The workers compensation system either will be replaced by an improved and revitalized system or decay into ruin, said Richard I. Fein, the acting president of the National Council of Compensation Insurance.

''For the last several years workers compensation writers have endured difficult times. Consistently unprofitable results have helped to swell the residual market to unprecedented proportions," Mr. Fein said.The NCCI is a voluntary, non-profit, statistical and rate-making organization for the workers compensation industry. Mr. Fein's comments came at the NCCI's annual meeting in Manhattan last week.

Mr. Fein reported that residual market share is up to "an astonishing" 21.8 percent of the market, reflecting the continuing unprofitability and lack of confidence in the future of the voluntary market. The residual market is designed for those risks unable to obtain insurance on a voluntary basis.

"The residual market represented only 9.7 percent of the workers compensation market just four years ago," said Michael Camilleri, senior vice president and general counsel for the NCCI.

In addition, Mr. Fein commented that poor operating results have done irreparable damage to surplus, leaving the industry unable to support additional business or shore up flagging reserves.

An insurance company's surplus is the amount by which its admitted assets exceed its liabilities and capital stock.

"This grim picture continues unabated, as indicated by the 1989 combined ratio of 120.1 percent - a worse outcome than anyone had expected," Mr. Fein observed.

A ratio of $1.20 means that for every dollar collected in premiums, insurance companies pay out $1.21 in benefits and costs associated with payment. The combined ratio was $1.17 in 1988, Mr. Camilleri said.

Another speaker at the conference, William Watt, chairman of the board of the NCCI, warned that workers compensation faces both long- and short-term problems that must be repaired.

"Perhaps the most urgent short-term problem is the persistance of broad and chronic rate inadequacies magnified by the burden of the involuntary market," Mr. Watt said.

He explained that many regulators, feeling the industry has "unlimited

financial resources," are reluctant to grant requested rate increases in the voluntary market. Rate increases are needed to "bring the system back into balance."

In addition, Mr. Watt commented that since workers compensation insurance is tightly regulated by state authorities, large rate increases, which can be justified by past loss experience and actuarial trends, are politically difficult to accept in spite of need. "In a sense, our troubles are part of the larger process of denial we see in our political system every day."

Mr. Fein also cited the regulators as among those with "a key to the soundness of the system and the cycle."

Mr. Watt disputed those who suggest cutting workers compensation benefits as a means to bring costs under control and suggested that the insurance industry must "become part of a larger coalition for reform of the entire system."

The NCCI has adopted a new resolution supporting rate incentives as a means to step up carrier participation in voluntary workers compensation markets.