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The State of Workers’ Comp in 2016

Over the last two years, employers and groups that self-insure their workers’ compensation exposures have enjoyed reasonably favorable terms on their excess insurance policies. Both premiums and self-insured retentions (SIRs) have remained relatively stable since 2014. This trend is likely to continue through 2016, but the long-term outlook for this line of coverage is less promising. Changing loss trends, stagnant interest rates, deteriorating reinsurance results and challenging regulatory issues are likely to have a negative impact on excess workers’ compensation insurance in the near future.

Predictions for 2016

Little direct information is available on the excess workers’ compensation marketplace even though written premiums well exceed $1 billion nationwide. Accurately forecasting changes in the marketplace is largely a function of the prevalent conditions of the workers’ compensation, reinsurance and financial marketplaces. But, based on available information, premium rates, retentions and policy limits should remain relatively flat on excess workers’ compensation policies for the balance of the 2016 calendar year. This projected stability is because of four main factors: positive results in the workers’ compensation industry over the last two years, availability of favorable terms in the reinsurance marketplace, an increase in the interest rate by the Federal Reserve at the end of 2015 and continued investment in value-added cost-containment services by excess carriers.

For calendar year 2014, the National Council on Compensation Insurance (NCCI) reported a 98% combined ratio for the workers’ compensation industry nationwide. In 2015, the combined ratio is projected to have improved slightly to 96%. This equates to a 2% underwriting profit for 2014 and a projected 4% underwriting profit for 2015. This is the first time since 2006 that the industry has posted positive results. The results were further bolstered by a downward trend in lost-time claims across the country and improved investment returns.

Reinsurance costs and availability play a significant role in the overall cost of excess workers’ compensation coverage. On an individual policy, reinsurance can make up 25% or more of the total cost. Excess workers’ compensation carriers, like most insurance carriers, purchase reinsurance coverages to spread risk and minimize volatility generated by catastrophic claims and adverse loss development. Reinsurers have benefited from underwriting gains and improved investment returns over the last three years. These results have helped to stabilize their costs and terms, which have directly benefited the excess workers’ compensation carriers and, ultimately, the policyholders that purchase excess coverage.

According to NCCI, the workers’ compensation industry has only posted underwriting profits in four of the last 25 years. This includes the two most recent calendar years. To generate an ultimate net profit and for the industry to remain viable on a long-term basis, workers’ compensation carriers rely heavily on investment income to offset the losses in most policy years. For the first time since 2006, the Federal Reserve increased target fund rates at the end of 2015. Although the increase was marginal, it has a measurable impact on the long-term investment portfolios held by workers’ compensation and excess workers’ compensation carriers. Workers’ compensation has a very long lag between the time a claim occurs and the date it is ultimately closed. This lag time is known as a “tail.” The tail on an excess workers’ compensation policy year can be 15, 20 and even as much as 30 years. An additional 0.25% investment return on funds held in reserve over a 20-plus-year period can translate into significant additional revenue for a carrier.

Excess workers’ compensation carriers have moved away from the traditional model of providing only commodity-based insurance coverage over the last 10 years. Most have instead developed various value-added cost-containment services that are provided within the cost of the excess policies they issue. Initially, these services were used to differentiate individual carriers from their competitors but have since evolved to have a meaningful impact on the cost of claims for both the policyholder and the carrier. These services include safety and loss control consultation to prevent claims from occurring, predictive analytics to help identify problematic claims for early intervention and benchmarking tools that help employers target specific areas for improvement. These value-added services not only reduce the frequency and severity of the claims experience for the policyholder, but excess carriers, as well.

Long Term Challenges

The results over the last two years have been relatively favorable for the workers’ compensation industry, but there are a number of long-term challenges and issues. These factors will likely lead to increasing premiums or increases in the self-insured retentions (SIRs) available under excess workers’ compensation policies.

