Report: Calif. Workers’ Comp Insurance Market Still Needs Improvement

California workers’ compensation claims and disability costs have dropped significantly since the state’s workers’ compensation system was overhauled in 2003 and 2004. Yet “many of the same incentives, institutions and regulatory practices that contributed to the market volatility and insurance insolvencies during the past 15 years remain in place,” according to a recent study by RAND Corp.

Among the key factors that drove the unpredictable market and led to insolvencies were inaccurate claims-cost projections; policies priced below projected costs; poorly aligned incentives with reinsurers and managing general agents; inadequate reserves to cover claim costs; and inadequate policyholder surplus, researchers found.

The California Commission on Health and Safety and Workers’ Compensation asked RAND Corp. and Navigant Consulting researchers to identify factors that contributed to dramatic workers’ comp insurance market swings, since insurance rates were partially deregulated in 1995. The researchers said the cost of workers’ comp claims rose significantly between 1995 and 2002, for reasons “that had little to do with price deregulation.”

Because insurers did not accurately estimate future claims costs, insurers priced policies too low and collected insufficient revenue to cover future claims payments, the researchers said. They suggested that the California legislature could help to reduce uncertainty about the likely impacts of legislative reforms in the future by writing legislation with more explicit language and providing the Workers’ Compensation Insurance Rating Bureau with more comprehensive data on workers’ comp claims.

Additionally, researchers suggested that the Department of Insurance implement more pricing discipline, and make more information available to the public, such as WCIRB reports that describe the ratio of charged rates to projected claim costs for each insurer.

In the second half of the 1990s, insurers charged prices “that were below the already low projections of claim costs, further reducing revenue below future claim costs.” This contributed to the surge in insurer insolvencies, according to the report. Instead, surcharges could be placed on brokers who place policies with insurers that subsequently become insolvent, the researchers recommended.

At least some of the insurer insolvencies in the 1990s were a result of problems with reinsurance arrangements that created incentives for insurers to relax underwriting standards, reduce prices and passively process claims, the report indicated. Consequently, the authors recommended assessing the adequacy of the requirement that insurers retain at least 10 percent of the risk in a reinsurance transaction and broadening the legal definition of a MGA “so that firms that take on the insurance functions of an insurer cannot avoid being classified as an MGA and avoid regulations already in place on MGAs.”

To further prevent insolvencies and reserve deficiencies, researchers suggested the CDI consider appointing actuaries and charging insurers for the actuarial reports, to avoid the conflict when insurers are responsible for hiring their own actuaries to certify that their reserves are reasonable. The report also indicated the CDI might want to review how it prioritizes insurer financial examinations and mandatory triggers for the exams.

Finally, the report noted that the National Association of Insurance Commissioner’s risk-based capital system — which specifies how much capital an insurer should hold and what regulatory actions should be taken if the surplus falls below the target — should be improved.

“The RBC system would have been of little help in averting the insolvencies that occurred following open rating,” the report said. Consequently, the CDI and NAIC should examine the pros and cons of having more stringent targets for policyholder surplus and “modify the RBC system to better reflect the risks faced by insurers whose business is concentrated in states with a difficult workers’ compensation market,” the report noted.

For more information on the author’s suggestions on how to reduce workers’ comp market volatility and insurer insolvencies while maintaining the benefits of competition, visit www.rand.org.