Study: Workers’ Compensation Public Options Outperform Private Industry

State funds blunt the impact of bigger losses through concerted loss prevention efforts.

An insurance industry think tank has concluded that 25 public and quasi-public workers’ compensation insurance plans perform better financially than the private market in a number of performance categories and at least as well when it comes to the bottom line.

The so-called state funds, typically operating in a single state and driven less by the need to show a profit, also are effective at preventing losses, improving safety at workplaces and contributing to economic development in their states, according to the report by Conning Research and Consulting, which counts state funds among its clients.

Without disclosing actual ratios and numbers behind the conclusions, the study’s author says the research found that while public workers’ comp providers tend to have higher losses than the workers’ compensation insurance industry as a whole, they more than offset those losses with lower expenses, higher investment returns, bigger dividends to employers and better injury prevention efforts.

The report further concluded that through more stable reserves and superior investment income, state funds have managed to achieve operating income on a par with that of the workers’ compensation industry as a whole.

The study looked at the combined experience of workers’ compensation options in Arizona, California, Colorado, Hawaii, Idaho, Kentucky, Louisiana, Maine, Maryland, Minnesota, Missouri, Montana, New Mexico, New York, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, Texas, Utah, Washington State, West Virginia and Wyoming.

Four states (North Dakota, Ohio, Washington and Wyoming) have monopolistic funds that are employers’ only option for buying coverage. The remaining 21 states have organizations that compete with private insurers. The competitive state funds often act as markets of last resort, providing coverage for high risk or other businesses that can’t obtain it in the private market.

These public and quasi-public workers’ compensation funds specialize in writing insurance in a single state, although some have even branched out into other territories.

Performance, Market Share

The country’s 25 state workers’ compensation state funds have not only performed well but have also achieved a significant share — 25 percent — of the nation’s overall insured workers’ compensation market, and appear to be growing in many states, according Conning.

“Workers’ compensation state funds now control a quarter of the insured workers’ compensation market, despite the fact that they only write in 25 states,” said Mark Jablonowski, analyst at Conning and author of the study, “Workers’ Compensation State Funds: Evolution of a Competitive Force.”

Jablonowski said the findings show that public insurance options, which he prefers to call “private/public interfaces,” do work, depending upon how they are structured, and that the public and private sectors can learn from each other. “It’s an argument not to fear public options if they’re properly structured. You have a definite case here where you’ve got … these companies that operate independently within the states and are mandated in most cases to operate on their own, in other words, to not dip into state funds. So, there are lessons to be learned on both sides. But obviously it indicates that there is such a thing as an effective public/private interface, absolutely. The devil is in the details: How are you going to structure it?”

Loss Prevention and Control

State funds are not only operating well financially but also are contributing to injury prevention and safer workplaces.

“While state funds have strong financial results, there is more to the story of their successful growth,” said Stephan Christiansen, director of research at Conning. “Our research indicates that a key to the state fund success may well be their dedicated approach to loss prevention and control. Their mission often includes shared responsibility for health and safety with other state agencies, and so they often incorporate state-of-the-art loss prevention initiatives with financial rewards tied to the insured’s loss performance.”

State funds typically have to pay more losses from every premium dollar than private industry. But Jablonowski says this is not necessarily a negative indicator.

“[A] high loss ratio doesn’t mean that somebody is doing something wrong. It really places the emphasis on the combined [losses plus expenses] and, ultimately, the operating ratio,” he told Insurance Journal.

He said despite their higher loss ratios, state funds are able to still make money. Spurred by their mission to improve safety, state funds blunt the impact of bigger losses through concerted loss prevention efforts. As Jablonowski put it, “They are able to convert the marginal and poor risk into something better.”

The public providers offer employers significantly higher dividends, which provide an incentive for businesses to adopt safety measures. These dividends can also create a competitive advantage and build customer loyalty, according to the study.

