Safe, not sorry: EL Insurance
Chris Dyer reviews the government's proposals for revamping the Employers' Liability Insurance regime through the development of better health and safety management systems.
The government has published its proposals to reform compulsory Employers' Liability Insurance (ELI), starting what Mary Francis, director general of the Association of British Insurers (ABI), recently described as a "once-in-a-generation" opportunity to create a better system of workplace compensation. A cross-departmental review, led by the Department for Work and Pensions (DWP), and involving the Treasury, Department of Trade and Industry and the Lord Chancellor's Department, has examined the factors driving recent premium increases and considered the case for reform (EL review offers a "once-in-a-generation" opportunity).1 The essence of the proposed changes is more emphasis on health and safety management, early rehabilitation for the injured and the reduction of legal costs. This review complements a separate fact-finding study of the general liability insurance market by the Office of Fair Trading (OFT).2
Announcing the proposals, minister for Work Nick Brown said that the government recognised that many businesses were hit hard by ELI premium increases last year: "The package announced will work on two fronts by aiming to make the market work better and improving the overall system. In the short term, we are supporting current initiatives in the market while working towards a fairer system by developing a basis for more risk-related premiums." A second review in the autumn will report on progress and any further steps the government intends to take.
Market adjustment
The DWP review, which takes account of the simultaneous OFT inquiry, found no evidence of a broad failure of the ELI market (see box 1). It did find a substantial increase in premiums in 2002, estimated at 40% on average, but larger for smaller firms and in some sectors perceived as high risk, such as hot roofing. (The National Federation of Roofing Contractors estimated the average premium increase for its members during 2001/02 at 161%.)
Businesses were surprised by the extent of these increases and many had difficulty passing the additional costs to customers, which affected profitability. Coupled with renewal notices that often arrive close to the renewal date, leaving little time to negotiate premiums, to respond to the new price levels or to seek other sources of ELI, the DWP acknowledges that these events are likely to have contributed to some companies ceasing to trade altogether. Nevertheless, the DWP suggests that the overwhelming majority of firms can find ELI cover, albeit at a price.
Four factors have driven the increased cost of ELI premiums:
the underwriting cycle;
external impacts on the insurance market;
legal costs; and
uncertainty over long-tail risks.
Underwriting cycle
The insurance market is cyclical, capital flows in and out. Recently, the market has been in a "hard" phase with price increases that have particularly affected liability insurance. During the earlier "soft" phase of the cycle, premiums were set that resulted in an underwriting loss, ie the cost of claims outstripped premium income. During 1999, the overall loss ratio on ELI was 154%.
Insurers bore these losses for two reasons:
low cost ELI was often sold as part of a package - what insurers lost on ELI, they gained on other classes of insurance; and
by investing premium income in the stock market, they were able to offset underwriting losses with investment gains.
External impacts
The position changed significantly prior to 2002. After a period of record and sustained levels of return the stock market fell. This cut the margin for absorbing underwriting losses and reduced insurers' capital. At the same time, the attacks on the World Trade Centre on 11 September 2001 led to large increases in reinsurance costs, which flowed through to the cost of insurance premiums.
Cost of claims
Claims depend on negligence being established and the legal costs involved directly affect the cost of claims and premiums. Claimants' costs, legal costs and medical assessment, are estimated to have risen by 50% since 1997, with the biggest annual cost increases in the past three years, just when other pressures on the market were acute.
Future risks
Insurers are increasingly concerned about "long-tail" risks arising from occupational diseases that do not manifest themselves for many years. These risks are said to discourage the entry of new capital and threaten the commitment of existing capital, although the DWP found little evidence that long-tail risks had had a quantifiable impact on the current ELI market difficulties.
Trends in price increases appearto relate to past accident performance, such as in the construction sector, rather than the new areas of occupational health concern, such as office-based work-related upper-limb disorders. Claims for occupational diseases such as asbestosis, industrial deafness and vibration white finger amount to just 25% of the total ELI claims bill; the number of occupational disease claims is falling slowly but steadily.
