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Workers' Comp Cycle: Have We Been Here Before?


By Patrick Andersen, AASCIF News Editor

Reading the industry journals, one would gather that the current market conditions for workers' compensation are part of a "cycle" that revolves once every eight to 12 years. A layman would assume, then, that executives might be able to predict market conditions and plan proactively. But some AASCIF members have encountered some new bumps and loops in the latest turn of the wheel, while other newer organizations are traveling on this side of the merry-go-round for the first time.

"The cycle" generally describes the periodic ebb and flow of market share between private carriers and state funds in competitive environments. During a "soft" market, conditions are favorable for private insurance companies, which in turn offer competitive discounts and other incentives in order to gain market share. The state funds for the most part refrain from deep discounts, lose market share and endure belt-tightening measures during these periods because their premium rates are higher than those of the private carriers. During a "hard" market, on the other hand, the private carriers find workers' compensation less profitable and reduce or even halt their participation in that insurance line, causing a flood of business for the state funds.

Missouri Employer Mutual Insurance (MEM) was created in 1993 and started selling policies a year and a half later. "We entered the market in 1995 and grew very rapidly. We depopulated the assigned risk pool in 1995 and early 1996. (But) when the soft market hit, we lost 15 to 20 percent of our volume," said Dennis Smith, MEM's president and CEO. But the recent change of the market has dramatically reversed MEM's situation.

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"(With the hardening of the market) we've replaced that 15 to 20 percent we lost and have increased by another 30 to 40 percent on top of that. In 1999 we had $77 million in premium. In just two years we've grown to $135 million in premium," Smith noted.

Arizona's State Compensation Fund has felt the heat too. "Has the market in Arizona been turning hard? Oh yeah!" laughed Jon Allen, regional vice president. "In the first six months of last year, we wrote $11 million in new business. In the first six months of this year, we wrote $33 million."

The increase in volume places immediate pressure on an organization's infrastructure. AASCIF members that have experienced the cycle before have remembered and acted on the lessons learned.

For example, in the hard market of the late 1980s, the phones at the Arizona State Fund were ringing so often with employers seeking new policies that the staff had difficulties just handling the volume of calls, let alone the underwriting. In the current market the State Fund is concentrating on "working smarter."

"For instance," Allen said, "we've changed our phone system so that a caller can punch in his or her zip code. Then the call will be automatically directed to the proper person" in one of nine regional offices. The Fund has also made refinements to its financial services division to speed up transactions. The organization has not significantly added staff but has reallocated duties and responsibilities among existing personnel to clear bottlenecks and streamline work processes.

MEM's Smith said the mushrooming volume necessitated increased hiring. "We've written 2,500 new policies. We've increased our (internal) workforce by 20 percent."

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Volume vs. ratios

The increase in volume and market share does not necessarily translate into stronger financial standing, however. John Leonard, president and CEO of Maine Employers' Mutual Insurance Company (MEMIC), blames workers' comp industry executives for bringing problems upon themselves. In an article he wrote for The Standard, a regional trade magazine based in Boston, Leonard decried the shortsighted competition for market share that leads to under-pricing, resulting in "pitiful" loss expense ratios and bottom-line results. He pointed to the demise of several major workers' comp carriers in California as the result of this shortsightedness and added, "Here's the scary part: The problems are not limited to California."

"In the late '80s and early '90s we can point to runaway benefit programs, sympathetic legislatures and overdue reform needs. Now those forces are in check, yet our results have never been worse," Leonard said. He noted that, nationwide, carriers have been offering discounts of about 20 percent. "Pricing discounts must be addressed. If we assume rates are adequate, how do we possibly continue to price our product 20 percent below this level? This guarantees financial disaster."

Jim Neary, vice president for actuarial services for California's State Compensation Insurance Fund, agreed that the workers' comp industry brings misery on itself. "The cycle behaves the way it does because insurance pricing isn't like manufacturing furniture, in which you know your cost of materials, labor and overhead before you try to sell your product. In insurance you are dealing with perceptions of what might be the unknown costs out there in the future, so pricing is often very inexact," he said.

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"For instance," Neary continued, "when the California market entered open rating in 1995 and 1996, the perception was that you could pretty much give away workers' compensation coverage, so prices went very low. Because we are dealing with a cycle of perception, our industry is a bunch of lemmings all headed for the cliff. Either everybody wants to write policies at give-away prices or they all want huge rate increases to make up for the losses they suffered as a result of low pricing. I'm here to tell you that today some of my competitors are proud that they are increasing their rates by only 35 percent."

State Fund has always been known to "lean against the prevailing wind," Neary said. "When competitors were under-pricing their products in a race for market share, our rates were adequate and were considered high. We lost a lot of business during that period. Now that our competitors have to file for very large rate increases, the business is coming back to us. Because State Fund's rates were already priced adequately, we have been able to file for increases in modest bites of just 6 percent, 9.5 percent and 13 percent over the past three years," Neary noted.

