Thursday, July 21, 2011

Pendulum Swinging Can be Stopped - Get Rid of Open Rating

The California Coalition on Workers' Compensation (CWCC) began its 9th Annual Educational Conference yesterday, and according to a WorkCompCentral News story, speakers were telling attendees to brace for new "reform" legislation in the next couple of years as Democrats take more hold of the state's politics, injured workers gain increased benefits, rates increase and medical costs continue unmitigated.

Speakers advised that California is rapidly climbing to top status, again, as the most expensive workers' compensation state and that the average indemnity claim now costs upwards of $60,000 with combined ratios nearing 130.

Anyone who has been in this industry more than 10 years will recognize the characteristics that make this system untenable and wildly unpredictable: complaints of costs, special interest maneuvering, attempts at surgical correction, restatement of costs based on said correction, quiet solicitude for about 4 years while the surgical correction develops scarring tissue, re-initiation of complaints of costs as the scarring starts to hurt then protest and "reform".

However, since 1992, the pendulum has been swinging more wildly and to greater extremes.

Missing from the pendulum debate is, what I believe, the single ultimate "reform" item that initiated the wild physics of the workers' compensation cycle in California, and that is "open rating".

Prior to 1992 California floor rates were set by the Department of Insurance (DOI). DOI was responsible for ensuring that the market for work comp insurance remained vital and vibrant by reviewing system costs and establishing the bare minimum rates that any carrier could establish premiums on. Carriers could charge more, but not less, than the rate established by DOI.

The effect of this system was that carriers competed on claims servicing because since no one could under price the competition the way to keep costs down was to ensure a high level of claims servicing so that the experience modification factor (x-mod) would not be adversely affected, thus keeping long term premiums down.

The market effect of this system was a very robust market for workers' compensation insurance with many small specialty insurers covering highly technical risks and using that special knowledge to manage safety and claims most efficiently.

Starting with 1993, the effective start date of "open rating", things got wild. Price competition blew away half of the capacity in California, and while employers enjoyed record low premiums for several years, the cat got out of the bag around 2000 when capacity dried up, supply became scarce, and premiums skyrocketed at hyper-inflationary rates nearing 50% annually.

I have observed as well a much more dramatic swinging of the pendulum in our industry and that has begat increased legislative and regulatory burden impacting all system participants. We now have a mind-numbingly complex system with networks, exceptions, presumptions, etc. that is nearly impossible to navigate with out special expertise.

In addition we are seeing market contraction with large carriers stating that they are not interested, again, in writing California business because the risks are just too difficult to gauge to ensure some profitability.

While prices are climbing, premiums will again skyrocket as supply diminishes, and since demand is constant because work comp is mandatory, prices can only go up.

As the debate for more "reform" starts heating up, I urge those shaping the dialogue to go back to 1992 and return to a rate floor.

I'm an open market type of guy - I like market competition. But it only works where there truly is a market. Where the market is the product of a legal mandate it is not open, and must be highly regulated. That is workers' compensation. I think the proof is in the history - yes we had swings in workers' compensation prior to "open rating" but since then the swings have become perilously uncontrollable.


  1. I might add that the combination of open rating AND an elected Insurance Commissioner took the brakes off a relatively stable system and introduced a high level of volatility. Neither Quackenbush nor Garamendi did much to calm the excesses that the new system generated.
    the immediacy of a future political office makes it too difficult for the commissioner to do what is right for the long term benefit of california.

  2. Agreed Smack - an elected Insurance Commissioner does the industry or the people of the state no good in my opinion. It has just become a launch pad for gubernatorial endeavors.