Danger signs in workers’ comp, a Viewpoint

With all the attention focused on that other recently deregulated market in California, electricity, it’s important to talk a bit about clear and present danger in the market that did it first,workers’ compensation insurance.

Back in 1995, California’s workers’ comp market shed its 75-year-old “minimum rate law” and went head over heels into the great unknown of competitive pricing for workers’ comp insurance.

With California having the most expensive system in the nation at that time and one of the lowest rankings when it came to disabled worker benefits, it was pretty clear what would happen. And it did: Employer premiums dropped on average 34% in the first three years of deregulation. Carrier profits, which were “generous” under the minimum rate law, settled down to something more normal and everything looked good, for a while.

Premium reductions should have stopped a couple of years ago, owing to adverse loss projections, and carriers should have begun squirreling away reserves against those future claims by slowly raising premiums. But they didn’t. Why? Utter stupidity is a possibility, but more than likely it was the quest to maintain or even grow market share: Those companies which could afford to take the losses would drive out the weak competitors and position themselves to reap the benefits of a future oligopolistic market,textbook economics in action.

At about this time a year ago, before any “hardening” of the market had taken place, it was estimated that the workers’ comp system in California was approximately $3.0 billion under-reserved. Now, with prices finally rising by something approaching the 18.4% recommended by the Workers’ Compensation Insurance Rating Bureau and approved by the infamous Commissioner “Quack,” system reserves are now estimated to be $4.7 billion below where they should be.

For 1999, carriers spent 43% more paying losses and covering operating expenses than they took in by way of premiums. A good bond market helped bolster returns on invested reserves, but not enough to offset a horrible cash flow problem. It is going to take some time to catch up.

There’s an interesting parallel here to the situation we presently face in the electricity market, where the wholesale cost to the utilities is running at close to 100% above the price they can charge to consumers under temporary pricing restraints. To date, SCE and PG