Bad signs for California Workers Compensation system?
Having spent a large part of my career focused on Workers Compensation, I still find it interesting to follow the macro and micro economic trends in this part of the industry.
Private insurers, that offer Workers Compensation in the state of California, are attuned to the importance of the WCIRB Research reports. The research and analysis that comes from the WCIRB drive business decisions across insurance carriers and reinsurers, as it is difficult to ignore the studies due to the strength of the data collected and reviewed by WCIRB (findings are based on insurer aggregate financial data, unit statistical data, and medical transaction data reported to the WCIRB as well as WCIRB surveys of insurer claim information).
The recent study about Emerging Trends in California Workers’ Compensation ALAE Costs have many worried this is a Bad sign for California Workers Compensation system. The WC system costs also play a part of the health of the state’s economy. These costs are embedded in everything consumers purchase as they are costs employers cannot avoid (as mentioned in Florida article).
As you know, California is a large state by square mileage as well as economically. The economy of California is the largest in the United States. As of 2015, California’s gross state product (GSP) was about $2.496 trillion. The state’s GSP grew 4.1% in 2015. As written in the Wall Street journal, “Since 2012, California’s economy has grown faster (an annual compounded 3.4%) than every state save Texas (4.8%) and Colorado (3.6%), according to the Bureau of Economic Analysis. Tech has led the upswing, but agriculture and manufacturing have increased, too. Lo, California two years ago eclipsed France to become the world’s sixth-largest economy, with a GDP of $2.46 trillion.”
With an economy that size, the labor force is also going to be large. Hence a small trend or change in employment, inflation, ALAE trends, will have large effect on a number of people.
Workers’ Compensation Insurance Rating Bureau of California (WCIRB)
California is a non-NCCI state, but the WCIRB is California’s trusted, objective provider of actuarially-based information and research, advisory pure premium rates, and educational services integral to a healthy workers’ compensation system.
The Workers’ Compensation Insurance Rating Bureau of California (WCIRB) is a California unincorporated, private, nonprofit association comprised of all companies licensed to transact workers’ compensation insurance in California, and has over 400 member companies.
No state money is used to fund its operations. The operations of the WCIRB are funded primarily by membership fees and assessments. Click the link below to see the list of member companies.
To accurately measure the cost of providing workers’ compensation benefits, the WCIRB performs a number of functions, including collection of premium and loss data on every workers’ compensation insurance policy, examination of policy documents, inspections of insured businesses, and test audits of insurer payroll audits and claims classification.
See more about the WCIRB.
Allocated loss adjustment expense (ALAE)
Allocated loss adjustment expense (ALAE) costs are the costs of handling claims that can be attributed to an individual claim (vs. ULAE which will be defined elsewhere). ALAE levels have historically been much higher in California than in other states. In addition, ALAE costs have increased sharply over the last several years despite implementation of many of the components of Senate Bill No. 863 (SB 863) intended to reduce total loss adjustment expense (or “frictional cost”) levels which include ALAE costs.
As ALAE costs are a significant component of pure premium rates, the WCIRB regularly studies the costs underlying the high ALAE in California as well as the factors driving the recent increases in ALAE levels.
Senate Bill No. 863 (SB 863) was signed by California’s Governor on September 18, 2012. The bill increases permanent disability benefits while making a number of reforms designed to reduce administrative costs and speed the delivery of medical care to injured workers. The WCIRB is closely monitoring the impact on system costs of SB 863 as they emerge in statewide loss and loss adjustment expenses.
SB 863 included a number of provisions intended to reduce Loss Adjustment expenses levels, including ALAE. These provisions included changes to remove the future earning capacity component of permanent disability ratings (effectively eliminating the impact of the Ogilvie decision), a new lien filing fee and statute of limitations on lien filings, and the new independent medical review and independent bill review processes. In total, the WCIRB prospectively estimated that these SB 863 provisions, once implemented, would save approximately $0.5 billion in total LAE costs annually.
However, since the implementation of SB 863 ALAE levels have not decreased as projected but in fact have increased significantly.
On November 17th 2016, the WCIRB reported “Based on the most current information, the WCIRB estimates the impact of SB 863 is an annual net savings of $1.3 billion, or 7% of total system costs.”
WCIRB report on Emerging trends
Some important findings and takeaways include:
- Average ALAE cost per claim have increased by more than five-fold in the last 25 years. In addition, despite the implementation of SB 863 in 2013, average ALAE costs have increased by 20% since 2012.
