California Commission on
Health and Safety and Workers’ Compensation

California State Seal

Background Paper

State of the Workers’ Compensation
Insurance Industry in California

CHSWC Members

Tom Rankin, Chair
Allen L. Davenport
Jill A. Dulich
Leonard C. McLeod
Kristen Schwenkmeyer
Robert B. Steinberg
Darrel "Shorty" Thacker
John C. Wilson

Christine Baker
Executive Officer

April 2002


TABLE OF CONTENTS

Background
   Minimum Rate Law

Insurance Market Before Reform

Insurance Market after Reform
   Price Competition
    Changing Insurers
    Reinsurance

Profitability of Insurance Companies
   Premiums
    California Workers’ Compensation Written Premium
    Advisory Workers’ Compensation Pure Premium Rates
    Combined Loss and Expense Ratios
    Under-Reserving
    Average Claim Costs

Current State of the Insurance Industry
   Market Share
    ’September 11’ Impact on Insurance Industry
    Insurance Market Insolvency

Prevention of Financial Insolvency

Solutions to Financial Insolvency
   Regulatory Supervision
    Conservation
    Liquidation

California Insurance Guarantee Association
   Background
    Current Insolvencies
    Assessments and Surcharges

CHSWC Informal Hearing on the State of the Workers’ Compensation Insurance Industry in California

Recommendations
   Possible Research Areas

Sources

Appendix – Summary of the Proceedings of the Informal Hearing on the State of the Workers’ Compensation Insurance Industry
      Michael Nolan - California Workers’ Compensation Institute
        Mark Webb - American Insurance Association
        Larry Mulryan - California Insurance Guarantee Association (CIGA)
        David Bellusci - Workers’ Compensation Insurance Rating Bureau of California
        Norris Clark and Larry White - California Department of Insurance
        Pat Quintana and James Neary - State Compensation Insurance Fund
        Mark Johnson – DWC Audit Unit
        Glenn Shor – DWC Policy, Program Evaluation and Training Unit
        Richard P. Gannon - Administrative Director of the Division of Workers’ Compensation
        Gilbert Stein and Rick Wooley - California Applicants’ Attorneys Association (CAAA)


Background

In California, approximately two-thirds of total payroll in the state has been covered for workers’ compensation through insurance policies, while the remainder is through self-insurance. There are more than 100 private for-profit insurers and one public nonprofit insurer – the State Compensation Insurance Fund (SCIF).

These insurers are overseen by the California Department of Insurance (CDI), whose mission is to

• Protect consumers and the financial security of injured worker benefits
• Foster a vibrant, stable, marketplace
• Maintain an open, equitable regulatory process, and
• Fairly and impartially enforce the law.

To accomplish its principal objective of protecting insurance policy holders in the state, the Department examines insurance companies to ensure that operations are consistent with the requirements of the Insurance Code.

CDI plays a significant role to conserve, rehabilitate or liquidate licensed California financially distressed and insolvent insurance companies under appointment by the courts in order to provide for a stable and consistent insurance market. The agency’s 2001 Strategic Plan specifies that one of its particular goal is to "Minimize financial insolvencies of insurers".

Minimum Rate Law

Until a few years ago, California’s workers’ compensation insurance rates were regulated by the Insurance Commissioner under the minimum rate law passed in 1915. Under this law, an insurer could not issue, renew or continue workers’ compensation insurance at premium rates that were less than the rates approved by the Insurance Commissioner. The Commissioner, through its statistical agent, the Workers’ Compensation Insurance Rating Bureau (WCIRB), gathered and analyzed premium and losses data, classified businesses, did actuarial projections, and determined final, fully developed, premium rates that included all the costs of benefits and administrative overhead. The final premium could be lower depending on the dividends paid by insurers at the end of the policy period.

In 1993, the workers’ compensation reform legislation repealed California’s 80-year-old minimum rate law and replaced it beginning in 1995 with an open-competition system of rate regulation in which insurers set their own rates based on "pure premium advisory rates" developed by the WCIRB. These rates, approved by the Insurance Commissioner and subject to annual adjustment, are based on historical loss data for more than 500 job categories.

Under this ‘open rating’ system, these recommended, non-mandatory pure premium rates are intended to cover the average costs of benefits and loss adjustment expenses for all employers in an occupational class, and thus provide insurers with benchmarks for pricing their policies. Insurers typically file rates that are intended to cover other costs and expenses, including unallocated loss adjustment expenses.

Insurance Market Before Reform

California workers’ compensation direct written premium peaked at nearly $9 billion in 1993, the same year the legislature enacted a major overhaul of the system. Adoption of open rating, which took effect in January 1995, was a key provision of that reform. However, beginning in mid-1993, prior to the conversion to open rating, the legislature and the Insurance Commissioner approved a series of rate decreases. The first, mandated by the Legislature, called for a reduction of 7% in workers’ compensation rates. Then, with the state experiencing a major economic recession and workers’ compensation claim frequency and claim costs declining for the first time in years, the Insurance Commissioner followed the legislated rate reduction with a 12.7% reduction in January 1994 and a 16% reduction in October 1994, just before the minimum rate law was eliminated and open rating took effect. As a result, by 1994, statewide premium was down to $7.7 billion, and by 1995 – the year open rating took effect – written premium was already down to $5.7 billion – a decline of over 35 percent in 2 years.

Insurance Market after Reform

Subsequent to the repeal of the minimum rate law effective January 1995, changes were noted in the actions of insurers and employers.

Price Competition

While declining claim costs and the mandated premium rate reductions initiated the decline in the total California workers’ compensation premium, open rating apparently spurred competition among insurers seeking to retain or add to their market share. Some insurers attempted to increase their market share by writing coverage at low prices that eventually proved to be below loss costs. This deregulated market kept premium rates near their historic lows throughout the latter half of the 1990s, even though losses were no longer declining.

In addition, the commercial market was able to solicit and quote public agencies for the first time. Prior to open rating, a public agency could either insure with State Fund, or self insure. Since so few public agencies were insured previously, the WCIRB data on them was very scant and probably not representative, especially in urban areas. This caused some significant under pricing, which led public agencies especially schools to go back to full insurance.

Total premium volume did begin to edge up after 1995, as California’s booming economy added many new jobs, driving up covered payroll. By 1997, however, industry wide losses exceeded premiums, and the situation for many insurers was deteriorating. As the link between the price of insurance and loss costs became more and more tenuous, some insurers left the state, others ceased writing workers’ compensation or were merged or acquired by other carriers, and still others, including several of the largest insurers in the state, became insolvent and had to be taken over or supervised by the state. As a result, the workers’ compensation market became much more concentrated than in the past, with only a few insurers - aside from State Fund, mostly large, national carriers - accounting for the lion’s share of statewide premium.

Changing Insurers

WCIRB identified some trends in employers changing insurers pre and post open rating. WCIRB estimates that before open rating, about 25% of California employers with experience-modifications (x-mods) changed insurance carriers each year. Post open rating, about 35% of the employers did so, and the first quarter of 2001 shows that half of the employers changed carriers. It should be noted, however, that in many post open rating cases employers had no choice but to change insurers as the market had deteriorated to the point that many carriers – including several of the largest workers’ compensation insurers in the state -- ceased to exist or stopped writing workers’ compensation in California.

Reinsurance

After open rating, many carriers shifted the risk of their workers’ compensation claims to other insurance companies, some of whom were inexperienced with the California workers’ compensation insurance market. According to Professor Aigner of the University of California at Santa Barbara, and the Workers’ Compensation Executive many carriers used reinsurance aggressively in order to mitigate the risk of having to make large future payoffs. Backed by reinsurance treaties that lowered the reinsurance level to $50,000 or less from the more typical $500,000 to $1 million, some primary workers’ compensation carriers offered extremely low rates that proved to be inadequate in the face of soaring losses. Some reinsurance companies also sold off their risk to other reinsurers in a process called "retrocession." During 1999, several major reinsurance pools experienced financial difficulty and ceased operations.

Profitability of Insurance Companies

Profitability of insurance companies as measured by the National Association of Insurance Commissioners decreased with deregulation. In the late 1980s, workers’ compensation insurers in California had profit levels of nearly three times the national average. With open rating, California insurers have lower than average profit margins, and during the late 1990s had the lowest return in the nation. Several indicators including those discussed below pointed to a decrease in the profitability of the insurance industry.

Premiums

Immediately after the reform and the elimination of the minimum rate law, in part from reasons discussed above, workers’ compensation insurance premiums continued to decline. The total written premium declined from a high of $8.9 billion in 1993 to a low of $5.7 billion ($5.1 billion net of deductible) in 1995. The written premium grew slightly from 1996 to 1999 due to growth of insured payroll, an increase in economic growth, movement from self-insurance to insurance and other factors, rather than increased rates. But even with well over a million new workers covered by the system, the total premium paid by employers remained below the level seen at the beginning of the decade.

At the end of 1999, the insurance commissioner approved an 18.5% pure premium rate increase for 2000 and the market began to harden after 5 years of open rating, though rates remained less than two-thirds of the 1993 level. Since then, the market has continued to firm, with the Insurance Commissioner approving a 10.1% increase in the advisory rates for 2001, and a 10.2% increase for 2002. Rates continue to move up, and with the expansion of covered payroll, the WCIRB estimates total written premium will end up at or near its all-time high in 2001.

A chart showing the California workers’ compensation written premium and a history of the workers’ compensation pure premium advisory rates since the 1993 reforms follows. Please note that these amounts are exclusive of dividends.

California Workers' Compensation Written Premium
(in Billion $, as of September 30, 2001)
California Workers' 
  Compensation Written Premium Chart
Source: Workers’ Compensation Insurance Rating Bureau of California

Advisory Workers’ Compensation Pure Premium Rates
A History since the 1993 Reform Legislation

1993
Insurance Commissioner approved:
Pure premium rates reduction of 7% effective July 16, 1993 due to a statutory mandate.

1994
WCIRB recommendation: No change in pure premium rates.
Insurance Commissioner approved:
Two pure premium rate decreases: a decrease of 12.7% effective January 1, 1994 and a second decrease of 16% effective October 1, 1994.

1995
WCIRB recommendation:
7.4% decrease from the pure premium rates that were in effect on January 1, 1994.
Insurance Commissioner approved:
A total 18% decrease to the pure premium rates in effect on 1/1/94 was approved effective January 1, 1995 (including the already approved 16% decrease effective October 1, 1994).

1996
WCIRB recommendation: 18.7% increase in pure premium rates.
Insurance Commissioner approved: An 11.3% increase effective January 1, 1996.

1997
WCIRB recommendation: 2.6% decrease in pure premium rates.
Insurance Commissioner approved: A 6.2% decrease effective January 1, 1997.

1998
WCIRB recommendation: The initial recommendation for a 1.4% decrease was later amended to a 0.5% increase.
Insurance Commissioner approved: A 2.5% decrease effective January 1, 1998.

1999
WCIRB recommendation: The WCIRB initial recommendation of a 3.6% pure premium rate increase for 1999 was later amended to a recommendation for a 5.8% increase.
Insurance Commissioner approved: No change in pure premium rates for 1999.

2000
WCIRB recommendation: An 18.4% increase in the pure premium rate for 2000.
Insurance Commissioner approved:
An 18.4% increase effective January 1, 2000.

2001
WCIRB recommendation: The WCIRB initial recommendation of a 5.5% increase in the pure premium rate was later amended to a recommendation for a 10.1% increase.
Insurance Commissioner approved: A 10.1% increase effective January 1, 2001.

2002
WCIRB recommendation: The WCIRB initial recommendation of a 9% increase in the pure premium rate was later amended to a recommendation for a 10.2% increase. WCIRB filed a mid-term recommendation that pure premium rates be increased by 10.1% effective July 1, 2002 for new and renewal policies with anniversary rating dates on of after July 1, 2002.
Insurance Commissioner approved: A 10.2% increase effective January 1, 2002. A decision is pending on mid-term increase request.

 

Combined Loss and Expense Ratios

The accident year combined loss and expense ratio, which measures workers’ compensation claims payments and administrative expenses against earned premium has been increasing greatly since 1993. In accident year 2000, insurers’ claim costs and expenses amounted to $1.50 for every dollar of premium they collected – and that was an improvement over the record high of $1.70 noted in 1999. In fact, the ratios seen in the past 4 years (as shown in the graph below) are the highest ever recorded by the industry since WCIRB began collecting data.

Combine Loss and Expense Ratio

Combine 
  Loss and Expense Ratio Chart

Source: Workers’ Compensation Insurance Rating Bureau of California

Under-Reserving

Furthermore, a serious under-reserving of claims was noted. As of December 31, 2000, the WCIRB estimated that the amount of statewide reported reserves were $7.1 billion below the estimated ultimate cost of incurred claims.

According to many, these unprecedented results are explained, at least in part, by inadequate pricing due to an extremely competitive insurance market. According to WCIRB, for most of the second-half of the 1990’s insurers were, on average, pricing their policies well below the pure premium rate level. (Pure premium rates provide only for losses and loss adjustment expenses and include no provision for other insurer expenses.)

Average Claim Costs

At the same time that premiums and claim frequency were declining, the total amount insurers paid on indemnity claims jumped sharply due to increases in the average cost of an indemnity claim, which rose dramatically during the late 1990s. According to the WCIRB, both average indemnity and medical claim costs have shown increases over the last several years, as shown on the following graph.

Estimated Ultimate Total Loss per Indemnity Claim by year
of accident as of september 30, 2001

Estimated Ultimate 
  Total Loss per Indemnity Claim by Year  Chart
Source: Workers’ Compensation Insurance Rating Bureau of California

The WCIRB predicts that the average cost of a 2000 indemnity claim will be $38,397, which is a up 4% since 1999 and 100% since 1993.

Please note that the WCIRB’s estimates of average indemnity claim costs have not been indexed to take into account wage increase and medical inflation.

Current State of the Insurance Industry

Market Share

A number of California insurers left the market or reduced their writings as a result of the decrease in profitability, contributing to a major redistribution of market share among insurers since 1993, as shown in the following chart. According to the Workers’ Compensation Insurance Rating Bureau, California companies (excluding the State Compensation Insurance Fund) insured seven percent of the California workers’ compensation market in 2000, compared with 33% of the market in 1993.

