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Do Insurers’ Returns on Investments Significantly Impact Premiums?
By John M. Stahl, Esq.
Realistic budgets and other benefits associated with accurately predicting the cost of providing workers’ compensation insurance coverage were factors in J. Paul Leigh, Ph.D., and Abhinav Bhushan, Ph.D., examining the recent history of this expense. Dr. Leigh is the lead author of the study and holds a Ph.D. in Economics and has written papers on occupational injuries and illnesses within the context of the workers’ compensation system.
The study, “National Trends in Occupational Injuries Before and After 1992 and Predictors of Workers' Compensation Costs”, appears in the September-October 2011 issue of Public Health Reports, and addresses the period between 1973 and 2007.
This article will provide an overview of the study and then share some thoughts provided in telephone interviews with Dr. Leigh, who is a professor in the Department of Public Health Sciences in the Center for Healthcare Policy at the University of California, Davis, Trey Gillespie, who is senior workers’ compensation director for the Property and Casualty Insurers Association of America, and Mark Gerlach, who is an insurance consultant with the California Applicants’ Attorneys Association.
The study states specifically that “understanding trends and exploring possible predictors [of workers’ compensation costs] are important for health policy and planning.” The study adds that “the apparent steady decline in injury rates since the early 1990s has led some observers to wonder why workers’ compensation costs have not also demonstrated a steady decline.”
Variables that the study considered include:
Logic indicates that the first three factors would affect workers’ compensation costs the most, but the study concluded that “for 1992-2007, the Dow Jones variable was the only robust predictor of premiums; the number of injuries was not a significant positive predictor.” The study clarified additionally that not even medical inflation of workers’ compensation benefits impacted premiums as much as the Dow.
The study explained the connection with the Dow by pointing out essentially that insurers do not stuff premiums that they collect under their mattresses; the study noted that those companies invest those funds and raise premiums to offset declines in the returns on their investments.
J. Paul Leigh Interview
The conversation with Leigh began with discussing the California workers’ compensation system because some providers limit their coverage to employers in that state and because that state is one that lacks rate regulation. Leigh stated that a study that evaluated the factors that affected workers’ compensation costs in California would be feasible, but that he had not considered conducting one.
When asked about workers’ compensation regulation greatly restricting the types of investments that insurance companies can make in a manner that keeps these companies out of a large portion of the stock market, Leigh reminded the interviewer that “there have been wild disastrous swings in the stock market.”
Leigh stated further that restricting insurance companies’ investments to generally “widows and orphans” options was why he also looked at the interest rates on Treasury bonds; he pointed out, too, that fluctuations in the stock market affected those rates.
Leigh also discussed the effect of the “combined ratio,” which refers to the relationship between the costs of workers’ compensation claims and premiums and has exceeded 100 percent, on his study’s subject matter. When asked if there was a “sweet spot” regarding the return on investment that insurers must achieve to make a profit considering the combined ratio, Leigh replied that he imagined that there was, but that he did not study that factor; he estimated that such a return would have to be between 5-10 percent.
Leigh further responded to the conclusion of Gillespie and others that medical inflation in the workers’ compensation system was the most significant factor regarding premiums. Leigh replied that that consideration was “important and critical”, but reiterated that returns on investments was the most significant factor.
Leigh additionally addressed the absence of other variables, such as changes in state law that affected workers’ compensation premiums positively and negatively, from the study. He pointed out that the study looked at roughly 18 data points and examined information from all 50 states.
Leigh added that “we [in the workers’ compensation community] already understand that returns on investments are going to matter.” He then stated “that’s so obvious I don’t understand why that’s controversial.”
Leigh next expressed the opinion that he believed that the insurance industry was challenging his conclusion because that industry “like[s] the fact that so much of the public thinks that lazy malingering workers push up rates.” Leigh added that that impression “plays into the narrative of insurers and employers” and is consistent with the public relations efforts of insurance companies.
Trey Gillespie Interview
Gillespie shared that the nature of workers’ compensation claims can result in benefits on those claims taking up of all of the charged premiums and requires that insurers make additional money somehow. He indicated that investments were a source of that income.
When asked if state regulation of workers’ compensation systems would prevent insurers from linking the amount of premiums to the performance of an investment portfolio, Gillespie responded “in general, yes.”
Gillespie explained that typical state regulations require that companies that provide workers’ compensation insurance restrict how these insurers invest their money to more conservative options; Gillespie pointed out that limiting these choices to low-risk investments results in insurers’ portfolios generating low rates of returns.
These general mandatory limits on how insurers can invest their money also reduces the effect of the market volatility that the study identifies as the most significant factor in setting workers’ compensation insurance premiums from 1992 to 2007. This additionally explains why the study looked at the Dow Jones Industrial Average rather than the NASDAQ, which typically consists of newer and more risky stocks.
A perception that the study might not have considered an adequately broad range of variables, such as changes in the nature of state workers’ compensation laws and any increases in the companies that were not required to provide workers’ compensation coverage, prompted asking Gillespie about the study’s limited scope. Gillespie responded that “that was some of the troubling part of the study.”
Gillespie stated that the study was insufficiently broad; he further identified medical inflation in the workers’ compensation system as the most significant factor affecting workers’ compensation insurance premiums.
Gillespie stated specifically that “medical inflation has been so high in the workers’ compensation system that it has offset the decrease in the frequency” of claims.
Mark Gerlach Interview
Gerlach identified some people interpreting Leigh’s analysis of the statistics on which he based his study as asserting that fluctuations in insurance company’s returns on investments “caused” the changes in workers’ compensation costs that were the study’s subject as a source of the controversy regarding the study. Gerlach clarified that Leigh merely showed that a correlation existed between those returns and costs.
Gerlach stated that the study’s value included the facts that “investment income is where they [insurance companies] are making all their profit” and that Leigh “identified a factor that most people did not consider in rate setting.” Gerlach added that insurance companies invest heavily in the stock market and that “studying returns on investments is particularly important right now because the economy is doing so poorly.”
Gerlach also addressed the narrower point that the study helps explain why workers’ compensation premiums are rising at a time that state regulators are under pressure to reduce workers’ compensation costs as part of overall job-creation programs.
Gerlach also provided a useful primer on the relevant history of insurance company investments; he shared that these companies began playing the market soon after World War II and that regulators ultimately caught on that insurers were not including their considerable investment income when proposing rates. Gerlach estimated as well that workers’ compensation insurance rates would be between 10 and 25 percent higher if insurance companies did not factor in their investment income when setting rates.
Gerlach further provided some support for the theory that medical inflation is a significant element of the rate setting equation; he stated bluntly that “you’re a complete fool if you think that workers’ compensation will be exempt from medical inflation” and estimated that relevant medical costs have increased roughly 1,000 percent in the period that the study examined.
Gerlach additionally cited regulatory requirements and competition as reasons that the combined rate is so high. He observed that an increase in the number of relatively new insurance companies has put downward pressure on premiums and that political pressure to increase workers’ compensation benefits has exerted upward pressure on the cost of workers’ compensation benefits.
Statistics can show connections between a wide variety of variables, and experts in a field can validly explain most of those connections; however, the nearly infinite number of variables that can impact workers’ compensation premiums hinder definitively proving the extent to which any of a number of highly relevant factors has the greatest effect.
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