Changes Needed to Reduce Volatility in California's Workers' Compensation Insurance Market
December 10, 2009
California's workers' compensation insurance market will remain vulnerable to wide swings in performance unless changes are made to improve the predictability of costs, transparency of pricing decisions, regulatory oversight and consistency of the incentives facing different parties, according to a study issued today by the RAND Corporation and Navigant Consulting.
"We do not recommend that California reregulate worker's compensation rates," said Lloyd Dixon, lead author of the study and a senior economist at RAND, a nonprofit research organization. "Rather, we offer recommendations to reduce the volatility of the market and the frequency of insolvencies, while realizing the benefits of a competitive market."
In 1995, the California legislature allowed state insurers far greater flexibility in setting rates for workers' compensation insurance, which provides medical care and financial compensation to workers injured on the job.
But for reasons beyond price deregulation, the changes ushered in a period of great volatility. Insurer profits dropped dramatically during the second half of the 1990s, and 31 insurers out of the roughly 250 insurers who wrote these policies in the state failed—including some of the largest companies. Premium prices also fluctuated wildly.
"The workers' compensation insurance market has been like a roller coaster for more than a decade," said Bill Barbagallo, co-author of the study and a managing director at Navigant Consulting. "Volatility makes it harder for businesses to plan and threatens the ongoing health of the insurance market."
The fallout from the market volatility has been widespread. Employers ultimately will be assessed $4.9 billion to pay for the unresolved claims left behind by insolvent insurers and unpredictably high workers' compensation costs can discourage companies from moving to California, according to the report.
Support for the study was provided by the California Commission on Health Safety and Workers' Compensation. It was conducted by the RAND Center for Health and Safety in the Workplace and Navigant Consulting, a specialized independent consulting firm providing dispute, financial, regulatory and operational advisory services to government agencies.
The study identified six key factors that contributed to the insolvencies and volatility over the past 15 years:
- Inaccurate projections of claim costs
- Pricing workers' compensation policies below expected costs
- Reinsurance contracts that give insurers and reinsurers insufficient stake in the profitability of the policies
- Managing general agents who have little financial interest in the ultimate profitability of policies
- Under-reserving for claim costs by insurers
- Insurer policyholder surplus that is inadequate to provide a cushion against adverse events.
The study offers 29 recommendations that aim to increase the predictability of workers' compensation costs, enhance the transparency of the system, better align the incentives of the major players and improve the California Department of Insurance's oversight.
Examples of the suggested changes include requiring the California Department of Insurance to appoint and pay the actuaries that certify that insurers have set aside reserves that are adequate to cover the expected costs of claims. The study also recommends that the Workers' Compensation Insurance Rating Bureau publicly release the quarterly reports that compare the rates charged by each insurer with the expected costs of coverage.
The state-chartered State Compensation Insurance Fund also should report the relationship between rates charged and expected costs by policy-size category. The study also focuses on improving the performance of managing general agents, who often write and adjust policies on behalf of insurers. Contracts that insurers enter with the managing general agents should be augmented to give managing general agents a stake in the ultimate profitability of the policies.
The performance of the Workers' Compensation Appeals Board System also should be reviewed for the consistency of judges' opinions and for how closely judges follow the law. In addition, the California Department of Insurance should consider increasing the amount of capital that insurers must hold to protect against adverse events.
The study's findings are based on interviews with a wide range of stakeholders, detailed examination of eight insurer groups that became insolvent and eight that survived, a review of previous studies, and an analysis of data from the California Department of Insurance, the Workers' Compensation Insurance Rating Bureau, the State Compensation Insurance Fund, the California Insurance Guarantee Association, and the Conservation and Liquidation Office.
The study, "California's Volatile Workers' Compensation Insurance Market: Problems and Recommendations for Change," can be found at www.rand.org. Jim Macdonald of RAND also co-authored the report.
The RAND Center for Health and Safety in the Workplace is dedicated to reducing workplace injuries and illnesses by providing objective, innovative, crosscutting research to improve understanding of the complex network of issues that affect occupational safety, health and workers' compensation. The center draws on the expertise within three research units of the RAND Corporation: the RAND Institute for Civil Justice, RAND Health and the RAND Infrastructure, Safety and Environment division.
Navigant Consulting, Inc. (NYSE: NCI) is a specialized independent consulting firm providing dispute, financial, regulatory and operational advisory services to government agencies, legal counsel and large companies facing the challenges of uncertainty, risk, distress and significant change. Navigant focuses on industries undergoing substantial regulatory or structural change including healthcare, energy and financial and insurance services, and on the issues driving these transformations. For more information, visit www.navigantconsulting.com.