Loss Trends: Workers’ compensation claims frequency, especially lost-time frequency, has steadily declined on a national level over the last 10 years, but the average cost of lost-time claims is increasing. These two diverging trends could ultimately result in a general increase in lost-time (indemnity) costs. Further, advances in medical technology, treatments and medications (especially opioids) are pushing the medical cost component of workers’ compensation claims higher, and, on average, medical costs make up 60% to 70% of most workers’ compensation claims.

Interest Rates: While the Federal Reserve did increase interest rates by 0.25 percentage point in late December, many financial analysts say that further increases are unlikely in the foreseeable future. Ten- year T-bill rates have been steadily declining over the last 25 years, and the current 10-year Treasury rate remains at a historically low level. A lack of meaningful returns on long-term investments will necessitate future premium increases, likely coupled with increases in policy retentions to offset increasing losses in future years.

Reinsurance: According to a recent study published by Ernst & Young, the property/casualty reinsurance marketplace has enjoyed three consecutive years of positive underwriting results, but each successive year since 2013 has produced a smaller underwriting profit than the last. In 2013, reinsurers generated a 3% underwriting profit followed by a 2% profit in 2014 and finally an underwriting profit of less than 1% in 2015. Like most insurance carriers, reinsurers utilize investment income to offset underwriting losses. As the long-term outlook for investments languishes, reinsurance carriers are likely to move their premiums and retentions upward to generate additional revenue, thus increasing the cost of underlying policies, including excess insurance.

Regulatory Matters: Workers’ compensation rules and regulations are fairly well-established in most states, but a number of recent developments at the federal and state levels may hurt workers’ compensation programs nationwide. The federal government continues to seek cost-shifting options under the Affordable Care Act (ACA) to state workers’ compensation programs. Later this year, state Medicaid programs will be permitted to recover entire liability settlements from state workers’ compensation plans – as opposed to just the amount related to the medical portion of the settlement. At the state level, there are an increasing number of challenges to the “exclusive remedy” provision of most workers’ compensation systems. Florida’s Supreme Court is currently deliberating such a challenge. Should the court rule in favor of the plaintiffs, Florida employers could be exposed to increased litigation from injured workers. A ruling against exclusive remedy could possibly set precedent for plaintiff attorneys to bring similar litigation in other states. Lastly, allowing injured workers to seek remedies outside of the workers’ compensation system would strip carriers and employers of many cost-containment options.

Ebola and Beyond: Protecting Self-Insured Work Comp Plans

Epidemic diseases such as Ebola present a significant threat to the safety of both victims of the disease and the individuals who come into contact with those who are infected. Even with advanced medical facilities and protocols, healthcare workers are particularly vulnerable to outbreaks of infectious diseases because they work in close proximity to the victims for extended periods. Further, the facilities themselves tend to be densely populated with workers who run the risk of secondary exposure from medical equipment and other workers who may have been exposed to the disease. Self-insured workers’ compensation plans are very popular among the large health facilities that are likely to deal with these outbreaks. It is therefore important for risk managers and hospital executives at these facilities to not only prevent these infectious diseases from spreading to their employees, but to protect the hospital financially if such an outbreak does occur.

An excess workers’ compensation policy provides reimbursement to self-insured employers for any workers’ compensation claim that exceeds the policy’s self-insured retention (SIR). Under most policies, a claim is defined as an occurrence or event that causes a loss. This provision allows the self-insured employer to combine the losses from multiple individuals injured in the same event under a single SIR rather than individually for each employee. Most policies however, require a separate SIR per employee for claims of occupational disease and illness. Therefore, if 10 employees contract the same disease in the course of their employment, the self-insured employer would be required to retain the SIR 10 times (once for each employee) under most basic policy forms. Clearly, this is an area of potential concern for self-insurers especially because most excess workers’ compensation carriers require minimum SIRs of $500,000 (or more).

