Why Workers' Comp Reform Is Not the Solution - Part 1

Sunday, April 25, 2004 | 0

Why Workers' Comp Reform Is Not the Solution - What You Can Do

Now, if I was only clear on what it meant!

By Brent Heurter

Chapter 1: How Did We Get Into This Mess?

The California workers' compensation system has been in a state of crisis for the past three decades. Workers' comp costs have increased in 24 out of the last 30 years, according to the Workers' Compensation Insurance Rating Bureau (WCIRB). The only sustained period of decrease was from 1995 to 1999. In 2000, rates began creeping up, and by 2001, they started their steep upward climb.

Understanding the 10 Year Cycle

Historically, property and casualty carrier pricing has run in cycles. Workers' compensation insurance in California is no different. While there is no scientific data to prove this, it does appear that workers' comp runs in 10 year cycles. Last year2003--was 10 years from the date the last significant workers' comp reform measure was passed.

The workers' compensation reform cycle develops like this:

1. The cycle begins with "reform" being passed, followed by a period of several years in which premiums drop.

2. As rates continue to drop, carriers see their profits erode. Carriers need to write more and more business just to keep up with the premium reductions on their current book of business and so drop their rates even more to try and catch up.

3. Underwriting guidelines become lax, and underwriting is instructed to bend the guidelines in order to write more business.

4. This happens until the point where the rates have been reduced so much that business is being written at a loss. Ignoring the fact that they are writing business at a loss, some carriers continue just so that they can try to keep up with their loss of premiums. Due to the nature of workers' compensation, the full losses for a policy period may take three, four, or even five years to develop.

5. Because carriers are actually undercharging premiums, once the claims catch up, the party's over. Carriers put the brakes on, underwriting tightens, and prices go up.

6. By this time, applicant attorneys have found all of the loopholes in the reform package, and the cost measures put in place are no longer effective, causing even more pressure on losses.

7. As costs rise, employers feel the pinch and start to rumble. After two or three years, the rumbling soon turns to yelling. The rates become unaffordable for many employers who failed to properly manage their workers' compensation costs and are forced out of business or flee the state.

8. The pressure gets to be so much that the legislators have no option but to make it an agenda item for re-election. The posturing begins.

In the workers' compensation reform cycle, actual reform is pushed further and further back as the special interest and business cannot agree upon what reform should be. Then, typically on the 12th hour of the last possible day to pass a law, a reform package is pushed through that had been negotiated by legislators who may not even understand workers' compensation and the real cost drivers in the system.

Major Complication: The Lack of Carriers

This scenario has played itself out in almost every state for several decades. However, due to a significant change of events that took place in California in 1995, it is our belief that this cycle will not repeat itself. At best, rates will stabilize even if recently passed SB 899 produces substantial reform. The stabilizing of rates will, in our best estimation, only last for two--possibly three--years at best before shooting back up, higher than the highs we are currently experiencing.

The major determining factor in California is the lack of carriers that are currently writing workers' compensation currently. Since 2000, more than 25 carriers have gone bankrupt or have been seized by the Department of Insurance. According to the National Association of Insurance Commissioners (NAIC), insurance carriers have not made a profit since 1995, and the average loss during the past 4 years has been 19.08%.

Workers Compensation Insurance Carrier Insolvencies:

Citation General Insurance Co.
National Auto & Casualty
LMI Insurance Company
Paula Insurance Co.
United Community Insurance Co.
Sable Insurance Co.
California Compensation Insurance Co.
Frontier Pacific Insurance Co.
Superior National Insurance Co.
AliStar Insurance Co.
Combined Benefits Insurance Co.
Western Growers Insurance Co.
Commercial Compensation
Legion Insurance Company
Credit General Indemnity
Villanova Insurance Company
Credit General Insurance
The Home Insurance Company
HIH America
Fremont Indemnity
PHICO
Great State's Insurance Company
Reliance
Employer's Casualty
Source: California Insurance Guarantee Association

The reason for the dearth of workers' compensation insurers? The costs of underwriting workers' compensation are just too high in California. When analyzing the years when rates dropped to the lowest (1997, 1998 and 1999) and comparing this against the adjusted carrier results for these years, it is not surprising to find out that carrier losses and expenses were the highest ever, reaching 152% in 1997, 169% in 1998, and the all-time highest national rate of 173% in 1999. In 2003, the losses for California workers' compensation carriers reached $1.8 billion.

The Domino Effect of Low Rates

Profits as a percentage of direct premiums reached an all-time low in 1999 of -22.9%, causing the domino effect of carriers tumbling under the pressure - including the biggest private carrier in California at that time, Superior National. Following in Superior's footsteps was Paula Insurance Company, Legion, and Villanova - all declared insolvent in 2002.

Even at current rates, national workers' compensation expert Edward Welch, director of the Workers' Compensation Center at Michigan State University, stated in an interview with the Sacramento Bee in January of this year: "Companies aren't profitable in California because they are charging premiums (that are) too low."

New carriers cannot enter California's workers' compensation insurance market without risking losses. Without carriers entering the market in California, market pressure cannot increase. And market pressure is necessary to lower premiums.

All of this has made State Compensation Insurance Fund, the carrier of last resort, the only carrier in many cases. State Fund has kept the California workers' compensation system afloat and has been forced to increase its market share from 20.8% in 1995 to as high as 60%, according to some estimates.

Our next article will look at the points and counterpoints to the current SB 899 debate, and we'll draw some conclusions as to whether employers will actually see premiums decrease (hint - it really is no surprise).

Article series by Brent Heurter. Brent Heurter is the Founder and Chief Solutions Officer of ClearComp, a workers' compensation alternative for companies that desire to control and reduce their workers' compensation costs. Brent can be reached at 888-CLEAR-89 or email brent@clearcomp.com.

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The views and opinions expressed by the author are not necessarily those of workcompcentral.com, its editors or management.