Key Themes and Takeaways
  • The labor market remains robust, characterized by an average of 266,000 net new jobs added over the past three months and strong annual wage growth of 4.2%, supporting premium growth in workers compensation.
  • Labor market statistics continue to improve with rising participation and more normalized turnover, taking some pressure off the economic drivers of workers compensation frequency.
  • The probability of a recession has diminished over the past quarter as consumer spending remains supported by strong employment levels, real income growth, further capacity for debt, and still-elevated excess savings.

Economic Outlook

Over the past quarter, the labor market has continued to evolve in a positive direction for the workers compensation system relative to the tight post-COVID market of a few years ago. We have seen job growth, turnover, and participation moving from the extremes of 2021 to more balanced levels and closer to pre-pandemic (2015–2019) averages. However, the key outstanding question for the industry remains: is the labor market moving softly into balance or are we seeing early signs of deterioration toward recessionary conditions?

In this Quarterly Economics Briefing (QEB), we will build off last quarter’s analysis of the consumer to help answer that key question. Based on the evolution of the data and the state of household finances broadly across the economy, we continue to see the economy moving toward balance rather than a recession, despite elevated risks.

The State of the Labor Market

Over the past several months, the labor market has continued to downshift from the extreme levels seen at the height of the Great Reshuffle of 2021. The table below shows a summary of key labor market statistics.

Net employment growth over the past three months averaged 266,000 (Table Bubble 1), up from 201,000 over the previous three months. The October jobs report showed strong gains for the month of September and included meaningful upward revisions to net employment gains in July and August. While employment growth has slowed from the heights of the Great Reshuffle, it remains healthy overall and continues to support economic expansion. Overall job growth also continues to support growth in the workers compensation premium base (Bubble 2). Calculated private payroll growth has slowed some in recent months while public (government) job growth has contributed meaningfully to overall employment; however, payroll growth remains elevated relative to pre-pandemic levels due to persistent elevated wage increases.

While wage growth has softened some from the peak, we expect it to remain elevated above the pre-pandemic trend for some time as the economy continues to expand and workers push for higher wage gains to offset their inflation experience from the past few years, even as the labor market broadly comes more into balance. These trends have two primary implications for workers compensation: higher premium growth (including audit premium), partially offset by higher indemnity severity.

Labor market drivers of workers compensation frequency continue to move in a supportive direction relative to the post-pandemic extremes and have moved more meaningfully in the past several months.

At first glance, the three-tenths rise in the unemployment rate in August (Bubble 3) looks like a worrying signal and an indication of a potential recession. For example, the “Sahm Rule”Direct Stimulus Payments to Individuals, Claudia Sahm, Board of Governors of the Federal Reserve System, The Brookings Institution, May 16, 2019. suggests that if the three-month average of the unemployment rate increases by at least 0.5 percentage points compared to its lowest point within the previous 12 months, it signifies that the economy is either in a recession or on the verge of entering a recession.

There are two main ways in which the unemployment rate increases: people losing their jobs creates a shift from employed to unemployed workers, and people beginning to look for jobs can create a shift from “not in the labor force” to unemployed. By definition, an unemployed worker must have actively searched for a job in the past four weeks, a strict definition that sometimes causes discouraged jobseekers to fall out of the unemployed worker pool despite still wanting a job.

August’s unemployment rise was due to the latter as the labor force participation rate increased meaningfully (Bubble 3), especially for those in the prime working ages of 25–54, causing an increase in the unemployment rate while the economy continued to add workers. Increased labor supply will further help balance the labor market as the pool of candidates for filling job openings expands.

Net employment gains do not always tell the full story of the health of the labor market, nor that of the economic drivers of frequency for workers compensation. The economy is not just adding new workers every month. Instead, employment grows when new hiring exceeds job separations. But the total amount of turnover is important too. A net employment gain of 200,000 workers that comes from 500,000 new hires and 300,000 total separations is a very different labor market than the same net employment gain with 5 million new hires and 4.8 million total separations. Higher monthly turnover at any level of employment gain leads to more low-tenured workers as a percentage of the labor force, with lower-tenured workers tending to be a key driver of compensation claims.“The Great Reshuffle and Workers Compensation Frequency,” Patrick Coate, ncci.com, September 28, 2022.