To help self-insured employers manage the expense of occupational disease claims, many excess workers’ compensation carriers offer a communicable disease coverage either as part of their policy form or as an endorsement to the underlying policy. A communicable disease coverage combines the losses of multiple employees suffering from the same disease or illness under a single claim and, therefore, a single SIR. Unfortunately for self-insurers, not all communicable disease coverage is created equally. Unlike traditional workers’ compensation policies, where carriers use the same policy form, each excess workers’ compensation policy is unique.

My current excess policy has a communicable disease endorsement, so I don’t need to worry… right?

Just because an excess workers’ compensation policy contains a communicable disease provision doesn’t mean the policyholder is fully protected from this exposure. Communicable disease coverage is unique to the underlying policies to which it is attached and the carriers that issue them. In many instances, the only consistency between various carriers’ coverage forms for this potentially serious exposure is the name of the coverage itself.

Each communicable disease coverage has its own set of definitions, rules and limitations, so it’s important for the policyholder to understand the key provisions that determine how the coverage is triggered and how it responds to potential claims. In general, communicable disease coverage can be compared using four basic criteria: covered diseases, transmission sources, symptom manifestation and coverage limits.

 What’s in a name?

The definition of a communicable disease is extremely important. Some coverage forms define communicable disease in very broad terms while others define such illnesses very narrowly. Forms that use the terms “disease” or “illness” generically but do not specifically enumerate covered or excluded diseases are most favorable to the policyholder. Forms with non-specific definitions can provide the policyholder with coverage for virtually any type of work-related communicable disease ranging from the common cold to meningitis.

Some carriers’ communicable disease forms will specifically list the names or types of diseases that will be covered or the types of diseases that will be excluded under the policy. Much like a named-peril insurance policy, a communicable disease form that lists specific illnesses will only respond if two or more employees contracted a disease that was listed on the coverage form. If the policyholder suffers a claim that does not appear on the list of covered diseases, it’s not likely to be subject to the communicable disease coverage. Narrow definitions of covered losses can be particularly problematic when an outbreak of a previously unknown illness occurs. Again, if it isn’t listed, it’s probably not covered. Conversely, coverage forms that exclude specific diseases not only prevent the self-insurer from seeking coverage for such losses under the communicable disease provisions but may also exclude coverage under the basic occupational illness section of the underlying excess workers’ compensation policy, as well.

Consider the source

One of the few universal components among communicable disease coverage forms is that the disease must be transmittable between individuals to be covered. Diseases such as black lung and asbestosis are often considered to be occupational illnesses but are not subject to communicable disease coverage because they cannot be transmitted from person to person. These specific diseases can only be contracted by prolonged exposure to coal dust and asbestos, respectively, and not merely by being in close contact with someone suffering from those diseases.

The term “transmission” (or some similar term) appears in all communicable disease forms, but the manner in which the disease is transmitted is far more important. Generally speaking, some policies require a disease to be transmitted directly from one person to another to qualify for communicable disease coverage while others allow for both direct and indirect transmissions. Indirect transmissions are commonly referred to as source-to-source exposures. Forms that require a disease to be transmitted directly from person to person are far more restrictive than those that permit diseases to be transmitted from source-to-source. For example, if a group of hospital workers contracts swine flu after being exposed to an infected patient or even another co-worker who was previously exposed, the incident would likely be covered under both the person-to-person and source-to-source rules. If, however, a janitor and a nurse contracted swine flu after handling a soiled pillowcase, communicable disease coverage would only be triggered under a policy with a source-to-source provision because the individuals contracted the disease from an object and not directly from another person.

Tell me the truth – how long do I have?

Communicable disease coverages typically require individuals to contract the same disease or manifest symptoms within a specified period to be eligible for the coverage. If two employees treat a patient suffering from SARS and both exhibit symptoms of the disease a couple of days later, this would likely meet the coverage triggers required under most communicable disease forms. Conversely, if one employee develops SARS within a few days of exposure and the second begins to exhibit symptoms eight weeks later, the communicable disease coverage would be unlikely to respond. The incubation period for this particular disease is normally seven days, therefore, even though both employees ultimately contracted the same disease, it is highly unlikely that they contracted it from the same exposure. Thus, their claims would not be combinable.

