Workers’ Compensation: Getting into the Workplace

Asian insurers can learn from the experiences of their American and UK counterparts in order to write profitably, says Richard Weston of EMB. 

Demand for workers’ compensation insurance is growing rapidly in Asia and is certain to continue doing so. As with Europe and North America, it is best to think of a series of individual national markets, with a variety of different models for delivering protection to people injured at work.

Fundamentally, however, there are two alternative approaches: to compensate through the state or to do so through insurance. In practice, most countries are somewhere between the two extremes, combining an element of both. Japan is among those countries that lie at the state-funded end of the spectrum, whilst Singapore depends overwhelmingly on insurance, with countries such as Australia going for a hybrid solution.

All these approaches can work. From an insurer’s perspective, the need for companies to compensate injured workers means opportunities to make a profit, but beware of the pitfalls. This article will look at the experience of American workers’ compensation underwriters and their employers’ liability counterparts in the UK and consider how Asian insurers might learn from their mistakes.

The US has no-fault coverage. In the UK, by contrast, the injured or sick person has to prove blame. Apart from this one important distinction, the US and UK systems have much in common. They rely heavily on insurance and it can be a very difficult class of business to write. Insurers in both countries have often miscalculated the true cost of risk, leading to under-reserving and under-pricing.

Although Asian business culture is undoubtedly different and conditions vary by country, the drivers that affect workers’ compensation underwriting are universal. These include: the growing expectations of workforces; greater awareness of workers’ rights; the ever-present temptation for government to transfer the expense of looking after injured and sick workers onto the insurance industry; and the rising cost of medical treatment.

Let’s now look in more detail at some of the problems that workers’ compensation and employers’ liability insurers have encountered.

1. Inflation
In the past, underwriters consistently under-estimated inflation. Medical costs rose quickly, as did the number and scope of potential treatments. Court decisions and legal changes, many of them retrospective, also changed the basis on which personal injury awards are made.

Prices were based on inflation assumptions that proved to be too low. In the UK, for example, personal injury costs have risen by up to three times the rate of national average earnings for well over a decade, catching many insurers by surprise. Good communication between underwriters and claims managers is important so that changes in claims costs can be accurately reflected in premiums.

2. Reserving
Setting premiums requires an understanding of historic profitability. However, it is difficult to establish the level of profitability on recent years due to the long time it takes claims to develop and settle. For example, US workers’ compensation has shown, and continues to show a marked deterioration in the 00-02 underwriting years. Non-conventional reserving techniques and greater understanding of assumptions have an important role to play in the early identification of required rating action.

3. Hidden dangers
Asbestos destroyed many American and UK insurance companies by creating an unexpected and very large source of claims cost long after the original insurance policies were written. People often ask, what will be the next asbestos? Whatever the answer is, appropriate allowance for latent liabilities, either in rates or terms and conditions, needs to be made when underwriting.

4. Frequency trends
The same social trends that pushed up the frequency of claims in the US and UK are noticeable today in many Asian countries, albeit they are usually less obvious and less pronounced. A strengthened legal infrastructure, sometimes with lawyers willing to work on a no-win-no-fee basis, are among the drivers to consider. Although it will vary from country to country, it is reasonable to assume an increased propensity to claim. Early identification of social trends and their likely impact on claims costs are advisable.

5. Investment income
Insurers often relied on investment income to make profits on long-tailed liability classes. The current economic environment appears to be one of sustained modest returns, which should be factored into pricing.

Profitable workers’ compensation underwriting
There has been a tendency to treat groups of customers as single entities, ignoring the differences that exist within them. With small and medium-sized enterprises it is possible to borrow well-established modelling techniques from motor to help differentiate between risks. These models require recording of the relevant rating factors for each risk. This enables more accurate underwriting, so that companies can quote competitively without sacrificing margins,

With large commercial risks, bespoke modelling based on a company’s historic claims experience is essential. This involves adjusting historic losses for inflation, development and changes in exposure (taking into account the factors mentioned above). After allowing for expenses and an adequate return for capital, it is then necessary to consider the quality of risk management, which can have a strong impact on claims levels for these large risks. Indeed, it is a constant complaint of commercial insurance buyers that underwriters take insufficient notice of good practice in their prices and terms.

Summary
Workers’ compensation and employers’ liability insurance have had some very profitable and very unprofitable years. By learning from the mistakes of their American and UK counterparts, Asian insurers can control the downside risk and improve their long-term returns.

This article appeared in Asia Insurance Review in August 2006