State of Workers Comp in California Part 1 of 3:
CALIFORNIA WORKERS COMPENSATION GROUP
The workers' compensation market has entered an increasingly tumultuous
period marked by pricing pressure and a general hardening of rates. Liberty
Mutual, the nation's biggest workers' compensation insurer, stated in its
annual report that profits from all of its domestic insurance businesses
were down 40%. Liberty Mutual lost money for the second year in a row in
workers' compensation. In addition, according to President Edmund Kelly,
the company looks for no more than a break-even year in 1999.
The workers? compensation insurance business has not heard that the
underwriting cycles in the property and casualty insurance business are a
thing of the past. In the 1980s, a number of companies abandoned the
workers? compensation market because they were losing so much money. After
many states, including California, passed major workers' compensation
reform laws in the early 1990s, conditions and profits improved. The return
to profitability attracted new competitors. In addition, the old players
cut prices in order to gain market share. This set off a rate war that is
still being waged. There were too many companies writing business and a lot
of them were losing money. Some of the new players didn't really understand
the workers' compensation business and may not have fully appreciated how
badly they were doing. And, a lot of those are gone now. And so, the rate
war waged on and workers' compensation went into another down cycle.
At this same time, there was a rapid upsurge in the economy. According to a
CIGNA study, this is a bad thing for workers' compensation. CIGNA undertook
its study so that its risk managers could recognize how changes in the
labor market affect work-related injuries. Researchers examined the
interaction of 22 economic variables and said that they found eight of them
that combined to produce a statistical model that could explain 84% of the
variation in the work-related lost workday injury and illness incidence
rate. According to the CIGNA model, when there are rapid increases in the
number of people employed, the work-related injury and illness incidence
rate increases. For example, a 1% increase in the number of employed
workers contributes to a 4.1 % increase in the lost workday incidence rate.
Conversely, the study found that in a downturn of the economy, when there
are layoffs or cutbacks, the employees who remain are often the most
experienced, most qualified, best trained and, therefore, the least likely
to have work-related injuries and illnesses.
Among some of the other findings was the fact that a 1% increase in average
hours worked creates job-related fatigue and stress and results in a 3.4 %
increase in the lost time incidence rate. The Workers' Compensation
Research Institute did a Massachusetts study and they found similar results
for an overheated job market. Executive Director Richard Victor said: "We
know that those on the job less than a year have a higher propensity for
injury," adding that tighter labor markets make employers more willing to
hire less experienced workers.
The workers? compensation business is under pressure because of highly
competitive conditions in the California market and difficult pricing in
the rest of the U.S. Also fueling competition is the inadequately priced
reinsurance that is available on this business. The health of the business
is also deteriorating due to an increase in medical cost inflation, a
slower growing economy, and the aging of the workforce.
NCCI STATES
The National Council of Compensation Insurers governs workers' compensation
insurance rates, forms, regulations, and statistical reporting, in almost
all states except California.
NCCI states are predominately a no-fault system with a few states offering
employers the right to option-out of the no-fault system. A few of the
states operate under a minimum rate basis. However, an increasing number of
states offer either a suggested loss cost in an open rated environment, a
deviation from a mandated loss cost, a minimum rate with schedule rating or
some combination of a deviated and schedule rating plan. There is no cost
limitation established for most benefits, however each state establishes
payment thresholds for indemnity reimbursement and medical procedures.
CALIFORNIA
The workers' compensation laws in effect in California differ from those of
the NCCI states. In California, rates and statistical reporting are
governed by the Workers' Compensation Insurance Rating Bureau, and forms
and regulations are governed by the California Department of Labor Division
of Workers' Compensation.
OTHER STATES
Some states have monopolistic workers' compensation insurance funds
administered by the state governments.
THE CALIFORNIA MARKETPLACE
The California workers' compensation market is commodity-oriented, highly
fragmented, and reflective of intense price competition. Nevertheless,
because each risk is unique in terms of insurance exposure, different
insurers can develop widely divergent estimates of prospective losses. Most
insurers attempt to segment classes within markets so that they target the
more profitable sub-classes with lower, although adequate, rates given the
estimated profitability of the segment. In some cases, no statistics are
available for the sub-classes involved, and the insurer implements
discounted rate structures based solely on theoretical judgment. Finally,
different insurers have widely divergent internal expense positions, due to
distribution methods, economies of scale, and efficiency of operations.
Therefore, although workers' compensation insurance is a commodity, the
price of insurance does not necessarily reflect commodity pricing.
California is the country's largest workers' compensation insurance market,
with total direct written premium of $5.2 billion in 1997. The California
market is composed of:
the State Fund,
companies that write workers' compensation insurance in California but have
significant writings in other lines of business and/or in other states, and
private sector companies that write exclusively workers' compensation
insurance specifically focused in California.
The State Fund is obligated to write workers' compensation insurance for
any applicant, including those turned down by the private sector carriers.
It is the largest underwriter of workers' compensation insurance in
California, accounting for approximately 19.8% of the direct written
premium in California in 1997. Because the State Fund must accept all
risks, its combined ratios have historically been much higher than those of
the private sector carriers. Despite these results, the State Fund has
consistently achieved profitability through the investment income earned on
its large invested asset portfolio. As of December 31, 1998, the State Fund
had invested assets of $7.2 billion and statutory capital and surplus of
$1.6 billion.
CALIFORNIA PRICING
Prior to January 1, 1995, the California Department of Insurance set
minimum premium rates for workers' compensation insurance to provide a
stable environment for the pricing of such insurance. On January 1, 1995,
the State of California formally converted to a system of "open rating" for
workers' compensation insurance written within the state. Insurance
companies now file and use their own actuarially defensible rates.
Following the introduction of open rating, total direct written premium in
the California market decreased from $9.0 billion in 1993 to $5.2 billion
in 1997 as many carriers engaged in price competition.
Under California's "open rating" rate regulation system, the DOI sets "pure
premium" (effectively, the estimated claim and allocated claim adjustment
expense) rates for each employment classification. Insurance companies then
apply their own "multipliers" to the pure premium rate to adjust for that
company's anticipated unallocated claim adjustment and underwriting
expenses. These rates are then subject to further adjustment for each
policyholder to account for the policyholder's historical loss experience,
the presence of stricter safety programs, dividend and commission plans,
and other factors. In practice, however, workers' compensation insurance
companies in California are not subject to meaningful rate regulation.
In California, where the landscape is dominated by companies offering only
workers? compensation (including the state?s quasi-competitive fund) tough
conditions persist following a wave of deregulation, which featured the
repeal of the minimum rate law. Somewhat of a free-for-all followed, with
smaller companies slashing rates by as much as 50% to gain market share.
Overall premium growth has been low now for about four years, and it was
negative for 1998.
The price pressures produce large increases in loss ratios for some
companies. The resulting declining operating earnings came in at a dramatic
minus 12% in 1998. The California Workers' Compensation return on equity
for 1998 came in at an anemic 7%. Its stock prices fell off, and the
falloff has accelerated in the early part of 1999. The stocks now trade at
very low levels. |
