018 combined ratio of 83% is the lowest observed since the 1930s.
The current atypical market environment, in conjunction with the magnitude of the recent premium level decreases observed across the country, has led to an increased stakeholder focus on whether these decreases will continue and where the market might be headed.
Ratemaking in Workers Compensation
Ratemaking in a long-tailed line of insurance such as workers compensation presents a formidable challenge, as the final cost of some claims may not be fully known for several decades after the accident occurs. Traditional actuarial techniques account for this by extrapolating historical data patterns to estimate the ultimate cost of policies that will be written in the future. In most jurisdictions for which NCCI provides ratemaking services, NCCI’s role is to file the loss cost portion of the full rate on behalf of its members and subscribers. In the context of this article, the general term “ratemaking” applies to the determination of both loss costs and full rates.
At NCCI, we have the advantage of leveraging the broadest and deepest workers compensation database in the industry. Yet, the ever-changing workers compensation environment presents numerous hurdles that must be overcome when determining actuarially appropriate rate/loss cost level changes to be filed with state insurance regulators for review and approval. These challenges include a balance between stability and responsiveness, estimating ultimate claims costs for immature years, and predicting future costs based on historical data.
Stability Versus Responsiveness
Ratemaking often requires a balance between stability over time and responsiveness to the most recent data. Is a deviation from the historical norm an anomaly or is it indicative of a market turn?
While NCCI rate/loss cost filings utilize the most recently available data, consideration of historical data is needed to maintain an appropriate level of stability. Underlying each filing is an experience period, which is composed of the premium and loss experience from a group of years that serve as the basis of the state's indicated overall average rate/loss cost level change. Relying on more than one year of premium and loss experience helps reduce the impact that volatility in the data may have on rates/loss costs from one year to the next.
Claim frequency, a measure of how often claims occur, is one cost driver whose decline has contributed to the historical rate/loss cost level decreases observed across the country. The following chart shows that lost-time claim frequency has fallen over the past two decades.
As an illustration of the challenge of balancing stability and responsiveness, consider the increase in frequency observed in the wake of the Great Recession. Countrywide lost-time claim frequency increased in Accident Year 2010—the first increase in more than a decade. At the time, it was unclear whether this was a temporary uptick or an indication that significant frequency declines would no longer be the norm. However, what followed this period was a reversion to the historical pattern of frequency decreases. From 2011 to 2017, cumulative countrywide lost-time claim frequency decreased by more than 25%.
In Accident Year 2018, NCCI observed a modest 1% decrease in frequency—seemingly inconsistent with the average decrease over the past 20 years. So is Accident Year 2018 an outlier? Should we expect a reversion to a historical norm? Or, perhaps, could this change be driven by job growth and a strong economy, as short-tenured employees may be more likely to sustain an injury when compared with longer-tenured workers? If so, how might the economy change over the next several years, and what impact could this have on workers compensation costs?
Only time will provide a definitive answer. However, NCCI remains committed to analyzing the data and striving to identify the latest trends. To enhance responsiveness, NCCI recently conducted midyear individual insurer surveys inquiring about the most recent frequency changes observed in the industry.
For an in-depth discussion of the current economic outlook and its impact on workers compensation—including a report on how recessions impact workers compensation—see NCCI’s October 2019 Quarterly Economics Briefing.
Estimating Ultimate Claims Costs
Ratemaking involves estimating future costs based on current information. Due to the long-tailed nature of workers compensation, it can be decades before stakeholders know the final cost of a claim. Future claims costs are difficult to anticipate because, for example, medical treatment innovations that occur years after the accident takes place may impact these costs. In addition, judicial rulings or changes in a jurisdiction’s statutes or benefit structures may also complicate projections, as historical claims data may be less indicative of future costs.
Loss development is a standard actuarial technique that leverages historical claim payout and reserving patterns to estimate the ultimate future costs of known, but immature, claims. Although a necessary and vital component of the ratemaking process, there may be uncertainty associated with estimating the extent that losses will develop over time.
Because historical patterns may change, each year NCCI reviews the estimated amount of loss development to be applied in rate/loss cost filings. As is summarized in the following chart, we have observed patterns of declining loss development over the recent past. These include (1) paid loss amounts alone (i.e., paid development) and (2) paid loss amounts plus insurance company reserves set aside to pay for future liabilities on known claims (i.e., paid + case development).
In general, numerous items, such as changes in claims handling, settlement practices, loss reserving, and structural benefit changes can influence loss development patterns. Another possible contributor in recent years is the general decline in opioid use, as societal awareness of the opioid epidemic has increased. Across all NCCI states, the percentage of claims with a prescription that included an opioid fell from approximately 55% to 40% between 2013 and 2017.
Estimating Future Costs
Because historical years’ data are used to determine rates/loss costs to be effective in a future time period, the data must be adjusted to account for expected cost differences between the time period of the historical data analyzed and the period when the rates/loss costs will be in effect. NCCI refers to this ratemaking adjustment as trend. NCCI actuaries perform a trend analysis as part of the ratemaking process to incorporate the estimated impact that inflation, for example, may have on workers compensation costs.
Estimating future trends can be challenging in an ever-changing workers compensation environment. Inevitably, the rate/loss cost level decreases observed in recent years have influenced expectations of how costs might continue to change over the next several years. During its trend analysis, NCCI reviews a variety of factors including state-specific patterns in claim frequency, average claim severity, and loss ratios. Additional considerations such as countrywide and regional trends, legislative changes, and information collected in the NCCI Medical Data Call may also influence the final trend estimates included in each rate/loss cost filing.
For the 2018–2019 filing season, the countrywide average annual indemnity and medical loss ratio trends were –3.8% and –2.8%, respectively. While trends less than 0% indicate that decreasing costs may be expected to continue, the magnitude of recent rate/loss cost level decreases is not expected to continue indefinitely. NCCI trend selections frequently reflect an expectation that historical patterns and results are generally more informative and predictive of the future when observed over an extended time period. It should be noted that the rate/loss cost level decreases approved across the country in recent years have been driven more by improvements in the newly reported premium and loss experience rather than by year-over-year declines in the filed trend factors.
Ratemaking in a long-tailed line of business such as workers compensation continues to be challenging—especially with the current environment’s atypical market characteristics. Actuaries must balance stability and responsiveness, estimate how immature claims will develop over time, and predict future costs through an analysis of workers compensation trends. Though the future remains to be seen, NCCI is certain about its continued vigilance in monitoring changes that may impact the system and striving to foster a healthy workers compensation environment.
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