Deregulation Is Taking Toll on Workers’ Compensation

SACRAMENTO —  California’s plunge into deregulation, which spawned the energy crisis, has now disrupted another segment of the economy: the workers’ compensation insurance industry, where a wave of insolvencies has led officials to warn of a looming crisis.

Overshadowed by the state’s electricity woes, the workers’ compensation problem has attracted little public attention. But regulators and lawmakers are increasingly concerned that the system that provides benefits to those injured on the job is in serious trouble.

“There is no question that workers’ compensation is at a critical stage,” said Assembly Insurance Committee Chairman Thomas Calderon (D-Montebello).

Deregulation’s role in the industry’s troubles, state regulators say, began when a 1993 law repealed the requirement that the state set a minimum rate for insurers to charge for workers’ compensation coverage, and instead allowed companies to charge whatever they wanted.

The new law gave California the least regulated workers’ compensation system in the nation and set off cutthroat competition. Insurers began charging less than cost for their coverage, and the result was a precipitous drop in rates that had been the highest in the nation.

While that drop was a bonanza for businesses that had been struggling to pay huge premiums, many insurers did not have deep enough pockets to stay in the game. They either became insolvent or stopped selling in the California market.

“What we have at this time . . . is an unprofitable market that is in turmoil, several defunct or financially troubled companies . . . and diminishing competition,” Deputy Insurance Commissioner Norris Clark told the Assembly Insurance Committee last month. “That sums up the financial health or more correctly the financial demise of the California workers’ compensation industry.”

Clark and other regulators worry that dwindling competition could result in skyrocketing costs again--at a time when employers are already struggling with soaring energy prices and business slowdowns.

For workers, the worst-case scenario could be a future in which some claims can’t be paid.

“Insurers’ long-term financial viability is of paramount concern,” said Clark, “because [their] obligation to pay workers’ compensation benefits in many cases may last 20 to 30 years or even longer.”

Last year, workers’ compensation coverage was provided to more than 500,000 California employers and their 13 million employees. Benefits were paid to about 1 million injured workers.

Clark and other industry watchdogs say the trouble signs are these:

* Of the top 12 companies that specialized in workers’ compensation coverage in 1994--the last year before deregulation--eight have become insolvent, been forced to operate under the supervision of the state, or are not doing any new business in California. Among the insolvencies was that of Superior National, the state’s largest private workers’ compensation writer when it was liquidated last year.

The second-largest, Fremont General, is in such financial trouble that it operates under state supervision. And last week, two more companies--HIH America Compensation and Liability Insurance Co., and Great States Insurance Co.--were seized by the Department of Insurance.

* The Workers Compensation Insurance Rating Bureau, a nonprofit association used by the state to track the performance of the industry, estimates that in 2000 the industry was $5 billion, and possibly as much as $7 billion, short of the reserves it needed to pay claims.

* The California Insurance Guarantee Assn. (CIGA), which pays claims for injured workers when an insurance carrier is insolvent, warns that it will run out of money in January. For Superior National alone, CIGA paid out $40 million a month in claims in the first six months after it was seized by the state. CIGA estimates the total cost for handling Superior’s claims will be $1.4 billion.

“The industry is in trouble . . . and it’s self-created trouble,” said Dale Debber, publisher of Workers Comp Executive, an industry publication. “They sold their product below cost and hoped to make up for it in volume. That was stupid, at best.”

The rating bureau’s assessment is less judgmental but equally clear.

“We do think that the insurance business for workers’ compensation has been grossly underpriced for a number of years now,” said rating bureau President Robert Mike, “and that companies cannot continue as a viable business writing insurance at the levels we’re seeing.”

Calderon, who held a series of hearings to examine the health of the workers’ compensation system, said he worries that the rate war will drive more smaller companies out of the market, until “there is no competition and prices will be artificially high.”

The one island of stability in the system, he said, is the nonprofit State Compensation Insurance Fund, created by the Legislature in 1914 to be the insurer of last resort. It sells 26% of all workers’ compensation insurance in California, and the state has deemed it financially sound.

Calderon said he is working with state Senate President Pro Tem John Burton (D-San Francisco) on legislation, SB 71, that would raise benefits for workers and give state Insurance Commissioner Harry Low tools to stabilize the private side of the industry.

The chief tool he’ll propose, he said, is what he calls a modified minimum rate plan--a proposal that would allow Low to reject rates that are below cost.

“That way,” Calderon said, “you can’t price yourself out of business.”

A second measure, AB 1183, would attempt to rescue the Insurance Guarantee Assn. by raising the surcharge on worker compensation premiums from 1% to 2%. The association uses the surcharge to pay the claims of injured workers who were covered by insurance companies that have gone bankrupt.

Despite turmoil in the industry, legislators and industry leaders say there is little appetite yet to scrap deregulation entirely and return to the old system of a uniform minimum rate.

“There is still a strong open competition kind of mind-set. I don’t see a whole lot of folks lining up to the bar to support change,” said Barry Carmody, president of the Assn. of California Insurance Companies. “I think we’re a ways from judgment day on open competition, but there is concern out there.”

The architects of the current system insist that it has gotten an unfair rap, that deregulation should not have to shoulder all the blame for the chaos.

Dennis Aigner, former chairman of the California Rate Study Commission, which proposed the system, said that in adopting the proposal, the Legislature failed to incorporate a key ingredient.

He said the commission had proposed that the state be allowed to set a floor on rates, which would have prevented companies from cutting them below cost.

But even without that authority, he said, the commissioner was still empowered to take steps to ensure that companies did not become insolvent. He said former Insurance Commissioner Chuck Quackenbush took no action despite ample evidence that some companies were in trouble.

“I would not blame this on deregulation,” said Aigner, who is acting dean of the Bren School of Environmental Science and Management at UC Santa Barbara.

“I do believe it is correct in the case of electricity that deregulation was bad. But I don’t think there is anything wrong with the workers’ compensation system, had it been properly handled by the commissioner.”

He said deregulation has been very successful in some states, especially Michigan.

“I think the deregulation law we have is a good one and is functional,” he said. “We’re unfortunately in a political situation where deregulation in California is a bad word.”

Former Sen. Patrick Johnson (D-Stockton), who sponsored the open competition law, said many of the critics of deregulation have forgotten that when the industry was highly controlled, its rates were the highest in the nation.

Almost immediately after deregulation went into effect in 1995, he said, rates dropped dramatically. In the first five years, they plummeted an average 30%, bringing them down to 1978 levels.

He said a natural readjustment occurs when an industry moves to deregulation; it is often accompanied by a number of insolvencies until “it finds its balance point.”

Johnston acknowledged that the adjustment period for California has been longer than he expected, but he is still not convinced that deregulation was a bad idea.

“The tremendous public policy value of a competitive marketplace has not been undermined by the couple of insolvencies that have more than one cause, including probably bad management,” said Johnston, who now works for the California Applicants’ Attorneys Assn., a group of lawyers specializing in the representation of injured workers.