Tuesday, September 16, 2014

Monopoly Part Deux

Yesterday was an exploration on monopolies and workers' compensation - it was my conclusion that competition is what makes workers' compensation inefficient.

Many have taken exception to that statement, understandably, because it defies conventional wisdom.

After all, we would think that competition would compel companies and people to be MORE efficient because if they are not then someone else will come in with a better mouse trap and do the job cheaper, faster, better.

But that's not how workers' compensation is, in large part because workers' compensation itself is not a market based system - it is a REGULATED market, which means that governmental interference with the market is necessary because system stakeholders - employers and employees - are compelled to participate.

Workers' compensation was established in the first place as a monopoly system, meaning the state was the monopoly and dictated the terms of engagement. The state creates as level a playing field as can possibly be created, and thereafter its job is then to enforce the rules of play.

When we disrupt the state's role, when we remove the monopoly power of the state, the playing field gets distorted because players with unequal strengths (in this instance, money) enter the game. When unequal powers are introduced inefficiency occurs because of misallocation of capital and resources.
The state's monopoly fostered innovation.

In California this happened starting in 1993, when Open Rating became the law.

Prior to OR, the Department of Insurance dictated a minimum rate structure. Workers' compensation insurance companies could charge more than the minimum rate, but could not charge less.

The reason for this rule was brilliant forethought by the people that created the system. Their initial reasoning was that in order for the market to be stable there must be a secure capital system, meaning that there would always be money available to meet the risk.

The less obvious role of the minimum rate rule was that it forced insurance companies to compete on service levels because pricing, if a company was efficient in and of itself, was a commodity; if everyone is forced to charge the same price then the buyer needs some other distinction in order to make a purchase decision.

Workers' compensation is a service pure and simple. There are no widgets to sell (except perhaps durable medical equipment, and that is something that is not core to the system). The only way for an insurance company under the minimum rate law to distinguish itself is to provide service levels over and above the next guy who happens to be charging the same price for that service.

When the minimum rate law ruled the insurance landscape there were oodles more (I think upwards of nearly 350+) insurance companies JUST WRITING COMP. They weren't very big insurance companies but they were all specialty carriers that knew their risk industries intimately, and they offered INNOVATIVE  services in claims management that were designed to get people back to work as soon as possible.

Because the ONLY way to save an employer money was to ensure that it's experience modification factor (x-mod) was low.

And the only way to get a low x-mod was by getting benefits initiated and delivered quickly, timely and efficiently to minimize the impact of a claim; the longer a claim stays open the more expensive it is, a fact that is immutable.

Sometimes there were failures in the delivery of services, of course. Nothing can be 100%.

And of course rates rose for various reasons, but overall the rise of rates was relatively benign - there were no huge spikes or rises, nor were there any huge declines. Rate inflation existed, but it was relatively smooth and predictable.

Most businesses don't care too much about rate inflation so long as it can be predicted and modeled into a company's products and services. Disruption occurs when the unexpected happens and rates deviate from the pricing model causing an expense item that wasn't accounted for, which can affect profits (which was part of the Grand Bargain in the first place, smoothing the disruption of a potentially disastrous jury verdict).

When OR came along innovation died because carriers competed on price only. Workers' compensation became a price-dictated commodity. Employers didn't understand the value of specialty services, or the impact of those services on their x-mod, and the ultimate affect was that pricing competition put insurance companies out of business, there became less choice in the market, and worse, less expertise for any given risk model and less service.

That's when wild fluctuations started to occur in the market as capital fled.

Because when an insurance company competes on price, that means that expenses become acutely more important. Trimming expenses means trimming service levels since payroll is by far the single largest fungible expense item.

Trimming service happens at the claims management level since it is reactionary: the level of service necessary to manage a claim isn't known until that claim arrives, and even then it's a guess as to severity.

In the end employers actually have less choice - competition actually destroyed competition! Business shock reverberated through California as employers saw premium increases of over 50% in a single year, destroying any plans and models that relied on stable pricing.

Worse, competition destroyed innovation. No longer was there a reason for an insurance company to specialize in Central Valley cotton crops, or East Los Angeles body shops, etc. There was no reason for a carrier to truly understand an industry, understand intimately the particular risks, or understand operational challenges, because what mattered to the business owner was the price of a policy.

The value of innovative claims management was lost on the business owner or financial officer until a claim came through the mail, and by then it's too late.

I'm not saying that all innovation died with OR, because there are still some players doing good things. But the pace of innovation, the creativity in the insurance market, slowed considerably.

All of the small specialty carriers have left the state or just called it a day.

And the market became much, much more volatile ... and expensive at the premium level, which is what really counts for employers.

So with the minimum rate floor, insurance carriers provided good value. They helped businesses grow, and helped injured workers get on with their lives.

California needs to return to the monopoly of dictating minimum rates.

1 comment:

  1. Nope - there is no such thing as the 'good old days'. In the 1930's all rural households had no electricity and used outhouses. A 1956 Oldsmobile wasn't a beautiful car - it was a piece of shit by today's standards. The steering wheel was that big because we needed the leverage to turn the car. If you could get the car going 55 mph (and I'm not saying you could) slamming on the brakes would take a football field to stop.

    Stop whining for the 'good old days' - there weren't any. The average number of indemnity claims per 1,000 workers is the lowest it has ever been - by about 70%. The average cost of an indemnity claim (93% of all costs) is the lowest it has ever been - adjusted for inflation.

    How the hell did we stand by and let costs go down by over 68% between 2004 and 2009 - with a combined loss ratio of less than 60%. Then watch the premiums go up by 60%? Are we really all that stupid?

    We all stand by and wait for the WCIRB to tell us what the numbers ought to be - increase or decrease. And, we forget - the WCIRB is the carriers.

    So, lets all grow up and grow a pair. We've all been 'drinking the cool aid'.

    I understand that carriers all deserve a profit based on the capital they commit to insure us. But - come on, how much money are they entitled to?

    I'm just saying - that's my opinion and it ought to be yours.