Jablonowski said private carriers are also involved in loss prevention but the “big secret” is that every state fund is doing it.

“When you look at the entire insurance world, there are obviously insurance companies in the private world that do a great job of loss prevention control,” he said. “But the unique thing about funds is that they all do it. Twenty-five of them and they all do it. So it’s not a random sample; it’s a sample that suggests that this group puts an emphasis on loss prevention control.”

This emphasis on loss prevention might be one of the lessons private insurers can learn from the public sector. “That is, maybe going back to basics, trying to link financial performance to health and safety performance. That’s what the old-timers like myself grew up on, and I think that is becoming somewhat of a lost art in the private world, and could cause long-term issues,” said Jablonowski.

“When you’ve got a state fund that writes half the business in the state, or 20 or 30 percent, it is a major writer in the state, they’ve got to be doing something right,” he said.

The State Compensation Insurance Fund in California writes about 22 percent of that state’s insured market. The company finished 2008 with $1.66 billion in earned premium, compared to $2.27 billion in 2007. The New York State Insurance Fund, which last month celebrated its 95th anniverary, handles $1.35 billion in premium or 41 percent of the market. In 2008, Texas Mutual wrote $768.3 million in premiums, about a 25 percent market share.

As private insurers that compete with the public options are quick to point out, state funds are able to operate with lower expenses because most do not pay taxes or licensing fees.

But Jablonowski said these exemptions, while contributing to lower expenses, are not a major factor and do not explain why state funds do so well. More significant are the efficiencies state funds realize through their widespread use of technology and their coordination of loss prevention, safety and health efforts with other state agencies.

While many private insurers also effectively employ technology, with state funds, “almost all of them are very savvy to the electronic world,” he said.

State funds’ expense ratios are also helped because they often have government partners to assist them in their loss prevention efforts and thereby absorb some of these costs that private carriers have.

“[A] lot of these funds rely on the state to provide ancillary services, like loss prevention, claims management, etc. Most of them, for example, work very closely with state occupational safety and health associations,” Jablonowski said.

Business acquisition costs, including agent commissions, of state funds were found to be about the same as those of private industry.

Competitive Pressures

Jablonowski said state funds’ reserving practices could be more stable because they might be less influenced by competitive pressures than those of private carriers.

“Private companies are under tremendous pressure to perform. And that means they’re going to be subject to the underwriting cycle. And the underwriting cycle a lot of times causality is disputable, but it’s not disputable the fact that reserves tend to move with the underwriting cycle. So when you see that, when you have those kind of competitive pressures that cause the underwriting cycles, you’re going to see the effect on reserves,” he said. “I think state funds are, to some extent, isolated from that shareholder pressure to earn more and more and more and be aggressive in the market and maintain market share and all this stuff.”

He declined to explain why they have better investment returns, noting that Conning has state fund clients that it advises on their investments.

Jablonowski would not share the actual loss, expense and bottom line numbers for the 25 state funds from his firm’s report — that’s the research information Conning developed and sells. But the report suggests that the state funds beat industry benchmarks reported elsewhere.

According to the National Council on Compensation Insurance (NCCI), which collects financial data and prepares rate filings on behalf of workers’ compensation carriers in 38 states, the private workers’ compensation calendar year combined ratio was 101 in 2008, which was unchanged from what it was in 2007.

A.M. Best’s workers’ compensation composite, which consists of 103 workers’ compensation insurer groups and unaffiliated single companies including state funds, had combined ratios of 110.8 in 2008 and 106.5 in 2007.

Most states require businesses to carry workers’ compensation coverage, with Texas being a significant exception. Workers’ compensation benefits cover medical care and lost wages for employees who are injured on the job.

Conning provides asset management and insurance industry research and consulting services to insurers and state funds. Until recently, it was indirectly owned by insurer Swiss Re. Its acquisition by private equity firm Aquiline Capital Partners LLC, which is run by Jeffrey Greenberg, was finalized in October.