IMPROVEMENT OPTIONS
The DWP accepts that there is a case for developing proposals to improve the ELI market within the fundamental principles that underpin the current system:
free markets - allowing markets to operate without intervention unless there is clear evidence of market failure;
"polluter pays" - the responsibility of employers to fund the costs of their negligence;
access to justice - the right of employees injured through their employer's negligence to be fairly compensated; and
efficiency - keeping the cost of the system low.
Commercial and economic options
Long-tail exposure could be tackled by separating its funding. Stakeholders who favour this approach argue that this would help to stabilise pricing and to ensure adequacy of capacity and the continued presence of insurers in the market. Long-tail claims could be met from a centralised state-managed fund financed by a levy that reflects current costs and is operated by insurers. Alternatively, a pay-as-you-go system could be used where employers pay premiums that directly reflect the current cost of disease claims arising from previous employment practices. Premiums covering workplace accidents and short-tail disease could then be linked more closely to employers' current health and safety practices since today's claim experience would not be blighted by latent exposures.
The DWP believes that it is difficult to quantify the effect of long-tail claims on the current premium increases and the potential benefits of change. It says the government will work with stakeholders to explore this area further, but that it is not yet convinced of the need for a radical change of this type.
Resolving claims
The insurance industry and some employers' organisations argue that legal fees are a disproportionately large part of overall court awards and that these have directly increased premiums. The DWP examined several options for change. The most radical would be a no-fault scheme, which removes the element of negligence from the process so that any qualifying injury is entitled to insured compensation. A no-fault scheme faces two main challenges:
its impact on incidence and costs is uncertain. A reduction in legal costs may lead to downward pressure on premiums, but is equally likely to increase the propensity to claim, resulting in higher costs; and
a strict no-fault system implies a curtailment of an individual's recourse to the courts. There are trade-offs to be made between the benefits of "bespoke-justice", including the potential for higher compensation awards, and swifter access to compensation, but the attractiveness of this trade-off for the individual is likely to reduce with the seriousness of the incident.
A less radical reform would be the introduction of an alternative dispute resolution (ADR) system, aimed particularly at smaller claims. This would speed up compensation and reduce the need for costly litigation. Employees would retain the right to sue, but it is hoped that most cases would settle more quickly without the need to litigate.
The DWP is not attracted to a no-fault system, but it does believe that it is worth exploring the scope for developing an ADR process.
Renewals
Because ELI is a compulsory class of insurance, there is particular sensitivity about the service standards offered. The DWP reports that some insurers have excellent service standards, releasing renewal terms at least 30 days before the date of renewal. Late issue of renewal terms causes problems because businesses have too little time to obtain alternative quotes or specialist advice, or to budget accordingly.
The DWP will be pursuing the subject of renewals with the insurance industry with a view to monitoring and improving performance.
Improving outcomes
As well as improving the operation of the market, the government wants to improve the outcomes of the system. The DWP thinks there is a strong case for making the improvement of health and safety practices an explicit, not just an implied, objective of the compensation system. This would be a sustainable way to manage the system, because it should reduce the number of qualifying incidents.
The DWP finds that the main challenge is to strengthen the currently weak link between health and safety practices and ELI premiums for many firms. Starting rates for most businesses are set according to the experience of the trade as a whole. Underwriters can discount these rates, but it is not always cost effective for brokers or insurers to gather and assess detailed risk management information in order to make each premium individual, particularly for small firms.
Initiatives to improve this situation aim to use pre-screening to make it easier for insurers to sort the relative risk of firms. The DWP believes that greater differentiation of health and safety management practices could provide two levels of incentive: by providing a level of discount on premiums; and because such practices might increasingly become a prerequisite to gaining access to the insurance market, slowly increasing minimum standards across the board.
