Workers' compensation rates in the state of California continue to decrease dramatically. In January 2007, the Department of Insurance approved a 9.5-percent rate decrease, and in July of 2007, an additional 14.2-percent decrease. These two decreases were on top of six consecutive previous decreases. When multiplied together, the Department of Insurance has actually recommended decreases of 65.4 percent since January 1, 2004 (see TABLE 1).
|Date of Rate Change||Workers' Compensation Insurance Rating Bureau||Department of Insurance|
|01/01/04||- 2.9% to + 5.3%||- 14.9%|
|07/01/04||- 13.0% to + 15%||- 7.9%|
|01/01/05||+ 3.5%||- 2.2%|
|07/01/05||- 13.8%||- 18.0%|
|01/01/06||- 15.9%||- 15.3%|
|07/01/06||- 16.4%||- 16.4%|
|01/01/07||- 6.3%||- 9.5%|
|07/01/07||- 11.3%||- 14.2%|
|07/01/07||- 63.3%||- 65.4%|
In order to understand these numbers and what they mean to businesses, business owners should understand a little bit about how rates are set in the State of California.
The Workers' Compensation Insurance Rating Bureau (Bureau or WCIRB) is a private, unincorporated, not-for-profit insurance industry trade organization. Its primary functions include:
- Publishing advisory and pure premium rates
- Calculating and issuing experience modification factors
- Enforcing California's classification procedures
Every six months the Bureau publishes and recommends loss costs for each classification. Loss costs do not include an insurance company's overhead. The insurance commissioner has an opportunity to review these "pure premium" rates and come up with his own rate recommendation. Regardless of what the Bureau or the commissioner decides, these rates are advisory. Insurance companies have the option of choosing whatever rate they want. Although most companies do not adopt the exact adjustments recommended, historically most of the market has tracked closely with the suggested changes.
The workers' compensation market in California has changed radically. In 1999, for every dollar the industry took in, it paid out $1.82 (see TABLE 2). Severe rate increases occurred, numerous insurance companies went out of business, and the industry was in turmoil. By 2003, average rates per $100 of payroll in the state of California had skyrocketed from 2.30 in 1999 to 6.47 in 2003. Simply obtaining workers' compensation insurance was a challenge for many firms. The State Fund's market share jumped from approximately 20 percent to as high as 60 percent during the height of the crisis.
Significant legislation was passed to curb the underlying losses that were driving the rate increases. These changes have been effective, and in 2003, the industry's combined ratio was under 100 percent. (The combined ratio is losses plus expenses divided by premiums. A ratio under 100 percent means the insurance industry is earning an underwriting profit.)
Since then, rates have continued to fall. This is a factor of not only decreased underlying costs, but also increased competition. Today (1Q07) the average rate paid by employers in California per $100 of payroll is 2.93. This is a decrease of approximately 55 percent from the high of $6.47 in 2003.
However, rates may have bottomed out. After eight consecutive rate decreases, the Bureau has recommended a 4.2-percent overall average rate increase effective January 1, 2008. Note that this increase does not include the impact of potential legislation, now pending, which could push rates even higher. At the same time, as written premiums decline significantly as a reflection of decreased rates, assuming that underlying losses remain the same or increase, insurance company margins will be squeezed, and the combined ratio will increase. This would result in higher pricing.
Nationally, workers' compensation also turned in an excellent performance in 2006. The combined ratio for the nation as a whole was 96.5 percent. This is the best underwriting result in at least 30 years. If California is taken out of the equation, however, the combined ratio goes over 100 percent. California's combined ratio for 2006 is currently estimated at 65 percent.
Recognize that every insurance company files its own rates. For the sake of discussion we will assume that your insurance company will follow the recommendations from the California Department of Insurance. If a company renews in the first six months of 2008, it would obtain the July 1, 2007, recommended rate decrease of 14.2 percent. It would also be subject to the recommended increase of 4.2 percent effective January 1, 2008. Collectively, this would mean a base rate decrease of 10.6 percent.
If a company renews in the second six months of 2008, it would be charged the 4.2-percent increase effective January 1, 2008, as well as any additional increase or decrease effective July 1, 2008. Based on current trends, it appears unlikely that rates will go down. Therefore, it would be prudent to factor in a rate increase of somewhere in the 5-percent to 10-percent range.
In addition to base rates, net rates are affected by the experience modification factor as well as other credits or debits an insurance company may apply. Recognize as well that the average rate decreases are not spread equally across all classifications. They vary depending on the experience of the classification. As a final note, experience modifications in general tend to be trending up because expected loss rates have come down so dramatically.
The only way to accurately forecast a company's 2008 workers' compensation insurance cost is for it to meet with an insurance broker and work through a 2008 experience modification and premium projection. Recognize, though, that this will only be an estimate.
The critical thing to remember is that workers' compensation insurance is more of a finance tool than an insurance product. Ultimately, through the application of the experience modification factor, companies will pay for their own workers' compensation losses. Because of this, the only way to lower costs in the long run is to lower the underlying losses that drive those costs.
At a time when rates have come down so drastically, it is easy to overlook the importance of proactive risk control. However, this is when you should be beefing up your risk control efforts in the areas of injury prevention and management to effectively control your underlying losses.
(Editor's Note: Jeff Cavignac is president of Cavignac & Associates in San Diego, Calif. www.cavignac.com .)