Oregon has not felt the full brunt of the hardening market. "We've seen some signs of it, but I think workers' comp is lagging the rest of the property & casualty market in Oregon," commented John Gilkey, corporate marketing manager of SAIF Corporation. "Our sales have been excellent for the past two or three years but have remained pretty stable. We actually written a bit less new business in 2001 than we did in 2000, though we're still on pace to match last year's sales by the end of this calendar year. Actually, we seem to see more fallout from market conditions in other states than Oregon. We have a lot of policyholders with multi-state exposures, so we've been helping them find markets in other states where they also have exposure."

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Gilkey noted that SAIF has written some new business as a result of rating agencies downgrading other carriers, but not to the extent reported by other AASCIF members. Also, a recent state Supreme Court ruling that "poked a hole in the exclusive remedy doctrine" has caused substantial hardening in the umbrella insurance market, he said.

But one of the classic signs of a hardening market is an increase in premium rates, and Oregon is enjoying rate decreases, Gilkey said.

Non-competitive environments

Non-competitive state funds and Canadian boards do not feel the impact of the workers' comp market in the same manner.

Andy Butler, a policy analyst for the Yukon Workers' Compensation Health & Safety Board, said workers' compensation in his province tends to be affected more by cycles in general economic conditions than by fluctuations in the insurance industry.

"The major impact (over a 10-year period) has been from an economic downturn resulting from changes in the Yukon's primary industries (mining, timber and fur production) as well as the decline in the population base. As a result there has been a reduction in the number of businesses registered for compensation coverage and employer size has been reduced, with the exception of the government sector," Butler said.

John Halvorson, research & development manager for North Dakota Workers' Compensation (NDWC), said his organization does not face the same challenges as competitive state funds.

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"Because we are a monopoly, we are not subject to the same pressures," Halvorson said. "We do see a 'hit' on reinsurance costs, because we go outside to obtain that."

The assumption that unemployment creates a "cycle" for workers' compensation may not always be correct either.

"Our claims remain consistent, with about 20,000 claims filed each year" during periods of both high and low unemployment, North Dakota's Halvorson said. "There are two schools of thought regarding the impact of unemployment on workers' compensation. One is that you have a higher number of claims during periods of increased unemployment. But another school says you have more claims during periods of low unemployment because there are more inexperienced workers on the job, and inexperienced workers are more likely to get injured. In either case the number of time-loss claims is down because we have implemented a number of new safety programs."

Core mission focus

All organizations contacted for this story indicated they are focusing on increased efficiency in handling their core mission goals to keep costs down. The conservative approach will help maintain their fiscal integrity and provide policyholders the greatest incentive to stay with them when the market turns again.

"Three major components undoubtedly drive the outcome of our efforts," said Maine's Leonard. "We need the appropriate blend of efficient claim handling, effective loss control, and adequate pricing. We should view these three components as links in a chain. When any one of them weakens or breaks, the whole value proposition is in jeopardy."

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Missouri's Smith agreed. "As with the rest of the state funds, we have a philosophy that adequate claims management and loss prevention pay off for us in the long run. The pressures of this type of market really put that philosophy to the test. But I think that our standards for claims management and loss prevention are an important distinction - these are the things that separate most state funds from other insurance companies."

Arizona's State Fund found that a renewed focus on mission and vision statements was important for the organization. "Part of our new vision statement - one of our primary goals - is to improve our image by elevating our level of customer service. Because of the changes we have made, when the market turns again, this time we think a lot of accounts will stay with us," Allen said.

Butler said the Yukon's WCS&HB has been able to reduce costs to employers despite economic pressures related to employment rates, seasonal fluctuations and "an upward trend to the number of self-employed persons."

"In 1999 the Yukon board completed a review and redesign of the classification and rate structure. As a result the new classification and rate structure is more equitable and the board, through sound investments, offers employers a minimum subsidy of 45 percent on their assessment rates," Butler said.

Despite the recent price hike for reinsurance, North Dakota's exclusive state fund reported it also has lowered its costs through improved claims handling, implementation of a medical fee schedule, and increased use of alternate dispute resolution resulting in less litigation. As a result NDWC recently announced its seventh consecutive rate reduction.

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What's Ahead?

"Looking forward, I, like many others, believe that comp results will improve over time - they have to," said Leonard. "However, that will only occur when we get sensible about pricing and realistic about loss control."

Neary expected the market to settle after a period of adjustment. "In the near future I would expect to see another round of significant rate increases. State Fund has the perception that it is indeed possible to maintain financially sound operations at our current rates. It will probably take a year or so for the rest of our competitors to come to a consensus, to share the perception that they can again be profitable at their then-current rate levels."

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