California is no place for a workers’ compensation insurer to make a profit these days. And that explains why Employers Direct Insurance Co. last week announced it was moving to the sidelines until sanity returns to the market.

It was no small decision for the private six-year-old Agoura Hills company, which opened its doors after the last workers’ comp crisis when carriers fled the state due to out-of-control costs. Though licensed in seven other states, Employers Direct still writes nearly all its policies in California.

But with medical costs on the rise, competitors offering premium rates below the likely cost of covering claims and recent regulatory decisions creating uncertainty about future costs, Chief Executive James Little said it was time for his company to hunker down for the next year or so.

“There are so many other companies offering significantly lower rates that we don’t think are representative of the true underlying costs in the market right now,” Little said. “To compete, we’d have to accept losing 70 cents on every dollar.”

Employers Direct will stop writing new or renewal workers’ comp policies in California as of Aug. 1, and will be cutting its work force by 18 percent. The remaining staff of around 170 people will continue to service existing policies and outstanding injury claims, plus focus on new business opportunities. New York’s Alleghany Corp., which acquired the company in 2007, is investing $7 million in information technology upgrades to help its subsidiary expand business beyond California.

Little isn’t the only industry veteran seeing storm clouds on the horizon for insurers and employers, which until recently had been enjoying workers’ comp premiums as much as 60 percent lower than earlier this decade.

After an overhaul of the workers’ comp system in 2003 and 2004, direct written premiums for workers’ comp insurance in California fell by $1.35 billion to $7.65 billion in 2008. Rates began flattening out in 2007, but are now seen as likely on the rise.

“We may very well be on the verge of another workers’ comp crisis. Not only is medical cost inflation driving up costs faster than rates are increasing, you have recent decisions on permanent disability awards that are unraveling the Legislature’s earlier reforms and bringing uncertainty back into the market,” said Dale Debbers, publisher of Workers’ Comp Executive, a trade publication based in Grass Valley. “I think that when this all plays out, Employers Direct and Zenith National Insurance Corp. in Woodland Hills, a carrier that has kept its rates high, will be seen as the smartest players in the market.”

Long tail

One of the trickiest issues with underwriting workers’ compensation insurance is that the policies tend to have an especially long “tail,” said Sidoti & Co. analyst Robert Paun, who covers Zenith. In essence, that means insurers can end up paying the costs of an injured worker for years, when medical costs can be radically higher than when the policy was written.

Zenith has taken a very different approach to the deteriorating market despite being undercut by competitors. It is still writing new policies but has filed for a 4 percent base rate increase a month after reporting a 94 percent drop in first quarter net income.

“Zenith offers a Cadillac plan and believes it can charge Cadillac rates, which puts them in better shape to weather cycles like this,” Debbers said. “They also tend to run a year or so ahead of the market. They’ve had a couple of bad quarters, but that means that in another six to nine months all the other carriers will too.”

However, rate hikes by many carriers may not be far behind. The State Compensation Insurance Fund, a not-for-profit insurer of last resort that controls roughly one-quarter of the California market, is seeking a 15 percent rate hike.

And the Workers’ Compensation Insurance Rating Bureau, a state advisory group, decided this spring that a 24 percent rate spike could be justified by market conditions.

The bureau in part justified its 24 percent recommendation its largest in six years by citing a trio of regulatory rulings on how permanent disability awards are calculated. The rulings, if upheld by the state Workers’ Compensation Appeals Board, would undo a central cost-saving provision of the reforms pushed through by then-newly elected Gov. Arnold Schwarzenegger.

The reforms established treatment and payment guidelines for workplace injuries in an effort to keep costs down. But the appeals board ruled in three cases that judges handling workers’ comp appeals could disregard the guidelines in individual cases. Insurance companies and employers fear that appeals from injured workers seeking higher reimbursements for claims will skyrocket.