California Workers'Compensation Insurance
Market Share by Type of Insurance
(Based on Earned Premium)

California Workers'Compensation 
  Insurance
  Market Share by Type of Insurance Chart

Source: Workers’ Compensation Insurance Rating Bureau of California

September 11’ Impact on Insurance Industry

The industry recent problems in the reinsurance market caused by the events of September 11 have significantly affected the cost and availability of catastrophe reinsurance and, correspondingly, have a significant effect on the cost of workers' compensation insurance. This extends to more than acts of terrorism and is a critical component of any evaluation of the California workers’ compensation insurance marketplace.

Insurance Market Insolvency

Currently, several insurance companies are experiencing problems with payment of claims. According to WCIRB, fifteen independent insurer/insurer groups, which collectively wrote over one-quarter of the total California market in 1994, are under regulatory action by the Department of Insurance.

As indicated in the following listing, Superior National and other insurance companies have been liquidated while some insurance companies have been placed under regulatory supervision by the Department of Insurance:

1. Superior National Group (in California liquidation), including

2. HIH Insurance Ltd. (under California liquidation)

3. Fremont Compensation Insurance Group (under California regulatory supervision)

4. Credit General Group (under Ohio liquidation)

5. Reliance National Indemnity Company group (under Pennsylvania liquidation), including

6. Sable Insurance Company (under California liquidation)
    Sable is a wholly owned subsidiary of Sable Insurance Holding Company, which in turn is owned by Reliance National Indemnity Company

7. Frontier Pacific Insurance Company (under California liquidation)
    Frontier Pacific Insurance Company is part of the Frontier Pacific Group whose stock ceased trading due to big losses.

8. PHICO Insurance Company (under Pennsylvania liquidation)

9. Legion and Villanova Insurance Companies (under Pennsylvania rehabilitation)
    The companies are part of the Legion Insurance Group

Prevention of Financial Insolvency

The American Insurance Association cited several mechanisms already in place (listed below) that give the Insurance Commissioner some tools to protect the solvency of the insurance system. However, there are differing opinions as to the applicability and effectiveness of these statutory and regulatory provisions relating to the Department of Insurance:

1. Authority over the adequacy of the aggregate reserves of an insurer (Insurance Code 923.5 and 11558) and regulations that provide, in part, "The minimum reserve requirements prescribed in Section 11558 shall be increased whenever the Commissioner determines that the computations set forth in Section 11558 are inadequate as provided by Section 11557."

2. Authority to require insurers to increase reserves whenever reserves "seem inadequate." (Insurance Code 11557)

3. Authority to require insurers to provide additional accounting or actuarial information regarding its financial condition whenever the insurer appears to require immediate regulatory attention. The additional accounting or actuarial supplementary information may be at such intervals as the Commissioner may require and must come from such accountants or actuaries as are satisfactory to the Commissioner. (Insurance Code 925)

4. Authority to require an insurer to stop any conduct that would render the company insolvent. (Insurance Code 1065.1)

5. Insurance Code 739 et seq. provides an oversight mechanism, Risk-Based Capital (RBC). RBC is a tool that allows the Department to review a number of critical components of an insurers operations to determine whether its financial condition warrants regulatory intervention.

6. Insurance Code 11732 provides that: "(r)ates shall not, if continued in use, tend to impair or threaten the solvency of an insurer or tend to create a monopoly in the market." Some conclude that this only allows intervention in the rates of an insurer when the insurer is faced with impending (if not actual) insolvency. Others believe that the CDI does have significant authority within the overall solvency regulation scheme in the Insurance Code to allow early intervention in an insurer's rate making when its other financial indicators, such as loss ratios, reserve adequacy, and loss development, are adequately reviewed and analyzed.

Solutions to Financial Insolvency

After a company is determined to be financially distressed, the California Department of Insurance conserves, rehabilitates or liquidates those licensed California insurance companies under appointment by the courts. If the company is experiencing financial difficulties, the California Department of Insurance can place the company under:

California Insurance Guarantee Association

Background

The California Insurance Guarantee Association (CIGA) was established in 1969, in part, to meet the obligations of insolvent workers’ compensation insurers by administering and disbursing covered claims. Each insurer, in order to conduct business in the state, is required to participate in CIGA, a fund from which insureds and claimants could obtain financial and legal assistance in the event insurers became insolvent.

When an insurer is declared insolvent, CIGA assures payments of claim liabilities. Unlike other claims covered by CIGA, the insurance guarantee association pays 100 percent of benefits on workers’ compensation claims. The valuation of each proof of claim is determined in accordance with policy provisions and statutory requirements.

CIGA derives the funds to pay claim liabilities through assessments levied against member companies, through distributions from the estates of the insolvent insurers and investment income. The insurers are then permitted to recoup their CIGA assessments by surcharging their policyholders.

Between 1969 and 2000, CIGA reports that it paid out an average of $51 million per year. Prior to September 2000, CIGA had a surplus of $290 million in its workers’ compensation account.

