On the mend: insurers and employers wait for workers' compensation reform in California to reduce their costs.

Many California employers And insurers are anxious to see whether newly enacted reforms will cure what ails that state's workers' compensation insurance system.

The California Legislature late in 2003 and again in April 2004 passed major reform measures designed to stabilize prices and eliminate waste and delay.

For the past several years, many California employers, facing premiums that were more than twice the national average, left the state headed for more business friendly climates.

Since 2000, these employers saw their workers' compensation premiums jump more than 130%. So many private insurers have ceased writing workers' compensation business in California that the State Compensation Insurance Fund of California, the "insurer of last resort," presently provides coverage to more than half of California's businesses. The State Fund reported net income of $712.4 million in 2003, but realized net losses in 2002, 2000 and 1999.

The problems facing California's workers' comp market date back at least 10 years. Among the factors to consider are a succession of elected insurance commissioners, beginning with Commissioner John Garamendi, since the position became a statewide elected office in 1991. Prior to that time, commissioners were appointed by the governor and tended to have extensive experience in insurance regulation. Since 1991, the position has attracted some of California's most ambitious politicians, many with no insurance regulatory expertise.

In 1994, during Garamendi's first term, the California Legislature, faced with complaints from employers that rates were too high, deregulated pricing on workers' compensation insurance. The goal was to promote competition, with the objective of lowering rates. The idea was that the public need not worry that overly zealous competition might lead to unrealistic price-cutting and eventual insolvencies, because the Department of Insurance and its financial surveillance bureau remained responsible for ensuring the financial solvency of insurers writing romp business in the state.

A price war among California workers' romp writers ensued, with much of the business reinsured into the then-soft reinsurance market. With open rating, premiums dropped dramatically, as insurers undercut each other in an attempt to corner the market. The war for market share claimed several casualties, major players who were declared insolvent or left the state. The roster of big market-share companies that were taken over by the state includes Superior National, Reliance Insurance Group, Fremont General, Golden Eagle Insurance Co. and Paula Insurance.

A 1993 law changed the presumptions applicable to the medical opinion and treatment recommendations of the treating physician chosen by the injured worker in a romp case. As a result of the change in law, it became extremely difficult for an employer, or the insurer representing that employer, to challenge the treating physician's decision as to the nature and extent of necessary care. This change, often referred to by the name of the first case enforcing the law (in 1996) as "the Minniear presumption," led directly to significantly higher medical costs for employers and their insurers.

Propelled by these events, medical costs skyrocketed in the late 1990s on policies that had been poorly priced in the first place; many insurers exited the state, often leaving employers to turn to the State Fund and to pay more than their peers in any other state to insure their workers. Before the open-rating era, the State Fund had about 20% of the market. By 2003, that market share had exceeded 50%.

Other factors that were instrumental in continuing cost increases include the availability of new medical treatments and liberal benefit packages. Employees have become more proactive in their medical treatment, asking to receive highly publicized treatments and prescription drugs. After Minniear, the treating physicians were not constrained from providing these treatments and drugs--not even by the reasonable possibility of a second opinion by a neutral physician. And, until the recent reforms, California workers enjoyed services from a wide array of providers--including virtually unlimited chiropractic visits, and such alternative medicine as acupuncture.

Late 2003 Reforms

By late 2003, the state of the workers' compensation system in California had become one of the issues driving the campaign to recall then-Gov. Gray Davis. As the recall vote that ultimately put Arnold Schwarzenegger into office loomed, the California Legislature passed two fairly limited reform bills, neither of which took on such major cost drivers as the Minniear presumption.

Assembly Bill 227 mandated the following changes to the handling of California workers' compensation claims:

* Authorized the California Insurance Guarantee Association to finance the costs of claims for insolvent workers' comp insurers by issuing bonds.

* Increased the maximum penalty for insurance fraud from $50,000 or twice the amount of the fraud, whichever is greater, to $150,000 or twice the amount of the fraud, whichever is greater.

* Provided that the State Fund is exempt from any hiring freezes and staff cutbacks otherwise required by law.

* Replaced the costly "vocational rehabilitation" system then in place with a "supplemental job displacement benefit" (i.e., educational voucher) if the worker was unable to return to work within 60 days of termination of temporary disability. (Subsequently, this significant reform was eliminated in 2004.)

Senate Bill 228 mandated the following changes to the handling of California Workers' Compensations claims:

* Made it unlawful for a physician to refer someone to outpatient surgery (or for medical goods or services) if the medical professional's immediate family has a financial interest in the referral.

* Required the administrative director to adopt specified protocols, if applicable, concerning medical billing and provider fraud; required certain parties to report claims believed to be fraudulent to the administrative director in accordance with these procedures.

* Required pharmacies to provide generic drugs unless otherwise specified by the prescribing physician or a generic equivalent is not available.

* Established procedures to be followed when an employer objects to a treating physician's recommendation for spinal surgery, and revised the Minniear presumption on that issue only.

* Established fee caps that stem from the structure and rules of the Medicare and Medi-Cal systems (that is, maximum reasonable tees for certain classes of services shall not exceed 120% of what Medi-Cal would pay for the same classes of services).

* Replaced an official medical Ice schedule that establishes reasonable maximum lees for medical services provided with a "medical treatment utilization schedule" for services, drugs, fees, and goods, other than physician services, which would eliminate some of the doctor's discretion. The utilization schedule creates a rebuttable presumption that it is correct with regard to the treatment necessary for a worker's injuries.

* Limited the number of chiropractic and physical therapy visits an injured worker may utilize, for injuries that occurred after Dec. 31,2003.

After he was elected governor, Schwarzenegger, who had criticized the 2003 reforms as not going far enough, announced his own reform plan.

Schwarzenegger's Reforms

In April 2004--a mere six months after the 2003 reforms became effective--the California Legislature approved more comprehensive reforms of the system that are estimated to result in 25% to 30% reduction in the cost of workers' compensation coverage.

Changes mandated by Senate Bill 899 include:

* Repealing the Minniear presumption of correctness concerning the extent and scope of medical treatment when an employee is treated by that individual's personal physician, even if the physician was designated prior to the date of the employee's injury.

* Limiting circumstances under which an employee may predesignate a personal physician to treat injuries.

* Requiring procedures governing the determination of any disputed medical treatment be consistent with standards to be used in connection with the new medical treatment utilization schedule adopted under the prior reforms.

* Authorizing reimbursements in accordance with the Return-to-Work Program to employers for workplace modification expenses only, and eliminating reimbursements for the payment of wages and premiums.

* Re-enacting the vocational rehabilitation system, that was repealed as of Jan. 1, 2004, but only for injuries sustained before Jan. 1,2004.

* Eliminating the rights of employees to bring civil actions to recover penalties in connection with the workers' compensation provisions of the California Code.

* Requiring the utilization schedule adopted under the 2003 reforms to reflect practices that are evidence and scientifically based, nationally recognized, and peer-reviewed.

* Limiting the employee to 24 occupational therapy visits per industrial injury.

* Establishing an independent medical review process for resolving disputes concerning whether the treatment is medically necessary.

The most important aspects of Schwarzenegger's plan may turn out to be the complete repeal of the Minniear presumption of correctness on the part of the treating physician and limiting the number of chiropractic treatments.

A Broader View

Other states faced and still face similar problems with their workers' compensation systems. The state of Connecticut underwent its own workers' compensation crisis in the 1990s and made some material changes that appear to be driving costs down. One change that seems to be working is Connecticut's boost to the informal arbitration system between employers and employees. The result is that nearly 90% of comp cases are now in alternative dispute resolution. Connecticut also increased the number of administrative judges who are able to hear appeals, beneficial to both employers and employees.

Florida underwent its own major legislative overhaul in 2003. Targeting fraud and excessive and costly litigation, the Florida reforms led to a reported 14% rollback in workers' comp rates ($420 million in premiums). Florida provided additional prosecutors and harsher penalties for those convicted of fraud; for example, a false report became a second-degree felony. The reforms also changed attorneys' fees from an hourly rate to a sliding percentage of the benefit obtained (for example, 20% of first $5,000; 15% of next $5,000). The Florida claimants' attorneys are likely to challenge the new laws, arguing that capped attorneys' tees are hurting employees because lawyers for insurance companies have no cap and the companies will always have the upper hand.

