State workers’ comp funds are a growing part of the market and can expect the same gloomy outlook for the remainder of 2010 as their private counterparts, workers’ comp analysts and state fund experts say. Even as their premiums shrink and better risks look for greener pastures, cash-strapped state legislatures look hungrily at these carriers as a source of quick cash.

State funds, especially California’s State Compensation Insurance Fund (SCIF), are grappling with increasing medical costs, frequency and legal uncertainty. The economy is a wildcard. The bulk of a state fund book is small business, a segment that has a harder time absorbing hits to profit and payroll.

It’s no longer a question of if there will be a hard market but when. Modest rate increases still need time to work their way through the system and boost premium, analysts say. State fund small-business accounts concentrate in specific industries, and when those recover, so will the fortunes of state funds.

 Some state fund executives say the new health care law will present challenges and maybe even opportunities for them.

“I think the largest thing right now, what we’re waiting for is what the [impact] health care reforms are going to have on the overall workers’ comp market,” says Michelle Baurkot, assistant vice president of A.M. Best Company.

One possibility that analysts and state fund executives toss around is the prospect of a healthier workforce, although nothing indicates that taking a big step toward national health care will somehow result in better health care outcomes. The assumption is that healthier workers who get injured will have less lost time.

 “This line has definitely benefited in earlier years from reform measures, particularly in California and Florida. Now the opposite is happening. We’re seeing deterioration.”
—Michelle Baurkot, A.M. Best

State funds are not immune from current market conditions felt by their private counterparts. They comprise 25% of the market share, with SCIF and the New York State Insurance Fund sixth- and seventh-largest carriers in the country, respectively.

State funds that operate in only one state will be affected by whatever legislative or regulatory changes happen in that state. Baurkot says Best is keeping a close eye on states with mandated rating schemes or, as in California, legal challenges to permanent partial disability, and costly impacts from Medicare set-asides.

Best currently rates seven state funds. Best last rated SCIF in 2002 after it suffered a downgrade to B- and asked not to be rated anymore. Baurkot says Best’s view of the workers’ comp market is “definitely not positive.” One of the main drivers is the economy, which results in lower payroll and more decreased exposures.

“This line has definitely benefited in earlier years from reform measures, particularly in California and Florida. Now the opposite is happening. We’re seeing deterioration,” Baurkot says, adding that premium levels have plummeted in the past two and half years because of reduced pricing and ongoing competition. In the past 18 months, the economy has had the biggest impact.

Baurkot notes deterioration in both loss and expense ratios, with rates going so low there is very little, if any, profit margin. In a state such as California, rates are declining faster than loss cost and outpacing the benefit of workers’ comp reforms.

“The workers’ comp state fund market is not insulated from the same things that are happening in the traditional carriers. We’re seeing very similar results in terms of performance measures,” Baurkot says. “For state funds that have a large market presence, competition is coming in and really decreasing market share, so [for] some of those risks that may not have been attractive in earlier periods, [companies say] maybe we can write this.”

Baurkot says that most state funds that Best rates have strong capital positions, which makes up a little for their high expense ratios.

Privatization and Sales

 “State funds tend to be a very tempting target for trying to balance the budget.”
—Sean Carr,
A.M. Best

A few states have taken steps toward privatizing their state funds. Arizona’s governor recently signed a bill to privatize Arizona’s state fund, SCF Arizona, by 2013. In addition, some states trying to balance budgets have viewed state funds as giant piggy banks to be broken open either through privatization or sale of a substantial book of business.

“A lot of state funds have higher levels of reserves than their private counterparts, and a lot of states are dealing with cash-strapped budgets,” says Sean Carr, senior associate editor at Best. “State funds tend to be a very tempting target for trying to balance the budget.”

California Governor Arnold Schwarzenegger tried to use SCIF to plug a budget hole last year by proposing to sell $1 billion of its book of business. Insurance Commissioner Steve Poizner filed suit to stop the sale. With no court date set, this scheme does nothing to fix the budget.

