California Workers' Compensation open rating.

For the first time in over 80 years, open competition will come to the California Workers' Compensation insurance market. As part of the 1993 Workers' Compensation reform, insurance codes that regulated rates and mandated the Minimum Rate Law were repealed. Many analysts and industry insiders predict the premium volume could drop from a 1993 high of $9 billion to $5.5-$6 billion in the next 2 years.

The Competitive Rate Law in California will be unlike any other, and its implications for employers, while still speculative, should be quite favorable across most industry groups and employer sizes. Early quotations for January 1, 1995 renewals already show reductions of 25% to 50% over the expiring rates controlled by the Minimum Rate Law.

Background

A substantial decrease in loss payments to injured workers that peaked at $7 billion in 1991 and then fell to $4.6 billion in 1993 spurred California's shift to competitive rating. The dramatic decrease is attributed to recent legislative reforms, anti-fraud efforts, and a recessionary economy where workers may have been reluctant to report and pursue Workers' Compensation claims.

The California environment leading to open rating has been so favorable that the Insurance Commissioner's office has mandated reductions of approximately 35% over the last 18 months. Insurance companies are expected to lower rates even more due to the expected competition under open rating.

The Insurance Commissioner's New Role

The Department of Insurance and the new Insurance Commissioner will find the authority to regulate rates severely restricted under open rating. Their authority will be limited to: requiring all insurers to file Workers' Compensation rates; prohibiting rates that threaten an insurer's solvency or could create a monopoly (20% or more of the California premium excluding the State Fund); and opposing any classification system or rate which includes arbitrary economic discrimination.

The Insurance Commissioner's primary role will be assuring solvency of individual carriers. Ironically, this will mean asking insurers to raise their rates, whereas the past focus has been more consumer driven in enforcing rate reductions.

What Will Insurers Do?

Insurers already are beginning to file their own rates, with up to 69 filings made as of December 1. Dividends will play a very limited role compared to the past. When insurers file their rates, they may put in small loads for underwriting contingencies. Under open rating, employers will receive their dividends "up front" in the form of reduced standard premiums that reflect an insurer's expectation of losses. Employers will be demanding better insurance prices and they won't want to wait 18 months to 5 years to see if some money will be coming back. Other plans such as guaranteed cost, incurred loss, and paid loss retros will still be available.

Impact of Deductibles

Deductibles will be allowed for the first time in California as of January 1, 1995. The Workers' Compensation Insurance Rating Bureau came up with an advisory deductible program of $500,000. Insurers can adopt the advisory program or develop deductibles of their own. The market will determine what level deductibles will go down, as well as premium discounts, and the size of deductibles offered. Deductibles are a mandatory offering in Texas where they go as low as $1,000. Many industry insiders doubt they will drop to that level in California.

A recently passed deductible bill in California requires the Department of Insurance to advise on security requirements for deductible plans. The security remains advisory and not mandatory, and carriers may take on a credit risk without collateral. But it is unlikely many carriers will pursue unsecured programs aggressively, since that would bring them under Department of Insurance scrutiny and solvency oversight.

Self-Insureds Return to the Market

Many self-insured employers are reexamining the insurance market, led by those who are unhappy with self-insurance and stringent collateral requirements. Several carriers are designing self-insurance buyout products to ease the transition from self-insurance. These should make insurance more attractive in strategic situations such as spinning off a subsidiary, considering a merger, or emerging from bankruptcy.

Employers with successful loss control programs will find California's open rating environment extremely appealing. Underwriters will be focusing on safety and health, early return to work, medical cost containment, and an overall safety culture when they pursue new clients.

Employer's need to scrutinize services and flexibility. Since the primary change under California's open rating system is that losses will drive premium now and in the future, employers should look for brokers and insurers who can help control the losses.

Looking at the Future

Insurer competition for desirable accounts will be fierce. Some experts are concerned this will create tremendous market volatility over the next 3-4 years when underwriters discover they are underpricing their Workers' Compensation product. This could be exacerbated by a higher frequency of claims as the California economy heats up.

In an effort to gain business, carriers will reduce expenses to offer the most competitive quotes, which may cut into their loss control and claim handling services. This will only hurt their customers in the long run, so it's very important for employers to know what service commitments they're getting.

Broker/consultant services will be needed to fill the service gap. The trend will be toward more unbundled services, where employers choose the best vendor to administer claims, loss control, and cost containment programs.

Open rating will be a markedly different culture for Workers Compensation. Under the Minimum Rate Law, it has been quiet -- with well-known landmarks; now we are going into unchartered waters.

David Fuhrman is vice president of Johnson & Higgins, located in Century City.