Current Insolvencies

In its "Current Situation Report" issued March 14, 2002, CIGA reports that it has been in "precarious financial condition" since the Superior National Companies were liquidated in September 2000. Since that time CIGA has paid out almost $650 million on claims for those companies alone, and since October 2001, CIGA has paid out $28 million to cover the insolvency of the Reliance Insurance Company. This "has nearly exhausted CIGA’s available cash to pay workers’ compensation claims."

According to CIGA, there are currently over 10 workers’ compensation insurance companies have been liquidated since September 2000. CIGA's total cash drain from all current insolvencies has grown to about $75 million per month, of which over $53 million is for workers’ compensation.

Assessments and Surcharges

In September 2001,California Governor Gray Davis signed into law Assembly Bill 1183, which allowed CIGA to raise the assessment on workers’ compensation insurers through September 12, 2002 from not more than 1 percent to not more than 2 percent of net direct premiums written.

However, according to CIGA, the short-term 2% assessment may not be enough to cover all claim liabilities. At the current pay out rate, CIGA estimates that it will run out of funds for workers’ compensation payments in April 2002.

In February 2002, Assembly Bill 2007 (Calderon) was introduced which would establish the assessment permanently at not more than 2% of net direct premiums written. A hearing on AB 2002 is scheduled for May 1, 2002 before the Assembly Insurance Committee.

CHSWC Informal Hearing on the State of the Workers’ Compensation Insurance Industry in California

The situations described above and at the urging of the community, CHSWC held an informal hearing on the state of the workers’ compensation insurance industry as part of its February 8, 2002 meeting in San Francisco. Several representatives from throughout the workers’ compensation community participated and shared their views, including

Michael Nolan - California Workers’ Compensation Institute
Mark Webb - American Insurance Association
Larry Mulryan - California Insurance Guarantee Association (CIGA)
David Bellusci - Workers’ Compensation Insurance Rating Bureau of California
Norris Clark and Larry White - California Department of Insurance
Pat Quintana and James Neary - State Compensation Insurance Fund
Mark Johnson – DWC Audit Unit
Glenn Shor – DWC Policy, Program Evaluation and Training Unit
Richard P. Gannon - Administrative Director of the Division of Workers’ Compensation
Gilbert Stein and Rick Wooley - California Applicants’ Attorneys Association (CAAA)

Summaries of their remarks are included in the Appendix.

Recommendations

CHSWC and the community have expressed concerns regarding the current and future solvency of the California insurance industry. The viability of the insurance industry is vital to maintaining the health of the workers’ compensation system, which benefits both workers and employers.

CHSWC recommends that efforts be expended to:

• Stabilize the workers’ compensation insurance market as soon as possible.
• Identify the impact of the insurance industry’s current financial crisis on the employers and employees.
• Determine the consequences of loss of competitiveness.

Further areas of study may include, but are limited to, the following:

Possible Research Areas

1. Review and assess the effectiveness of current regulations regarding the prevention of and recovery from insurer insolvencies so that injured workers are assured timely and proper benefits.

2. Explore whether the California Department of Insurance (CDI) should move towards a "rate adequacy" standard and whether this standard would be effective in preventing insurance companies’ insolvencies.

3. Assess the problems that the insurance industry is currently faced with and their impact on timeliness of payments to injured workers.

4. Analyze other states' approaches to improving competition through other methods such as dispersal of information or verifying insurance coverage, and their applicability to California.

5. Review the recommendations of the Workers' Compensation Rate Study Commission and determine their relevancy today.

6. Review the literature on open rating and exclusive state funds.

7. Identify key indicators to be utilized to conduct an ongoing evaluation of the insurance industry to prevent future insolvencies and sustain the viability of a healthy insurance market.

Sources

Aigner, Dennis. "Paradise Lost: Work-Comp’s Awful Prospects." Orange County Business Journal. August 9, 1999.
Aigner, Dennis. "Open Rating and California’s Workers’ Compensation Insurance Market." Underwriters’ Report. June 27, 1996.
California Department of Insurance: http://www.insurance.ca.gov
California Insurance Guarantee Association. E-mail from Mei Mei Wong, Workers’ Compensation Supervisor. December 2001 and "A Current Situation Report" issued by CIGA on March 14, 2002.
California Workers’ Compensation Institute. CWCI Bulletin 01-19, November 26, 2001.
Commission on Health and Safety and Workers’ Compensation Annual Report 2000-01.
CHSWC February 8, 2002 meeting transcript.
Department of Industrial Relations. Division of Workers’ Compensation. Annual Report for 1998.
State of California Workers’ Compensation Rate Study Commission "Commission Report Volume II Commission Staff Report", March 1992
Sacramento Business Journal. "Surcharge Raised to shore up workers’ comp system." September 21, 2001.
California Department of Insurance website: http://www.insurance.ca.gov/docs/FS-CLO.htm
Conversation with Ron Rosen, Bureau Chief of Property and Casualty, California Department of Insurance
Conversation with Glenn Shor, Division of Workers’ Compensation, California Department of Industrial Relations
Thomason, Terry, Timothy P. Schmidle, and John F. Burton, Jr. "Workers’ Compensation: Benefits, Costs and Safety under Alternative Insurance Arrangements", W. E. Upjohn Institute for Employment Research, Kalamazoo, Michigan, 2001
Workers’ Compensation Executive. November 7, 2001.
Workers’ Compensation Executive. September 19, 2001.
Workers’ Compensation Executive. May 9, 2001
Workers’ Compensation Executive. March 7, 2001.
Workers’ Compensation Executive. January 5, 2000
Workers’ Compensation Insurance Rating Bureau. "Summary of December 31,2000 Experience." WCIRB Bulletin No. 2001-06, April 18, 2001.
Workers’ Compensation Insurance Rating Bureau: Robert Mike, President, and David Bellusci, Senior Vice President and Chief Actuary