Carr points out that the Colorado legislature tried to do something similar and remove $500 million in reserves from Pinnacol Assurance, Colorado’s state fund. The solicitor general smacked it down. “It wasn’t their money,” Carr says. It belongs to the policyholders, and industry experts argue that the same holds true for the premium collected by California’s SCIF.

Carr says other privatization attempts in Oklahoma fell short but that supporters will take another bite.

When Will It Turn?

Most states have competitive state funds in some form, and most of their policyholders are small businesses. Some 92% of SCIF’s book is small business, defined as premium of $25,000 or less, according to a SCIF spokeswoman.

“When looking at competitiveness, [state funds] are doing something right, probably related to product, price, place, promotion and people,” says Kevin McCarthy, vice president of Risk Metrics Corporation. “They’re insuring a larger share of the small-business market, and the competitors that often come in there are the Hartfords, the CNAs, the Travelers…If we’re driven out of this recession by small-business spending and expansion, state funds will be some of the first and largest players to profit from it.”

 If we’re driven out of this recession by small-business spending and expansion, state funds will be some of the first and largest players to profit from it.”
—Kevin McCarthy, Risk Metrics Corporation

McCarthy tells Workers’ Comp Executive that, based on his policy research, state fund market share starts dropping off after 100-plus employers. “We haven’t seen anyone rushing to leave state funds, [but] the benefit of big carriers is they can write multiple lines, write a more competitive product,” McCarthy says.

Presidents of state funds say they’re trying to help their policyholders control their own destiny.

“The idea of writing a check, and getting a policy and standing back and saying, ‘You folks go handle it and keep my losses down,’ many of us in the business, we don’t necessarily want to hear that type of discussion,” says Roger Fries, president and CEO of Kentucky Employers Mutual Insurance Company (KEMI).

Fries adds that KEMI wants to educate policyholders on what they can do to keep their costs down in return-to-work and drug testing. “We’ve been very successful with some of the wellness programs we’ve put in place. The industry itself is working much closer with its policyholders to explain to them where they can really cut costs and save money,” he says.

John Leonard, president and CEO of Maine Employers Mutual Insurance Company, says quality of care for injured workers has increased dramatically in the past 20 years, but the bad news is that the costs are going up commensurately with treatment, especially medication costs.

“You have continued growth in the use of pharmaceuticals. That is becoming a costly issue for the insurance industry,” Leonard says. “There is particular emphasis on the use of pain medication for even mild or moderately injured workers. This is an area of cost containment that needs additional concentration.”

KEMI’s Fries says a shift in the soft market and an increase in premiums depend on how quickly payrolls pick up. He says his main concern is underwriting discipline and emphasis on price, and their impact on the industry.

“It’s not good for any of us when one of our own writers of workers’ comp in any part of the country… fails,” Fries says. “I’m very concerned about the trust situation in New York, some of the group funds in California. Some states regulate the group fund industry very well, some others don’t.” 

Health Care Possibilities

“If those federal insurance exchanges are set up with that mentality…I think state funds can be used as a model, but I would concur that our industry in general can be used as model of how we handle the medical situation in workers’ comp.”
—Roger Fries, KEMI

A.M. Best analysts say there is some wariness on the part of carriers on how the health care law will be handled from a state and federal regulatory level. One good thing, some carriers have noted, is the possibility of a healthier workforce. There is also the possibility of some cost sharing between workers’ comp and health care in which claims go where.

Fries says there might be some good things that come out of it, especially considering how expensive medical care has become.

“For those that have invested in the technology that allows them to perform very well in medical today…and trained people are the ones that will [probably] be able to handle what’s coming down,” Fries says, adding that cost efficiencies implemented by KEMI and other state funds that function as mutual insurance companies can serve as a model.

“If those federal insurance exchanges are set up with that mentality…I think state funds can be used as a model, but I would concur that our industry in general can be used as model of how we handle the medical situation in workers’ comp,” Fries says.

Leonard says the potential for cost shifting certainly exists based on reduced payments on the Medicare side. The law could also change based on shifting political winds.

“There is certainly a window of opportunity to tweak this health care bill. Even in a substantial way as we get into the next couple of years, so I think the best thing we can do right now is fasten our seat belts and hang on and see where it takes us,” he says.