California: State-run workers comp insurance fund eyed warily by private insurers

San Diego Union Tribune ^ | March 23, 2004 | Dean Calbreath

[John Jorsett]

As the Legislature works to pass a workers' compensation reform package, Insurance Commissioner John Garamendi has been encouraging insurance companies to do more business in California in the hopes that greater competition will drive prices lower.

But Garamendi discovered that most insurance companies are more concerned by the dominant market share held by the State Insurance Compensation Fund than by the legislative changes being debated.

In the meantime, some insurers are finding that it is already increasingly profitable to do business in California – partly because the legislative changes enacted last year are beginning to push down the cost of doing business.

"We've turned a corner," says Bob Sweeney, senior marketing officer in San Diego for Employers Direct, an insurance company founded last year specifically to handle workers' comp claims in California. "We've gotten to the point where we can price (insurance policies) appropriately without gouging people."

In the past 14 months, Employers Direct has written $80 million worth of policies, largely by undercutting its competitors on price.

Andrew Barile, who heads an insurance consulting firm in Rancho Bernardo, said the idea that there are profits in workers' comp in California "is starting to gel in minds of insurance companies."

Barile said he knows of four entities that have business plans for setting up workers' comp companies in California. But he adds that before they enter, they want to be certain they won't face too much competition from the State Fund, which dominates the market.

"From the industry's viewpoint, the major concern is having a single, state-run entity with an $8 billion share of the marketplace when the nearest privately owned player has just $500 million," he said. "That makes it difficult for a privately owned insurer to be competitive or to get other players to come into the market."

Currently, the State Fund holds 60 percent of the workers' comp insurance market, representing 265,000 clients statewide, while its nearest private sector rivals average about 3 percent or 4 percent each.

It didn't used to be that way. The State Fund was created in 1914 as an insurer of last resort, designed in part to insure high-risk businesses the private sector did not want to underwrite.

As recently as the early 1990s, the State Fund maintained only about 20 percent of the market.

But when workers' comp was deregulated in 1995, a devastating price war developed among insurers. By the time the dust cleared, more than two dozen insurers were driven out of business, and the State Fund assumed their clients.

The fund's financial statements concede that "such a dramatic increase resulted in significant operational and financial strains" for the fund. The financial strains were passed on to the clients. In the past two years, the fund's premiums have more than doubled to $7.6 billion in 2003 from $3.6 billion in 2001.

Jim Little, founder of Employers Direct, suggests that one reason why workers' comp prices have risen throughout California is that the State Fund may have bitten off more than it could chew and was unable to control the abuses of workers' comp.

"They had a huge increase in market share," he said. "It's very difficult to keep staffed up with experienced claims people in that environment."

During a visit to New York last week, Garamendi met with executives from the St. Paul Cos., Travelers Property Casualty Corp., Everest Re Group, Liberty Mutual and the American International Group, or AIG, as well as several investment bankers involved with the insurance industry.

Garamendi said he wanted to talk to the insurers about the workers' comp proposals floating through the state, "but they wanted to talk to us about the State Fund."

Garamendi said most of the insurers believed there wasn't a level playing field between the State Fund and the private market.

The State Fund, they complained, has been paying its brokers twice the commissions of its private competitors. And, they added, it has been less painstaking about weeding out fraud, which has helped drive insurance rates higher.

Garamendi has no regulatory control over the fund, whose board is appointed by the governor. Indeed, the fund sued Garamendi last year when he tried to regulate its business practices.

"Everyone (the New York insurers) found it incomprehensible that the State Fund is not regulated," Garamendi said. "That remains a major hurdle in their mind."

During the election campaign, Gov. Arnold Schwarzenegger accused the fund of "driving other insurers out of the market." At that time, he recommended subjecting the fund to an independent audit and actuarial review, although more recently he has focused on a legislative and ballot proposal aimed at curtailing workers' comp claims.

Barile's recommendation is to "depopulate" the State Fund by selling off some of its least risky clients. But before that occurs, he says, the fund needs to undergo a thorough round of data mining to see how much fraud and waste is in its portfolio.

Despite the dominance of the State Fund, some insurers have found that the market has been improving recently. Profits at Zenith Insurance Co. jumped to $67 million last year from $10 million in 2002 because of improvements in the California market.

Employers Direct has built a portfolio of 200 clients by going after relatively low-risk companies – such as car dealerships, golf courses, light manufacturing and retailers – while avoiding such professions as roofers, tree-trimmers and home builders.

Michael Ullman, who heads the La Valencia Hotel and Rancho Valencia Hotel, said he went to Employers Direct after his bill at a previous insurer jumped to $1.2 million last year from $650,000 in 2002. Employers Direct chipped $250,000 out of the bill, he said.

"Our bill's still much higher than it used to be, but I think Employers Direct recognizes that most of the worst is over," Ullman said.

Insurer Hill says he is able to keep costs low by aggressively pursuing workers' comp claims and ensuring that injured workers get back on the job as soon as possible.

Barile said that should provide an example to other insurers.

"If you come into the marketplace and decide to start a brand new strategy – going after clients, for instance, that have five years of history without any workers' comp claims, you could find a good niche," he said. "The big question is can you cherry pick the State Fund and be successful?"