Appendix

Summary of the Proceedings of the Informal Hearing on the State of the Workers’ Compensation Insurance Industry

On February 8th, 2002, the Commission on Health and Safety and Workers’ Compensation held an informal public discussion on California’s state of the workers’ compensation insurance industry. Several representatives from the workers’ compensation community presented their views on this issue. The following is a summary of these proceedings.

Michael Nolan, President of the California Workers’ Compensation Institute

Mr. Nolan set the stage for the hearing noting that there are diverse opinions about the issues to be addressed at the Commission meeting regarding the state of the insurance industry.

Mr. Nolan made several points regarding current dynamics in the workers’ compensation insurance market including:

The September 11 World Trade Center attack resulted in increasing reinsurance rates for carriers adding to the upward pricing pressure that employers already experienced and affecting the availability of insurance for employers.

Primary workers’ compensation carriers with post September 11 reinsurance treaties now have no reinsurance protection for terrorist acts. Also, the carriers have had difficulties in securing coverage on other catastrophic events at reasonable rates.

At the present time, insurers are faced with the issue of how to write insurance for terrorism. In California workers’ compensation, the primary carrier does not exclude such terrorism coverage for its employer. According to Mark Webb of the American Insurance Association, a current bill before the US Congress would provide a certain level of retention by the private marketplace, but also have a catastrophic layer of coverage provided by the federal government. This bill is modeled after a United Kingdom mechanism for terrorism insurance.

The increase in rates and the possible reduction in availability of insurance can lead employers to increase the use of variety of approaches to reduce their workers’ compensation costs. The different approaches can include: greater use of self-insurance, group insurance, large deductibles. This could present various regulatory oversight issues while regulatory budgets are declining.

Loss of value of the securities market has decreased investment returns and California’s return on net worth is at the lowest of any state as estimated by the National Association of Insurance Commissioners (NAIC). Thus, it is questionable whether California is able to obtain the capital to support the likely increase in written premium resulting from 9/11 and AB 749.

One of the crucial issues facing California is the economic viability of CIGA, which is the second largest workers’ compensation payer in the state, but is currently insolvent on a book basis.

Mark Webb, Vice-President of State Affairs for the American Insurance Association

Mr. Webb first addressed economic factors that needed to be considered in explaining the transition from the Minimum Rate Law to Open Rating Law. Mr. Webb commented that the drop in premiums seen after open rating was due to an infusion of new capital. The capital came from:

Excessive rates derived from the Minimum Rate Law in 1993 and 1994. The rates were excessive because of the precipitous drop in claim frequencies. Also, the Competitive Rating Law did not become effective until 1995. The convergence of these two occurrences led to a large amount of capital being accumulated during the transition period

Managed care organizations: After the creation of Health Care Organizations (HCOs) in the workers’ compensation 1993 reforms, there was some thinking in the HMO industry that acquiring workers’ compensation companies would be a good investment.

Availability of relatively inexpensive reinsurance.

Mr. Webb commented about the state of the insurance industry:

Although the worst of the insurance industry crisis is over, the increase in the cost of reinsurance and increase in benefit costs from pending legislation AB 749 could make the situation difficult for insurers. The pending legislation which would extend the current level of surcharge by CIGA beyond the sunset date will help the insurance market move in the right direction.

The Insurance Commission has the authority to disapprove of rates that would tend to impair the insurer or make it insolvent or rates that would tend to create a monopoly. And for private carriers, a monopoly is presumed if an individual carrier gets 20 percent or more of the marketplace. CDI feels that that does not allow them to intervene in the rate-making process early enough to prevent insolvencies.

California still has one of the most competitive workers’ compensation insurance marketplace when examining how many carriers can come into the market under proper insurance regulatory oversight. He noted that largely the domestic industry has left the market, but there are still national companies in the insurance market that are developing capital in California.

Larry Mulryan, Executive Director of California Insurance Guarantee Association (CIGA)

Mr. Mulryan spoke about CIGA and its role in the current insolvencies in the insurance industry:

CIGA is a semi-public, involuntary association of property and casualty insurers which was created in 1969 to pay claim liabilities in the event insurers became insolvent.