Areas where this is working or could be developed include:
guidelines and frameworks for improving and demonstrating risk management procedures produced by trade associations to a standard recognised by the insurers. Insurers should benefit from a better claims experience across the group as a whole, which allows for reduced premiums;
adapting the principles of the "Quality Mark" initiative for builders (Spring report for employer's liability insurance review) to other trades. Builders who apply to join the scheme are vetted on their health and safety standards. Larger firms receive proactive advice on health and safety procedure, risk assessment and the avoidance of claims. Members enjoy discounted premiums;
encouraging businesses to obtain an independent assessment of their health and safety practices that can be used by insurers. A sufficient incentive would need to be created through discounted premiums;
several self-certification systems for employers are being explored. The British Insurance Brokers Association (BIBA) is working on standard templates for risk presentations to improve the quality of underwriting information provided to insurers and help them to differentiate risk.
The HSE is already engaged in a major project to develop a health and safety performance management index; the government intends to see how this work might be pooled in a common approach that can be used by insurers, the regulator and businesses to assess how health and safety is being managed.
The government has asked the HSE whether current reporting requirements can be improved to assist and streamline the subsequent claims process as much as possible. It will also set delivery targets in the HSC's next strategic plan with the aim of significantly reducing the number of ELI qualifying incidents.
More rehabilitation
The principal objective of the UK ELI system is to secure financial compensation. This contrasts with many overseas workers' compensation systems, where rehabilitation plays a much bigger role.
Health and safety management starts with the objective of prevention; ELI kicks in once prevention has failed and injury occurred. The employee has suffered some degree of harm and in the UK this leads to a financial outcome. But in some countries, such as Germany, there is a formal, prior stage of rehabilitation: medical intervention to return the worker as near to their original state of health as possible. Only when the outcomes of this intervention are determined is the final level of financial compensation for the degree of disability assessed.
The government's review finds widespread support enhancing the role of rehabilitation: "there is both appetite and opportunity for a radical change in the objectives and culture of ELI and the wider UK compensation system."
The current ELI system does not encourage early rehabilitation. The DWP believes that rehabilitation needs to be out at the heart of the ELI system, so that a return to health and alleviation of suffering come before financial compensation in the list of objectives.
To this end, the distribution of cost is critical: a better link must be made between the levels of compensation payable and the provision of rehabilitation in order to create an "invest to save" incentive for employers or insurers. Unions argue strongly that present levels of compensation are still too low to provide proper recompense and would be cautious about initiatives that might lower payments further.
The DWP does not support any transfer of rehabilitation costs to the employee by way of reduced compensation per se. Better links to compensation payments may make it more attractive to provide rehabilitation, but they do not address the cost risk of early provision if liability is not subsequently established and no compensation is then paid.
The DWP believes there is much evidence, compiled by the HSE and others, that the provision by employers of private medical insurance or occupational health facilities as a benefit to employees, is of economic net benefit to employers. Nevertheless, it acknowledges that this case has not been made convincingly to the particular circumstances of the majority of individual employers and that there is a need to convince them of the benefits of investing in provision irrespective of negligence. Compensation awards that reflect intervention, or discounted premiums resulting from the demonstration that early rehabilitation resulted in fewer claims, would help in making this case.
There is also a strong link to the state benefit system. If a sound case for rehabilitation can be demonstrated by the state, with consequent reductions in benefits paid, it will act as a powerful argument for employers to adopt a similar approach. The DWP hopes that a link can be established between early rehabilitation and a reduction in ELI claims or benefits paid, which will create the ground for a partnership approach between employers, government and insurers.
The government plans to explore:
a market-driven solution rechannelling existing "dead costs", such as replacement and retraining, into a demand for occupational health services;
the scope for relating compensation awards to rehabilitation efforts;
the timing of rehabilitation and the scope for encouraging earlier intervention ahead of the establishment of liability;
the impact of preventative occupational health and early rehabilitation on the incidence of subsequent ELI or benefit claims, in particular to see if this creates a basis for cost sharing;
the economic case for the provision of rehabilitation, both for employers and the state;
the role of rehabilitation/screening in medical assessments; and
the development of an effective infrastructure with providers of occupational health whose services are shared by employers and the state.