New York's workers' comp system costs 20% more than the national average, and the last wave of reforms was passed in 1996. On March 23, 2004, New York Gov. George Pataki announced a workers' compensation reform plan, which he expects will decrease costs by 15% while increasing benefits by 25%.

Pataki's plan will, among other things:

* Expand the state's permanent partial disability benefits schedule to include more injuries;

* Increase maximum weekly indemnity benefits from $400 to $500, phased in over lour years (this is the first increase in benefits in a decade in New York);

* Authorize a fee schedule for comprehensive durable medical goods and pharmaceuticals (New York would be the 24th state to implement a pharmaceutical tee schedule);

* Increase the use of ADR; and

* Create a cap on the number of allowed payments (250-500 weeks).

Unless this last point is a major cost saver for New York, it is difficult to see how this plan will accomplish the stated goals.

Tennessee is among the nine states that do not cap medicine and service fees for workers' comp. Further, Tennessee and Alabama are the only states whose workers' comp systems rely on courts (as opposed to an administrative agency) to administer their workers' compensation systems. In Tennessee, a judge determines benefit entitlements by rating injuries. Many have complained that the system that allows judges to decide workers' fates leads to inconsistent verdicts. Tennessee's goal is to replace the court-based system with an administrative process--similar to what is in California and New York.

In March 2004, the Tennessee Legislature proposed creating a fee schedule for doctors; however, the proposal has been met with opposition by doctors who say fewer doctors will care for workers' comp patients and patients will suffer as a result.

Tennessee employers complain that comp rates in Tennessee are increasing faster than in surrounding states. These rates have reportedly tripled since 1999. (The average medical payment per claim in Tennessee is $7,218, which was second only to Texas [$8,048] in a 15-state study). Tennessee's governor recently declared that fixing the workers" compensation system in his state is a "priority," but no comprehensive plan has been forthcoming.

Texas is on the brink of its own workers' comp crisis, where it is predicted that workers' comp will be a primary issue in 2008. In Texas, employees choose their own treating physicians. A 2001 study found that individuals who choose their own doctors cost the system six times more than those who don't. Consequently, Texas employers would like to direct employees into group health plans, and attempted to propose legislation in 2003, but failed to do so.

California is a bellwether for other states on the brink of workers' comp crises. In charting their own courses, these states benefit from examining the likely results of California's workers' comp reform initiatives of 2003 and 2004.

State Compensation Insurance Fund of California

California's state-run insurer of last resort for worker's
compensation had 53% of the market in 2003.

Expense Ration

1999     22.4
2000     19.3
2001     17.8
2002     17.8
2003     15.6

Operating Ratio

1999    109.5
2000    105.7
2001    103.4
2002    107.8
2003     92.0

Combined Ratio

1999    146.1
2000    133.1
2001    117.9
2002    117.9
2003     99.0

Note: Table made from line graph.

Source: 2004 Best's Statement File

Net Income

($Thousands)

1999    -$112,301
2000     -$88,201
2001    -$110,470
2002     -$66,106
2003    -$712,394

Note: Table made from bar graph.

Source: 2004 Best's Statement File

Key Points

* California's new rules governing workers' compensation benefits are designed to significantly curtail insurance claims.

* The reforms address issues that caused several leading writers to leave the state and may bring insurers back into that market, which is the largest in the United States.

* California's reform plan may help other states facing similar cost control concerns to craft reform initiatives.

Learn More

State Compensation Insurance Fund of California

A.M. Best Company #: 04028

Distribution: independent agents, direct

For ratings and other financial strength information about these companies, visit www.ambest.com

Linda Dakin-Grimm is a partner in the Los Angeles office of the law firm of Milbank where she beads the firm's Reinsurance Department. Benjamin Valerio is a senior associate in the department.