In the case of workers’ compensation insurers CIGA has to pay 100% of the benefits. CIGA assures payment of liabilities through assessments levied against member companies, through distributions from the estates of the insolvent insurers and investment income. Currently, CIGA is handling over 25% of California workers’ compensation claims.

CIGA in the 32 years since its creation has paid out an average of $51 million in claims every year. However, since September 2000 it has paid out over $600 million just for the Superior National insolvencies alone. Since then there were additional insolvencies including Reliance, Sable Insurance Company, and Credit General which have put large financial demands on CIGA.

In order to help meet its financial demands CIGA obtained an increase in its assessment cap from 1% to 2% last year. However, in order to continue meeting its financial demands CIGA needs to have the 2% surcharge reinstated beyond the current sunset date and to have a regular flow of disbursements from the estates.

Currently, CIGA has not been receiving distributions from Superior National Insurance Companies’ estate, because a large part of the companies’ reinsurances was tied up in one treaty which is currently in dispute.

With the extension of the surcharge and the current rate of payouts, CIGA projects that by the end of this calendar year, it will be $219 million in the negative in workers’ compensation on a cash basis. By the end of 2005, CIGA will be in the black by $10 million dollars.

Changing the current deposit law would help in solving the problem of distribution of the estates. At the present time, insurance companies securities are not directly deposited into CIGA which has created a hold up of the deposits by sureties. He commented that the law should be simplified to allow CIGA to receive the deposits directly. This is being introduced into legislation this year.

David Bellusci, Vice President and Chief Actuary of the Workers’ Compensation Insurance Rating Bureau of California

Mr. Bellusci made a presentation on Workers’ Compensation Insurance Industry results. Several indicators pointed to the financial difficulties that insurance companies have been experiencing:

The written premium declined sharply for insurers before and into open rating in 1995 and flattening out for several years after. During the last couple of years, the premium has grown due to pricing increases in the market. In general, the premium has grown much slower than the cost side during periods of economic growth.

The rates in the market were inadequate just before and after open rating. The insurers should have been charging 20 to 25 percent above loss costs, approved by the Commissioner, to take into account other financial expenses. Instead, the insurers discounted significantly from loss costs. Although data for the first 9 months of 2001 shows that the rates were higher than they were at the start of open rating in 1995, the rates are still below their peak in 1993.

Although indemnity claim frequency has been decreasing in the 90s and is continuing, the cost of an average indemnity claim has increased.

The combined loss and expense ratios show that since open rating took effect in 1995 insurers are paying out substantially more than they are receiving in premiums. However, due to price increases in 2000, the combined loss and expense ratio is lower than in 1998 and 1999.

The market share for California workers’ compensation (excluding State Fund) insurers between 1994 and 2001 has declined substantially while State Fund’s share has grown from 19% to 31%. However, Mr. Bellusci noted that while many companies have left the market, many other ones have entered and the market is still competitive.

The WCIRB’s projections for the future include: a continued increase in insurance prices, continuing growth of the State Fund’s market share, and possibility of new entrants into the market attracted by higher rates.

Norris Clark, Chief of the Financial Surveillance Branch of the California Department of Insurance

Larry White, Senior Staff Counsel of the California Department of Insurance

Mr. Clark and Mr. White spoke about the current State of the Insurance Industry from the California Department of Insurance (CDI) perspective. Mr. Clark noted that:

The financial viability and profitability of the Insurance Industry is declining. In 1994 out of the top 20 companies writing workers’ compensation insurance business, 11 companies were California domestics. In 2001, only 3 California domestic companies wrote insurance.

At the present time there are several financially troubled companies and very little new capital entering the market place. In Mr. Clark’s opinion, most of the business has been increasingly going to fewer insurance groups and there is diminishing competition in the marketplace.

Mr. White commented on the deregulation of the state of the insurance industry, emphasizing that the cause of the current financial situation of the insurance companies is open rating.

Mr. White made several points on the impact of law changes on CDI’s regulation of insurers:

Under deregulation the law was changed from " rates should be adequate for all admitted insurers" (under Minimum Rate Law) to rates shall not tend to impair or threaten the solvency of an insurer." This modification meant that CDI could intervene only if a company’s solvency was impaired even if the insurer was losing money on its workers' compensation rates.

In the Minimum Rate law only the workers’ compensation experience of a company could be used to judge the adequacy of rates. After the new law was enacted in 1993, only if the workers’ compensation rates of a particular company would cause that company to be insolvent for the entire company book of business could CDI intervene.

Currently, the Insurance Commissioner has financial solvency authority over companies, but no authority over the market as a whole.

Pat Quintana, Government Relations Officer for the State Compensation Insurance Fund

James Neary, Vice President and Actuary of the State Compensation Insurance Fund

Ms. Quintana and Mr. Neary made several remarks on the state of the industry from the State Compensation Insurance Fund perspective.

Ms. Quintana spoke about the history and the mission of State Fund.