- California ALAE costs as a percentage of losses are by far the highest of any state and more than twice the countrywide median. Other interstate comparisons suggest that the differences in California ALAE costs are largely related to activities that occur later in the life of a claim.
- Recent increases in ALAE levels are related to both increases in the frequency of claims involving significant ALAE costs in addition to the average ALAE cost on those claims. Although the majority of claims with significant ALAE costs occur in the Los Angeles Basin area, recent increases in ALAE costs have occurred broadly throughout California.
- Cumulative injury claims are much more likely to involve significant ALAE costs than non-cumulative injury claims and these types of claims have been growing faster than other types of claims, indicating that the recent growth in cumulative injury claims is likely a key driver of recent increases in ALAE levels.
- The proportion of claims with significant ALAE costs that have been settled by compromise and release has more than doubled since 2010. Claims settled by compromise and release incur significantly higher ALAE costs than claims closed by other means, suggesting that the recent increases in these types of claims is a factor driving recent increases in ALAE levels.
- Based on a recent WCIRB claim survey on ALAE costs, a majority of permanent disability claims involve an applicant’s attorney and Workers’ Compensation Appeals Board appearances. In addition, significant portions of permanent disability claims involved depositions, liens, disputes for which no lien had yet been filed (i.e., “pre-liens”), surveillance or investigation costs, or costs of preparing subpoenaed records.
Disconnect with January 1st pure premium rate filing
Is there disconnect with the recent report on ALAE trends and the January 1st filing?
On October 27, 2016 – The California Insurance Commissioner issued a Decision regarding the WCIRB’s January 1, 2017 Pure Premium Rate Filing (Filing) which was originally submitted to the California Department of Insurance on August 19, 2016 and then amended on October 3, 2016 based on the WCIRB’s evaluations of June 30, 2016 experience and the cost impact of Senate Bill No. 1160 and Assembly Bill No. 1244.
In his Decision, the Insurance Commissioner approved advisory pure premium rates that average $2.19 per $100 of payroll. The average approved pure premium rate is 13.8% less than the industry average filed pure premium rates of $2.54 as of July 1, 2016 and 5.6% less than the average of the approved July 1, 2016 advisory pure premium rates of $2.32 per $100 of payroll.
The approved January 1, 2017 advisory pure premium rates differ from the pure premium rates proposed in the amended WCIRB filing, which averaged $2.22 per $100 of payroll, in that the CDI predicated the approved 2017 advisory pure premium rates on a slightly lower annual medical severity trend projection (1.8% as compared to 2.5%).
Albeit that ALAE as a component of loss is not the driver of loss costs, if ALAE costs are going up and the impact of SB 863 have yet to be seen on ALAE, why approve a rate decrease? Is this too premature?
What insurers will be most impacted by this decision? What will happen at 7/1?
For insureds: as a small business owner or large corporation with operations in California, the rate decrease is good news. But be careful what you wish for, although decreasing WC costs is important, maintaining a sustainable system and with less volatility should be a secondary goal. Align yourself with the right carrier to support you through good times and bad. Last thing your CFO or budgeting process needs is a significant rate increase as you are forced to move carriers or carrier taking rate action year over year. Work with your broker or agent to determine the best approach.
For insurers: What data will you use to drive your rate change decisions in 2017? Will insurers take the full pure premium rate decrease? Is market share more important than margin? Are you actively trying to avoid the Los Angeles region? Do you offer tier rating? What technology can reduce these costs?
If approximately 70% of ALAE costs are for defense attorney expenses and medical cost containment program costs, or other components such as deposition, surveillance and investigation, and subpoena preparation costs how does technology advancements help reduce these costs?
This is a great opportunity for technology or Insurtech companies to solve a problem, especially considering Silicon Valley is in the backyard of the problem…
Brokers & Agents: pay attention, do your due diligence…certain behaviors by market participants are not sustainable. E&O is a significant risk.
For reinsurers: Tread softly, reinsurers of California workers compensation have been historically focused on their Earthquake potential exposure, but the creep in trends can equally be as painful. California’s ALAE provision of 27% of losses is more than 10 points higher than the second-highest state and more than 150% greater than the countrywide median. Although California has had the largest ALAE provision for many years, this differential has continued to grow.
For investors: Understand what portion of your insurance company stock/investment is dedicated to the California WC market? Utilize the WCIRB and other sources to better understand/predict future cash flows or reserving for your investment. Ask good questions to executive team about what they are seeing in California and how it differs from reported results.
More to follow as new reports come out.