Over the past several months, the rate of hiring has continued to fall, and the overall hires rate is about the same as the pre-pandemic average (Bubble 4). While a 0.3% decline in the hiring rate from May to July may look inconsequential, it represents roughly half a million fewer new workers hired each month. Lastly, and despite some major media headlines, the layoffs and discharges rate remains near historic lows. The overall picture from key data around the labor market suggests balance is returning rather than a recessionary deterioration taking hold.

Will the Balance Hold?

In our last brief,“Economic Outlook for Q2 2023,” Quarterly Economics Briefing, Patrick Coate and Yariv Fadlon, ncci.com, July 24, 2023. we highlighted what we believe to be one of the largest risks to the labor market: reduced consumer spending. This could occur due to deteriorating household balance sheets and tightening credit conditions as the Fed raises interest rates. Households built up excess savings during the pandemic when incomes (including transfer payments from the government) vastly exceeded spending. Spending quickly recovered in the wake of the pandemic while inflation took a large bite out of household incomes, which has led to a drawdown in excess savings.

Since our last QEB, the Bureau of Economic Analysis (BEA) has updated the data used to calculate excess savings. The BEA made upward revisions to real incomes over the past 12 months, leading to a slower drawdown in excess savings than the previous data suggested. The basic fact that consumers have been drawing on excess savings remains unchanged, but the revisions help explain the lack of pullback on consumer spending to date—consumer finances still have a bit more cushion than it first appeared. The figure below has been updated with the latest available data and illustrates that in aggregate, households have several months of excess savings remaining, rather than savings having been largely depleted as data prior to the revision showed.

As the rate of economic inflation has slowed, real incomes have begun to slowly rise again in 2023, though there remains significant ground to make up in returning to the pre-pandemic trend and closing the savings deficit. As excess savings quickly run out, is there an impending “Wile E. Coyote running off the cliff” moment coming for consumers? If household finances were as simple as money in and money out, then yes, you would likely begin to hear that quintessential whistling sound after looking down in the near future, especially for lower income households.

However, recent spending from households has not entirely been funded by excess savings or current income. After paying down credit card balances early in the pandemic, consumers have illustrated an increased capacity for debt over the past few years to support higher spending. Overall credit card debt declined by roughly $160 billion during the pandemic as households paid down existing debt and declined to take on new debt.

Headlines like “Americans’ credit card debt hits a record $1 trillion”“Americans’ credit card debt hits a record $1 trillion,” Alicia Wallace, CNN, August 8, 2023. sound alarming without the context of this deleveraging. Recent increases represent households taking up excess capacity for debt, which remains below the pre-pandemic trend. Further, debt levels in isolation do not matter as much as the ability to service payments on those debts. Rapidly rising nominal incomes in the post-pandemic era have helped keep debt service manageable for the average household. As a percentage of disposable income, all debt service payments, including monthly rental payments, remain lower than pre-pandemic levels.

A combination of excess savings and increased capacity for debt has helped keep household spending elevated in the wake of the pandemic. Now, as nominal wage growth remains elevated and the rate of inflation slows, this positive real wage growth combined with further capacity for debt increases can help continue to sustain household spending and the economy going forward. While this sounds like a beautifully simple soft-landing story, bringing all of these facets of the economy into balance is typically easier said than done, as history has shown.

Economy Remains Benign for Workers Compensation

The labor market continues to evolve in a positive direction for workers compensation relative to the post-COVID extremes. Elevated wage growth combined with still-healthy employment growth is leading to continued strong total payroll growth overall. Turnover continues to slow, which reduces low-tenured workers as a percentage of the overall labor force over time. Current data does not contain warning signs of an imminent recession. Instead, it signifies that relative normalcy is returning as employment growth slows relative to Great Reshuffle levels. The household spending and savings imbalance has been offset by record levels of credit card debt; however, debt service remains quite healthy and no abrupt stop to consumer spending appears to be on the horizon. With real wage growth once again positive, consumer activity will likely be able to continue to drive economic growth. That means businesses are unlikely to begin broad layoffs that disrupt the labor market and the workers compensation system.