The State Fund was created 88 years ago under Governor Johnson.
The mission and objectives of State Fund include:

o To be free and fairly competitive with other insurance carriers

o To operate as a yardstick for the industry to encourage fair rates for employers and fair treatment for injured employees

She pointed out the possibility that open rating might not have been the cause of the current situation in the insurance industry. She commented that in 1915, under no open rating laws, there were companies that had also gone into liquidation while State Fund had prospered.

Ms. Quintana further pointed out that State Fund has been necessary in the marketplace and its market share has fluctuated over the years from 10 to 40 percent depending on economic conditions and the situation in the workers’ compensation industry.

Mr. Neary pointed out that:

In the current marketplace which is strained the State Fund’s role is to guarantee availability and affordability of workers’ compensation insurance to employers in California.

As prices in the marketplace increase, it will attract new entrants and a viable private market will again reappear in California.

State Fund has managed to maintain a good record while many other insurers have been taken over by the California Department of Insurance recently. The ability of State Fund to maintain good financial health is due to the fact that during open rating the State Fund’s price level was higher than other insurance carrier and it was committed to strong reserves.

Mark Johnson, Division of Workers’ Compensation Audit Unit

Mr. Johnson presented a summary of the audit results for the last five years with indicators of claims handling performances. Mr. Johnson’s presentation showed that:

Approximately 8500 claims were audited in 1997 and 9600 claims in 2001

Total number of penalties assessed increased by 22% between 1997 and 2001

Average unpaid indemnity per claim has increased from $897 to $1,066 between 1997 and 2001

The frequency of late first temporary disability payments in randomly selected claims increased from 21% to 30% during the same period.

Frequency of violations for failure to issue routine benefit notices in randomly selected claims increased from 24% to 30% between 1997 and 2001.

Frequency of violations for failure to timely issue QME notices in randomly selected claims increased from 18% to 21% between 1998 and 2001.

Frequency of violations for failure to timely issue notices of vocational rehabilitation eligibility in randomly selected claims increased from 48% to 58%

Frequency of violations for Failure to Timely Pay or Object to Bills for Medical Treatment in randomly selected claims increased from 12% in 1997 to 18% in 1999 and decreased to 13% in 2000 and 2001.

Frequency of violations for failure to timely pay or object to medical-legal bills in randomly selected claims increased from 7% to 9%.

The frequency differed between late payments of temporary disability and payments on medical bills because in medical bills there was a larger time frame in which to make the payment. Specifically, in temporary disability cases there is only 14 days from the date of injury when the payment has to me made. However, for the medical bills there is 60 days to make a payment from the date the bill is received.

 

Glenn Shor, DWC Policy, Program Evaluation and Training Unit

Mr. Shor first commented on the recommendations made by the Workers’ Compensation Rate Study Commission created by the Legislature in 1992 to study the rate system in workers’ compensation. Mr. Shor noted that two of the recommendations of the Commission were not adopted. These recommendations were:

To abolish the existing minimum rate law, replacing it by open competition with floor rates approved by the Insurance Commissioner based on loss costs provided by the Workers’ Compensation Insurance Rating Bureau.

The Commissioner of Insurance issue an annual report evaluating the state of competition in the workers’ compensation insurance market. Mr. Shor mentioned that such studies are done in several other states including Michigan and Maine, which have made the transition to open rating.

Mr. Shor made several observations about various innovations developed by states to improve competition, verify coverage, and report illegally uninsured employers.

The State of Missouri publishes all workers’ compensation insurance premium rates by company and by workers’ compensation classifications on their Department of Insurance website.

Texas has on their website an ability to verify workers’ compensation coverage for an individual employer.

Florida has on their website the ability to report an employer suspected of illegally failing to secure workers’ compensation coverage for his/her employees.

Richard P. Gannon, Administrative Director of the Division of Workers’ Compensation

Mr. Gannon commented that:

The solvency and profitability of the insurance industry impacts DWC’s responsibility to protect the interests of the injured workers entitled to timely payment and provision of compensation.

There is a need to study if the problems which the insurance industry is faced with are impacting the timeliness of payments to injured workers.

There is a need to monitor the transition to new audit processes specified in AB 749 and see if these processes increase the correct and timely payment of benefits.

Gilbert Stein, President-Elect, California Applicants’ Attorneys Association (CAAA)

Rick Wooley, Treasurer, California Applicants’ Attorney Association

Mr. Stein and Mr. Wooley pointed out their concerns of how insurance insolvencies related to delays in timely payments to injured workers. They commented that:

Currently there are problems in obtaining claim information which occurs when there is an insolvency and CIGA takes over. There can be several weeks in delay of benefits to injured workers when the file goes from the insolvent carrier to CIGA and then to the company that is contracted to take over the administration of the claim.

There are delays in cases of cumulative trauma where CIGA is involved. In such cases as long as CIGA can find a solvent carrier connected to the case, CIGA no longer needs to make payments. At the same time the solvent insurance carrier might be reticent to accepting the case for various reasons which leads to delays.