Improving enforcement
Compliance levels with ELI requirements are high. But companies that do trade without cover: leave employees personally exposed to the financial consequences of their employer's negligence; transfer liabilities to the state benefits system; and have an unlawful competitive advantage because their overheads are lower.
The government plans to toughen the enforcement system. It believes the current, passive system, which relies on an inspector checking for the existence of an ELI certificate during health and safety visits, is inadequate. Future enforcement will be active, employers will be required to provide ELI policy numbers as part of an annual return, which can then be checked by the HSE against an enforcement database. The DWP will be developing proposals with the HSE, insurers and other organisations. In the meantime, the government will try to expand enforcement and will discuss with local authorities the issue of giving them enforcement powers.
The government will also consider legislation to tighten enforcement powers, including whether:
current limitation periods should be extended;
current fines act as sufficient disincentive;
the existing regulations are clear in the duties they place on companies to ensure that their insurance arrangements are compliant; and
there is merit in introducing a personal duty on directors.
Many of these ideas will require further development in discussion between stakeholders and the government (see box 2).
Likely trends
The DWP concludes that the ELI market will continue to be difficult. The market consensus appears to be that rises in premiums will be significant in 2003/04, if somewhat less acute than in 2002/03. There is a risk that some businesses, which were able to weather a single round of premium rises, will find further sustained increases too much. The liability market remains in the hard phase of the cycle and pricing pressures will continue to bite on insurers and therefore on employers. These pressures include:
a need to ensure that premium levels are sufficient to pay for the forecast claims;
the trend of increases in legal costs; and
high costs of capital and re-insurance.
With a limited number of big players in the ELI market, the withdrawal of a major company or a significant reduction in Lloyd's capacity could precipitate difficulties. But the compulsory nature of ELI makes it central to any package of commercial insurance; to withdraw from ELI risks losing that wider business. This would be a serious and significant decision for any insurer. Notwithstanding the difficulties caused for business, recent pricing policies have increased premiums to a more economically sustainable level for insurers. This helps support insurers' continued engagement in the ELI market and the DWP sees no evidence that the market will not correct and be sustainable through the current cycle.
The DWP also believes that its research has identified some positive developments:
brokers are working with insurers to improve information, particularly relating to their clients' health and safety management, so that insurers can make better informed, tailored judgments;
trade associations, particularly those concerned with small business whose members were most affected last year, are promoting initiatives that are already assisting members. These include: negotiating insurance packages for their members at discounted rates, sometimes based on health and safety accreditation schemes; providing access to specialist brokers; and developing self-assessment packages to enable companies to provide insurers with better and more pertinent information about risk management policies;
insurers, brokers and business representatives are jointly looking at practical ways to make premiums better reflect individual risk; and
insurers' service standards and pricing policies are under the spotlight. As an industry they have stepped up their commitments to early communication and explanation.
The review has made a detailed analysis of why the market is in its current state and concludes that this is a result of market forces. What is less clear is precisely how the operation of the market is to be improved to produce the desired outcomes. Levers are needed if the targets set out in Revitalising health and safety (Making insurance costs count ) are to be met, and insurance was one mechanism identified as providing an opportunity to improve national health and safety performance. But the DWP review only commits the government to action in one ELI area - enforcement - even though it acknowledges there is already a high degree of ELI compliance.
In most other areas, it is proposing to facilitate developments in partnership with other stakeholders. This is not unreasonable; the outcomes that the government wants will require a partnership approach if they are to be achieved and the organisations representing stakeholders have welcomed the reports (see box 3). But if the next stage of the process, to be reported on in the autumn, is unable to be more specific as to mechanisms and timetables, it will start to look as if the once-in-a-generation opportunity described by Mary Francis may have been missed.
1"Review of Employers' Liability Compulsory Insurance: first stage report", Department for Work and Pensions, www.dwp.gov.uk/publications/2003/index.htm, free.
2"The UK liability insurance market: summary of key findings", Office of Fair Trading, www.oft.gov.uk/Market+investigations/Investigations/cases.htm.
