California Workers’ Compensation: Are we heading for another crisis? By David Kummer
Plagued by skyrocketing medical costs, arbitrary medical decisions, fraud and escalating legal challenges to treatment, the Workers’ Compensation system in California was in crisis in the late 1990s. By 2003, at the height of the crisis, employers were paying out an average of $6.45 in insurance premium per $100 of payroll. Despite the high rates, insurance companies were paying out $1.86 in claims costs for every $1.00 of premium collected. By 2004, year over year underwriting losses had forced 25 insurance carriers into insolvency. As private company rates continued to rise unabated, a majority of companies were driven to the California State Compensation Insurance Fund (intended to be an insurer of last resort), where rate increases simply failed to keep pace with the private market. At the peak, the State Fund provided coverage for nearly 60% percent of California’s employers!
In 2004, led by Governor Arnold Schwarzenegger, the California Legislature approved a series of landmark reforms designed primarily to control medical and legal costs. Then Governor signed Senate Bill 899, enacting reforms to stabilize the Workers’ Compensation system in California. These reforms provided meaningful relief to the system and were the primary catalyst triggering the beginning of a soft market cycle for California Workers Compensation. Reform measures included:
- Authorization for immediate medical care for an injury, up to a $10,000 limit or denial of the claim, whichever occurs first;
- Expanding the role of medical provider networks and the creation of a medical review process, controlled by the Administrative Director of the Division of Workers’ Compensation, to handle medical treatment disputes;
- Mandating the use of American Medical Association guidelines to define permanent disability; and
- Improved verification that injuries were the direct result of employment and permanent disability benefits reflect the degree by which the job caused the injury.
The reforms have saved California employers more than $50 billion and some companies realized decreases in their premium rates of as much as 70 percent. By 2010, the average rate in California had dropped to $2.68.
However, the picture in California is not nearly as rosy as it appears. California must compete for businesses that employ our workers and, despite the drop in rates through 2010, California’s work comp rates were still the fifth highest in the nation! California’s Workers’ Compensation rates remain 166 percent higher than the national median. Even at California’s own seven year lows, California must compete with neighboring states to keep employers.
Average Cost Per $100 of Payroll (2010)
California: $2.68
Idaho: $1.98
Arizona: $1.71
Nevada: $2.13
Colorado: $1.39
Utah: $1.46
It is not difficult to see why companies are closing up shop in California and moving to other states. Workers’ Compensation is just one broken element in a state that is hammering our businesses with regulations, taxes and other roadblocks that cumulate to create a burden that makes remaining competitive impossible.
More frightening is the fact that this value is captured at the trough of a soft market phase when rates are at their lowest. Despite the depth and power of the 2004 reforms, Workers’ Compensation attorneys, employer groups, unions and other interests began challenging the reforms almost as soon as they were passed. Workers’ Compensation law operates in a similar fashion to tort law, but governed by the Workers’ Compensation Appeals Board (WCAB.) Individual cases are brought before the board and are decided, creating “good” or “bad” “case law.” Since 2004, case after case has been brought before the board challenging elements of the reforms and seeking increased benefits and more liberal interpretations of the law. While there have been victories and defeats, the cumulative result has been the elimination of some elements of the reforms, the dilution of others and the steady increase in benefits to workers.
The best illustration of the deterioration can be seen in the average cost of a California Workers’ Compensation indemnity claim. Note the dip in 2004 and 2005 in response SB 899, and then note how the average cost has gone up nearly 60% between 2005 and 2010!
Average of a CA Workers’ Compensation Indemnity Claim
2003: $45,615
2004: $40,127
2005: $38,905
2006: $45,122
2007: $51,936
2008: $58,828
2009: $62,923
2010: $61,958
These are very real costs that hit the balance sheet of every company providing coverage in the state. Beginning in 2007, insurance companies’ Combined Ratio (a measure of total dollars collected in premium vs. total dollars spent in claims and expenses) crept well over 100.
Average CA Workers’ Compensation Combined Ratio
2008: 111%
2009: 130%
2010: 125%
2011: 131% (estimated)
One would assume that CA insurers would have raised rates consistently from 2008 to 2011 to keep pace with these dramatic increases. To the contrary, California’s average rate per $100 of payroll has remained basically flat since 2008. Insurance companies, in competition to keep and grow market share have continued to operate at a significant loss since 2008. Much of these losses have been “financed” by reducing claims reserves in prior years. Each dollar of claim reserves reduced in a prior loss year directly feeds the current year’s balance sheet. This creative mechanism has been widely used to produce acceptable financial results over the past three years.
There are two very major problems with this practice. First, prior years reserves are a finite pool of funds. Most experts agree that there is no more room in prior year’s reserves available to offset poor underwriting results moving forward. More critical is that (based on history) it is likely that many carriers have been overly aggressive in reducing these reserves. Reserve practices are audited by the state. As carriers are subject to audit, many may be forced to replenish prior years’ reserves. That money must be taken from the current years’ balance sheet, which may not be adequate. This combination of circumstance contributed heavily to the 25 carrier insolvencies seen in 2004-2005.
2011 marked the beginning of a transition from a soft to a hard market cycle and modest inflation in rate. By January 2012, all evidence clearly supports that the hard market is in full swing and rates are rising sharply. Insurance companies have a minimum of three full years of very poor underwriting results to recover and no more “reserve pool” to rely on to fund poor results. The underwriting “attitude” has also rapidly and clearly shifted from “soft” to “hard” or from “buyers” to “sellers.” Underwriting focus has shifted fully from gaining or retaining market share to pricing at what is adequate to turn a profit regardless of circumstance. Beginning January of 2012, companies with favorable experience in the past several years are experiencing 10-20 points of inflation. Moderate or neutral experiences will likely result in 15-40 percent increase and those companies with poor results in the past several year may see 30-100 percent increases! To put it succinctly, in 90 days, the wheels have come off the bus!
As a final exercise, let’s look at a case study. Consider a very real and very large employer in the San Fernando Valley. With 800 employees, this company’s decisions can immediately impact the lives of thousands of people in Los Angeles. They also have the girth to have their own statistical impact on our unemployment rate.
In 2004, at the peak of the last crisis, this company’s primary rate per $100 in payroll was $14.19. They enjoyed discounts that further reduced this rate to $10.96. By 2007, post SB 899, this company was enjoying a rate of $5.28. By 2011, this rate had deteriorated to $7.11. Absent intervention, based on decades of history and current conditions, we can expect this company to pay close to $9.00 in 2012 and likely well above $10 again by 2013.
By contrast, this same company could move to any of these states and pay:
Idaho: $2.27
Oregon: $2.40
New Mexico: $2.29
Texas: $3.47
With a current California Workers’ Compensation budget of just over $1,600,000, the difference between staying in California through 2013 and moving to any one of these states will likely be the difference between paying approximately $2,400,000 and $600,000 in premium. A potential savings of $1,800,000! This example should paint a clear picture of why employers are leaving our beautiful state. While the majesty, beauty and weather in California are a powerful draw, they are no match for out of control Workers’ Compensation costs, crippling regulations, absurd taxes and the many other roadblocks that cumulate to create a burden that makes remaining competitive impossible!
By David Kummer, CPCU, AIC
President/Sullivan Curtis Monroe Insurance Services, LLC