Illnesses with long incubation periods are sometimes more difficult to classify under communicable disease coverages because of the time constraints required under some forms. Some forms set forth very specific time frames in terms of hours or days between the time when a group of employees is first exposed to a particular disease and the time the symptoms manifest. Coverage forms that allow symptoms to be manifested at some point during the policy period are generally more favorable to the policyholder. Such forms can combine losses for a successive string of employees infected by one another over a prolonged period (weeks or even months) as long as the infections took place during the policy period and their respective illnesses can be traced back to the same original source.

One potential downside to the policy period provision can occur when the event straddles two different policy periods. If an infection occurs during one policy period and continues to affect employees through a second policy period, it is likely that two separate claims would be developed, thus requiring the employer to satisfy the SIR twice. In this instance, the communicable disease coverage from the first policy would respond to the employees who exhibited symptoms from the time of exposure up until the end of the policy period. Any employees who exhibit new symptoms after the effective date of the new policy period would constitute a separate claim under the new policy’s communicable disease coverage.

Take it to the limit

Coverage extensions and endorsements sometimes share the same limits as the underlying policies to which they are attached. In other cases, coverage extensions carry their own limits in addition to the underlying policy limits or sub-limits, which may erode the underlying excess policy’s shared limit. These limits can be provided on an occurrence basis, aggregated basis or both. Communicable disease forms that carry coverage limits outside of the underlying policy’s basic limits can pose a very significant (and hidden) exposure to the policyholder and therefore should be examined closely.

If communicable disease coverage shares its limits with the underlying policy, the policyholder need only determine an adequate coverage limit for the underlying policy. If, however, the communicable disease coverage carries its own limits, it’s important for the policyholder to make certain those limits will provide adequate protection in the event of a loss.

In some instances, communicable disease coverage can carry per-occurrence or aggregated limits as low as $1 million. Although the policyholder gets the benefit of combining multiple claimants under a single SIR, the collective losses can also serve to erode the occurrence limit very quickly, especially for diseases that require significant amounts of treatment and lost time. Aggregated limits are typically shared over the course of a policy period and are likewise eroded by each communicable disease claim filed during the policy period, thus leaving less coverage available for future claims. More importantly, once the limit is exhausted under communicable disease coverage, any amounts exceeding the coverage limit would be ineligible for reimbursement under the communicable disease coverage and possibly the underlying excess policy, as well. Depending on the circumstances of a given loss and the coverage provided under the applicable communicable disease form, it is possible that the communicable disease coverage could actually end up costing the employer more than a basic, unendorsed policy.

That’s great information, but what can I do with it?

Many excess insurance carriers do allow at least some flexibility in the coverage they offer. In many instances, limits are negotiable on the underlying coverage, and those limits can sometimes be increased even after the policy has been issued. There may be an additional premium required to add communicable disease coverage to an underlying excess policy or to increase the limits on existing communicable disease coverage but the cost is typically modest as compared to the excess policy and the overall self-insurance program. Self-insurers may also want to consider adding aggregate excess coverage to limit the collective unreimbursed costs resulting from multiple occupational disease or communicable disease claims occurring during a single policy period.

Lastly, it may be prudent for self-insurers to take the terms and limitations of various communicable disease coverage forms into consideration when choosing an excess workers’ compensation policy. Epidemic diseases represent potentially one of the greatest financial risks to self-insured employers with exposures to such claims, especially hospitals and other healthcare providers. It is therefore important for those self-insured employers to make the communicable disease and occupational disease coverage a priority and not simply an add-on. Again, not all communicable disease coverage forms are created equally. Choose carefully.