WHEN WILL THE WORKERS' COMP PARTY END

HOW BAD WILL THE HANGOVER BE?

For a very long time, 12 years to be exact, employers and brokers have been having a party in California's worker's compensation market reveling in the low rates. And what a wild party it has been with endless food, drink, and good times. Nobody wants it to end, and some may be convinced that it never will.

Workers' compensation markets are cyclical, going from hard to soft and back to hard again. Typically, this shift back and forth occurs about every 7 years, yet we are currently in the longest soft market in history. However, we have forgotten that the party will end, and many are so euphoric that they can't even acknowledge that reality.

What Created This Historic Soft Market

In 2012, California lawmakers signed Senate Bill 863 (SB863) into law. This landmark worker's compensation reform legislation increased permanent disability payments while eliminating high systemic costs and creating savings through several structural changes in the benefit delivery system.

The California Workers’ Compensation Insurance Rating Bureau (WCIRB) found in their SB863 Cost Monitoring Update in October 2019 that workers compensation "savings have accumulated to a total system-wide savings of over $10 billion since SB863's implementation, which has largely driven a series of advisory pure premium rate decreases totaling more than 40 percent and has resulted in the lowest average charged premium rates in the marketplace in more than 40 years."

Thus, the legislative reforms precipitated by SB863 set the scene for the groovy California workers' comp party we have enjoyed for the past 12 years.

The Winds of Change Are Blowing

Numerous recent events over the past couple of years have occurred that typically cause a shift back to a hard market. These include interest rate hikes, inflation, volatility in stock markets, wars in Ukraine and Gaza, geopolitical instability in four major regions worldwide, and a lot more. Surprisingly, these events have not triggered a return to a hard market as is typical and expected.? Despite all the uncertainty and fear, the US stock market remains strong and reached a record high of 38,000 this past week.

Profits and returns for their shareholders drive commercial carriers. The investment returns earned in the stock market run-up have buoyed these profits, and have allowed carriers to charge low premiums, in some cases, less than the underlying cost of insurance. The stock market is also cyclical, following the adage of what goes up must come down. While we are sitting at an all-time high in the market currently, do we really believe that the market will never come down? I don't want to frighten anyone when I say this, but rest assured, it will go down and then back up again. This is the nature of cyclical markets, just like workers' comp.

In the past few weeks, I’ve picked up indications from industry thought leaders that we are hitting last call for this party.?

Discussing the cyclical nature of the workers' comp market on December 5th, 2023, at the Goldman Sachs U.S. Financial Services Conference, W.R. Berkley Corporation CEO Robert Berkley Jr. said, "The cycle is really driven by fear and greed, and that is what has, what is and will continue to drive the cycle." WR Berkley is one of the largest commercial lines carriers in the United States.

Red Flags Foreshadow the Coming Hard Market

The signs are everywhere that the market is in flux and heading for a change. In a webinar earlier this month, James Auden, managing director for North American insurance at Fitch Ratings revealed the rating agency's projections of a 103 combined ratio and a 15 percent drop in net earnings for 2024. Fitch further forecast that the U.S. property/casualty industry won't report an underwriting profit or double-digit returns for the year.

Fitch is watching to see if prices keep up with loss costs and monitoring signs of loss reserve weakening in 2024. In Auden's words, an item to watch is "whether heightened loss estimation risk in the most recent accident years tied to inflation and rising litigation costs, particularly in longer-tail liability lines (emphasis added), leads to weakening in reserve strength".

If reserve strength weakens, regulators will require carriers to increase their reserves. Carriers generally increase reserves by building profits that come from raising premiums.

Long-Tail Liabilities Add Risk and Concern

In December 2023, Michael Lagomarsino, a senior director with AM Best, a rating agency, presented a review of various market conditions. Echoing Auden's comments, Lagomarsino voiced concern about longer-tail liability lines (think workers' comp) stating, "Reinsurers have expressed pricing and reserving concerns regarding casualty lines as reported claims have started to accelerate recently. As such, we remain cautious that reserve deficiencies in casualty could weaken the capital base and hence the credit profiles of reinsurers".

Cautions About Reserve Development

Kimberly George, senior vice president at Sedgwick and Mark Walls, vice president at Safety National, highlighted adverse reserve development as one of the '20 Issues to Watch in 2024' published recently in Insurance Thought Leadership.

George and Walls explain, "There are concerns that the insurance industry may find itself needing to increase tail claim reserves in multiple lines because of a variety of factors". Some of the factors they identify include are, adverse development on workers' compensation tail claims due to increased attendant care costs and longer life expectancy for severely injured workers, and additionally, a remaining backlog of pending cases in the courts due to COVID-19.

They continue stating, "Risk managers and brokers should pay attention to the carrier earnings calls. If there are comments around the need to strengthen reserves in lines of coverage, this may signal that rates could increase or that the carrier might withhold certain lines of coverage."

Rate increases, discontinuing to write certain lines of business, or exiting California are examples of the impacts of a hard market. During a previous hard market, so many carriers stopped writing workers' comp coverage in California that the State Compensation Insurance Fund (SCIF) had nearly 60% of the California workers’ comp market share. That scenario sharply contrasts with SCIF covering only around 11% of the California market share today. If carriers start to exit the market again with the onset of the coming hard market, we will see SCIF's market share increase dramatically as they are the carrier of last resort.

Preparing For a Hard Market

When will the market turn hard is the million-dollar question. Unfortunately, no one has the answer to this question. We do know that it is not a question of whether it will turn hard, but?when?it will turn hard. A couple of facts to consider are the current soft workers' comp market is the longest we have seen in history, external events and pressures all indicate the market should have turned many times in the past few years, and the market is beginning to show signs of hardening.

Will it happen in 2024? The crystal ball says it’s too soon to tell. Sometimes, the market change occurs suddenly, like flipping on a light switch; in other cycles, the change happens slowly, like death by a thousand tiny cuts. The latter is occurring as I write this.

The real question to ponder is when the market does turn, are you prepared? What will you do? Have you planned and put strategies in place to survive the hard market hangover?

Alternative Risk Solutions for the Hard Market

When the hard market returns, two key issues to prepare for are dramatic rate increases and carriers exiting the market, creating a situation where coverage availability is scarce.

Alternative risk solutions can be a safe harbor during a hard market and offer benefits in all markets. Self-insurance has provided rate stability and access across all markets for over 105 years. Many of the largest companies in California are self-insured for precisely these reasons. In addition to protecting against market forces and volatility, they also enjoy other benefits that include greater control, improved outcomes, and lower costs.

Small and mid-sized companies can also benefit from the advantages of self-insurance through membership in self-insured groups (SIGs). Well-run SIGs provide the same benefits large employers enjoy from being self-insured and give predictable coverage access and stable rates.

Many brokers are unfamiliar with self-insurance and SIGs, but now is the time to become familiar with these alternative options for your clients before the party ends and the hangover of a hard market gives you heartburn. Good preparation now will help you weather changes in market conditions. Knowing where Alka-Seltzer and Pepto-Bismol are before the hangover hits is always a good idea.?

ABOUT THE AUTHOR: Jon Wroten, MBA, CPP, is Senior Vice President at The PATH Alliance and Managing Director of California Risk Advisors LLC, where he provides strategic leadership to help California employers derive maximum benefit from being self-insured. In his prior role as the Chief of the Office of Self-Insurance Plans (OSIP) for the State of California, the nation's largest self-insurance marketplace, he was responsible for managing $22 billion in risk exposure, protecting 4.6 million California workers representing $192 billion in annual payroll. Jon taught business, insurance, and risk management as an adjunct professor at Sierra College for over fifteen years.