Daniel P. Marshall
Mr. Marshall is Senior Legal Counsel in the California Department of Insurance, Sacramento.
Employers will confront a brave new world of workers' compensation insurance in 1995. The reform legislation of 1993 that repealed the "minimum rate law" also repealed a host of other parts of the system.
Winners and Losers?
This is the last year of the old, highly regulated system. During phase-out in 1994, insurers and employers are bound by the old rules but will jockey for position under the new ones. The new system for 1995 is "open rating," which will present previously unmet challenges to California's employers.
Larger employers with good safety records have always been desirable clients for insurers, which competed heavily for their business. Under minimum rate, larger employers were highly profitable; a good loss history usually produced a hefty dividend a year or two after the policy year ended. Those large employers will continue to be the big winners in the new system.
Conventional wisdom holds that medium to small employers will lose out under the new system. Just how much premiums will change under open rating is obviously unknown, but as in any competitive setting (and as in health insurance), the market clout of a small business is hampered by its size. So even disregarding the particulars, it can be said that premiums of individual small businesses will be higher than those offered to their larger competitors.
Why is this to be so? Under open rating, each carrier determines its own rating plan - a written document that assigns a rate to each risk. A rating plan may have a number of factors that increase or reduce the premium. The minimum rate law provided a floor below which a carrier could not price a policy; a floor for the rate offered to the best risks provided some downward price pressure for the bad risks (such as the individual small business). Open rating has no floor. The most desirable risks will be priced at rock-bottom rates, linked in some way with their cost to the insurer, and insurers' rating plans will so provide. Not all businesses can or should be written at the lowest rate, so this means there will be a tendency to price small business policies at their actual, higher cost.
Some carriers plan to offer high-premium employers a deductible workers' compensation insurance policy, where the employer pays a part of any medical costs in exchange for a lower premium. Retrospective rating plans - where premiums may vary from year to year based on the employer's loss experience - will probably be available to large employers. Insurers will require substantial amounts of capital in a business that requests a deductible or retrospective plan, and small businesses just do not have access to substantial capital.
Insurers Face Changes, Too
Specific rate predictions aside, it's a completely new horse race for insurance companies and employers. If insurers that have depended on the benign competition structure of the minimum rate do not price carefully and intelligently, they may require regulatory attention from the insurance commissioner.
Insurance companies that have policies in other states besides California can be expected to do well under open rating. The new law will allow them to balance their loss exposure in California workers' compensation with profits from other lines of insurance in other states.
Under the old rate law, some smaller, California-only insurers that found a niche market and served their clients well have prospered. But because California-based insurers that write nothing but California workers' compensation will be unable to shield potential losses with profits from other lines, they might leave the starting gate of the workers' compensation marketing race at a disadvantage.
Observers of the insurance industry expect that some carriers will not survive open competition and will leave California. At the same time, however, some companies are showing new interest in entering California, probably because the wide extent of rate deregulation under the new law is a profit opportunity for a smart company. Since November 1993, six more companies have applied for a license to write workers' compensation for California employers.
The Department of Insurance will make all appropriate efforts to ensure that the new players remain solvent and do not endanger California businesses in their push for profits. It is the department's hope that the market will remain healthy and diversified, despite the turbulence we can initially expect.
The State Fund
Although it competes in the insurance marketplace, the nonprofit State Compensation Insurance Fund is actually a unique state agency, chartered under state law. As California's "carrier of last resort," it must insure the employers that cannot obtain insurance elsewhere. For example, it insures most of California's individual small employers, which on average are substantially less profitable for a workers' compensation insurer than are larger employers.
State Fund also writes policies for a significant amount of larger, profitable businesses. Under the minimum rate, the Fund was able to subsidize some costs of its burden of insuring small employers by competing for and insuring larger businesses. In an openly competitive setting, and with marketplace pressures driving down rates dramatically for traditionally more profitable accounts, small employers in the Fund will probably see rates rise to reflect more closely the higher costs they represent. Small employers whose policies are now written by private insurers - due to the overall subsidy in the minimum rate system - will find themselves clients of the Fund, as private carriers seek out more lucrative risks.
The New Landscape: Surcharges, Dividends, and Experience Rating
The Department of Insurance has all the new reform laws under active review to determine what industry regulation will be needed. [Under the new law, insurers' rates are not required to conform to rates set by a central rating organization, such as the Workers' Compensation Insurance Rating Bureau of California (WCIRB), nor are insurers required to adhere to a uniform classification plan. Under the new system, only when a carrier's rates are so low as to threaten its solvency or when its market share approaches 20 percent (exclusive of the State Fund's 20+% market share) can the commissioner disapprove a company's rate. This is truly minimal regulation.] The department is also meeting with industry groups and the WCIRB to obtain their views on the proper scope of regulation. Thus far, opinions from insurers range from "just tell us where to file" to suggestions of a comprehensive set of rating rules. Our goal is to have regulatory requirements that strike a balance between the flexibility consistent with the legislation and the legitimate regulatory purpose of ensuring financial soundness and equitable application of rating plans. The department should complete draft regulations by early summer.
Surcharges and dividends prevalent in the minimum rate environment will become much less of a factor. In fact, surcharges will probably become just part of a base rate, not separate, stated charges. Company rating plans will reflect factors such as business location, previous loss history, and insurer-established subclassifications in addition to the traditional uniform classification and payroll level. In the short run, at least, dividends paid long after policy expiration will give way to up-front price competition.
Experience rating will continue, but as the law now reads, it will be significant only during 1994, the last year of the minimum rate. One of the first actions taken by Insurance Commissioner John Garamendi in reaction to the reform legislation was to require the adjustment of experience rating for 1994 policies to exclude the kinds of claims that, after July 16, 1993, are no longer compensable (certain "stress" claims, and the like). Although those claims filed before July 16, 1993, technically remain in the system, they are not valid predictors of future loss experience and they will not continue to affect the experience modification. In 1995 and beyond, with an insurer's rates being something of a moving target and no classification-wide rates generally employed, experience rating - although it will still be calculated and applied as the law requires - will be less relevant to the bottom line price of an insurance policy.
Controlling Losses
Every employer should be aware that his or her insurance carrier is now required to provide free loss control services under a loss control plan certified by Cal-OSHA. The insurance commissioner has long been a strong supporter of services to help employers reduce workplace hazards and prevent employee injury. The loss control requirement resulted in part from a department study, which showed that in several high-risk industries, modest preventive measures significantly reduced workplace accidents.
Numerous studies have shown that managed health care yields real savings over care for the same conditions obtained through nonmanaged plans. But getting care through a health care organization does not alone solve the problem of high workers' compensation medical costs. Commissioner Garamendi is a proponent of 24-hour, universal health care system, where the circumstances of the injury are immaterial to obtaining treatment. Such a system may offer the best way to control costs. It cuts administrative costs and delivers care more efficiently than fee-for-service care, the norm in workers' compensation.
An Approach to the New Market
Agricultural employers should certainly be active market participants in the new workers' compensation environment. In a market where rates are directly tied to losses, loss control is vital to keep insurance costs down. Employers should take care to review their workplace practices and take advantage of the insurer's loss-control services. Be aware that an insurer may cancel your policy if you fail to follow recommendations of the loss-control representative.
Smaller employers could explore ways to band together into groups to enhance their ability to negotiate a lower price.
There is opportunity in the marketplace right now: