Workers' comp carriers in California still have plenty of wiggle room to cut operating expenses, according to Department of Insurance actuaries. This, they say, could be a likely reason that loss adjustment costs (LAEs) industry-wide have failed to wane commensurately with system costs.
And perhaps due to the rapid decline in premium volume at State Compensation Insurance Fund, which has left it with more claims adjusters than it needs for its volume of business, or perhaps due to SCIF's government-like attitudes, systems and procedures, the Department removed the insurer's LAEs from the mix when calculating overall industry LAE. This was done on the grounds that SCIF's numbers may be skewing the industry's average LAE.
There appears to be no conclusion other than that SCIF's LAEs are higher than those of the private markets.
Taking these issues into account, California Insurance Commissioner Steve Poizner ordered no change to the average pure premium rate, going against the recommendation of his own actuarial staff that they be increased an average of 3.5%, as well as that of the Workers' Compensation Insurance Rating Bureau, which had recommended an increase of 5.2%.
The Bureau had cited increasing LAE as the largest factor contributing to its recommendation, followed by a one-point increase due to a new law that takes effect Jan. 1, 2008.
Neither the commissioner's advisory rate nor the Bureau's recommendation must be followed by carriers. The Bureau's recommendation is usually a harbinger of what the market can expect, in this case, an indication that rates may go up next year.
During his tenure, former Insurance Commissioner John Garamendi challenged carriers to implement change, so the cost savings would be reflected in lower rates.
"The cost of adjudicating claims has not gone down. We have a lot more things to contend with, such as utilization review and litigation, and I don't see it as temporary. I see it as a permanent phenomenon."
– Jim Little,
Employers Direct Insurance Co.
Now that there are new reforms in place, Poizner says, there is still fat to be trimmed, putting the pressure on the industry to decrease rates even more next year.
Echoing the sentiments of the critics, namely applicant attorneys and labor representatives, who say that rates are still too high, the Department analysis points to the profitability of insurers. Loss ratios continue to go down and according to the Bureau's data, combined loss and expense ratios are at 79%, 56%, 51% and 63% for accident years 2003, 2004, 2005, and 2006, respectively. That's compared with a national combined ratio for workers' comp at 87% in 2006.
Despite the Department staff recommendation for a modest increase, its actuaries also assert that there is still room for premium reductions because carriers have not taken all of the rate decreases recommended over previous years. The Department cites the most recent industry-wide rate level to advisory pure premium rates ratio of 1.471. The Department's target is 1.05.
"Using the same ratemaking formula and assumption, a 1.471 ratio produces an after-tax return on statutory surplus of over 20%," writes Chris Citko, senior staff counsel at the Department, in the decision. "This still represents an opportunity for premium reductions beyond the prior decreases in the advisory pure premium we have previously proposed and despite our recommendation to increase the advisory rates as a result of other factors, since the premiums charged have not decreased in line with our recommendations.
"I expect insurers will continue to decrease their premiums and there will continue to be competition for California employers' workers compensation business since there clearly continues to be lag between Pure Premium Rate adjustments that the insurance commissioner recommends and what employers are charged."
LAE Projections Questionable
In its filing and at the hearing in October, the Bureau recommended the 5.2% increase in the average pure premium rate based primarily on the impact of allocated and unallocated LAEs. The LAE is the cost of administering claims, and the theory, supported by the Bureau's data, is that the reforms have created extra costs, including litigation and utilization review considerations that were not present prior to the reforms. As a result, claims adjusting costs are not dropping commensurately with claim severity and frequency.
The Department did not entirely dispute the notion that the costs of administering claims are higher. The consensus is that the phenomenon warrants more study and that other possibilities need to be considered. One issue involved whether the costs are the result of permanent changes to the workers' comp system or merely a temporary or "transitional" hiccup that's testing how well the system is working in practice.
And then there is the SCIF issue. Its costs are higher than the industry average.
But perhaps the most significant argument put forth by the Department is that insurers are likely not reducing their staffing fast enough to account for fewer claims. This creates an extra expense that's not necessary to settle claims.
Industry players don't necessarily agree with the Department's assessment.
Jim Little, president of Employers Direct Insurance Company, says that the Department's analysis of the LAE doesn't ring true.
"The cost of adjudicating claims has not gone down. We have a lot more things to contend with, such as utilization review and litigation, and I don't see it as temporary. I see it as a permanent phenomenon," Little says. "We've made it much more complex and it will continue to be expensive...because regulations keep changing."
Little says it was the understanding that although there would be significant savings with the reforms, there would be a cost associated with executing the reforms. And expensive claims handling is one of those costs. He cites costs associated with another cost-saving tool, medical provider networks.
"With medical provider networks you see a big savings on the claims side, but there is a cost associated with getting people enrolled. You've got to spend money to save money," he says.
SCIF Numbers Removed
In its decision, the Department referenced the fact that SCIF's LAE ratios have increased dramatically over the past three years. According to data from the Bureau on a net deductible basis, SCIF's market share has fallen to 31% as of 2006, down from 53% in 2003. This is net of large deductibles and other market conditions.
According to the analysis, SCIF's calendar year ratios of paid ULAE to paid loss went from 12.3% in 2004 to 18.4% in 2005 and 21% in 2006. SCIF's ratio of incurred LAE to incurred loss went from 17.9% for accident year 2004 to 18.0 percent in accident year 2005. This increased to 23.6% in 2006. SCIF's ALAE ratios changed very little, staying within 5%. But the ratio of incurred ULAE to incurred loss went from 12.9% for accident year 2004 to 13.1% for accident year 2005. It's continued to climb, according to SCIF's most recent annual and quarterly statements.
As a result, the Department is basing its estimate claims-adjusting cost estimate on just the LAE data from other insurers and not SCIF. It thinks SCIF's figures are throwing the curve. As stated in pertinent part:
"We will bring our staffing in line to meet the obligations of our dual role as a market of choice and the safety net for California employers seeking workers' compensation insurance."
– Patrick Andersen, State Compensation Insurance Fund
"...[W]e are of the opinion that SCIF's increases in the LAE ratios are not indicative of its post-reform expense requirements, but are instead largely due to its inability to reduce claims staffing as fast as its claims handling workload is reduced due to its reduced market share," the decision reads.
Industry sources tell Workers' Comp Executive they surmise that SCIF, as the market of last resort, ends up handling more diverse and volatile accounts than its private-sector competitors, which may require more adjusting.
"State Fund has reduced staff by 15% in the past two and a half years, eliminating approximately 1,500 positions by attrition," says Patrick Andersen, spokesman for SCIF. "Much of our current claims workload is a result of the claims inventory we developed when we had 50% of the market share. Those claims are working their way though the system."
Andersen says that SCIF will continue to address its staffing overage as part of a larger cost savings initiative in 2008.
"We will bring our staffing in line to meet the obligations of our dual role as a market of choice and the safety net for California employers seeking workers' compensation insurance," Andersen says.
Other Ratemaking Issues
The Department also emphasized the need for the Bureau to adopt better methods to address the LAE portion of its analysis. It says the Bureau needs to take advantage of "exploding" new technologies in the actuarial field. It also encourages bringing in an actuarial consultant to do a comprehensive review of the Bureau's ratemaking methods, something the Bureau says it's going to do.
"There were a lot of questions about the LAE. It is a transitional [cost] or are there more core issues?" rhetorically asks Jack Hannan, spokesman for the Bureau. He adds that the Bureau is working on its study of the LAE costs and hopes to have it completed by the first quarter of next year.
He says that if there is a July rate filing and there will be enough time and data from the report to incorporate into the filing, it will be included. If not, the study will be submitted as a separate report.