No Simple Formula for Repairing Dysfunctional Workers’ Comp System

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No Simple Formula for Repairing Dysfunctional Workers’ Comp System

By LAURENCE DARMIENTO

Staff Reporter

When a business like Wescom Credit Union is notified that its workers’ compensation insurance is about to be raised from $1.1 million to $1.6 million even after the Pasadena-based lender had made successful efforts in recent years to cut down injury claims the obvious question is why?

Unfortunately, there is no obvious answer.

Much of the blame for the current workers’ comp crisis has been ascribed to a dysfunctional system that has allowed medical and other costs to escalate. That has caused many carriers to get out of the business, increasing prices even more.

But there’s a lot more involved. The premium rates charged to California businesses are arrived at through a complex system that has developed over decades and involves arcane calculations and a tightly controlled relationship among regulators, carriers and businesses.

“There is a lot of statistical manipulation that goes into these numbers to ensure they are credible,” said Jack Hannon, communications director for the Workers’ Compensation Insurance Rating Bureau of California, a key public agency involved in the process.

The folks at Wescom were able to find cheaper insurance only hours before its old coverage expired on Aug. 1. But their experience highlights not only the variability in rates, but the frustration in trying to anticipate whether they will go up or down.

“I was speechless it had gone up and it was that much money,” said Michelle Esser, Wescom’s vice president of human resources. “We felt like we had no option. Your wheels start spinning on how can we lower this. It consumed every working minute to try and get a new policy.”

Reform on the way

In recent months, workers’ compensation has become more than an operating drain it’s been cited within the business community as among the most serious problems facing economic growth in California. It has come up again and again during the recall campaign as illustrative of Sacramento’s inability to fix the system. And while there’s a general understanding of what it does businesses providing benefits to their workers for on-the-job injuries less is known about how the system works and what can be done to damper those mammoth rate hikes.

As of late last week, state lawmakers were putting the finishing touches on reform legislation that would set fees for all medical services, while limiting access to certain services, such as chiropractic care. Under the duress of the recall effort, the Democratic-controlled legislature was seen likely to sign off on an overhaul plan that could be sent to Gov. Gray Davis.

Whether that happens, and to what extent it’s effective, remains to be seen. At this point, the system is so out of whack that it will likely take many months, if not years, for the necessary overhauls.

In the meantime, business owners up and down the state are bracing for the day when their premium rate notice arrives. And unlike other costs that can be passed on to customers or even employees, this burden is typically borne by the company itself.

So how are premiums established?

It starts at the rating bureau where a host of factors are considered, including health costs, legal costs, disability costs, worker retraining, the kind of business, the types of workers and the size of the payroll.

The bureau calculates these factors based on regular reports it receives from insurance carriers on how much they have already spent on claims and how much they project to pay out on existing open claims, Hannon said.

The data are then applied to formulas that take into account medical inflation, the cost of drugs and other factors.

Effects of deregulation

Out of all this, the bureau each year publishes what are called “pure premium rates.” (When costs are rising rapidly, the rates come out more frequently.) They reflect projected workers’ compensation costs for every $100 of payroll in some 500 different job categories.

For a job such as real estate sales, where the probabilities of an injury are relatively low, the workers’ compensation rate is set at 43 cents for every $100 of payroll. A more hazardous occupation, such as a concrete construction worker, has a rate of $12.29 per $100 of payroll. (These costs reflect both the medical costs, as well as temporary disability payments.)

But under California’s system, deregulated almost a decade ago, that rate is only advisory. Carriers do not have to follow it. “We have our data but they have whole sets of data,” said Mary-Lou Misrahy, chief of operations for Employers Insurance Group.

Carriers are allowed to “load” into their rates general administrative, sales, legal and other expenses, as well as profit margins. They then file those rates for all 500 categories with the state Department of Insurance, which reviews them but cannot alter them.

There is still more to it than that.

Companies that are large enough get credit for attempting to reduce their claims or are penalized for being sloppy about worker safety. This is done through another figure developed by the rating bureau called the “experience modification factor,” or “x-mod” in insurance lingo.

That involves projecting a company’s expected losses by comparing pure premium rates to actual annual losses. If those losses exceed what is expected, the employer gets hit with a penalty, the size of which is determined by the excess claims. If the losses are lower, the premium is discounted. (An x-mod of 1.2 would raise the premium 20 percent; a .8 would lower it 20 percent.)

The x-mod formula involves calculations that penalize a company more for frequency than size of claims, with 10 small claims raising the factor more than one large one, for example. “The theory is you can manage the frequency of claims more than the one catastrophic occurrence,” Hannon said.

(Small companies with only a handful of employees do not have x-mods since they cannot be developed with any statistical validity.)

Up, down, then up

Carriers do offer additional discounts for steps that companies have recently taken, such as an aggressive workplace safety program. Companies perceived as being sloppy, no matter how low the x-mod, can end up getting stuck with big premiums.

Given how the system operates, it’s understandable why Westcom executives were surprised by its $1.6 million rate quote from its carrier, Zenith National Insurance Co.

The lender had had a poor loss experience one year in the late 1990s that resulted in its x-mod being raised to 1.61 in 2002, the year that Zenith underwrote its workers’ compensation insurance for $1.1 million. But this year, the rating bureau assigned it a 1.22 x-mod, a reflection of the company’s program to keep better track of workers’ compensation claims.

“We have CPR training. We have training where we come in and stage a disaster. We have ergonomic consultants,” said Esser.

The company has been experiencing less than two dozen claims a year, mostly for carpal tunnel syndrome, as well as slip and fall, lacerations and stress. However, over the past year, Wescom has hired programmers and other employees, adding about 30 people to its staff.

With those additions came an increase in payroll. That factors into a higher rate.

On top of that, the 24 percent reduction of its x-mod from 1.61 to 1.22 could not make up for the fact that pure premium rates have risen 32 percent since January.

Last year, Zenith charged $3.63 for every $100 of Westcom’s payroll. The new quote was $4.70, nearly a one-third jump. (As a credit union, all workers at Westcom are classified under a single rate.)

The rate quote prompted Westcom to seek out a new carrier, The Hartford, which offered the company an alternative to traditional workers’ compensation insurance, in which a carrier pays all claims and picks up the entire risk in return for a flat premium.

Westcom now has a form of limited self insurance with Hartford that requires it to pay the first $350,000 of all claims up to an aggregate of $1.5 million for the one-year period covered by the policy. Anything over that is picked up by Hartford. The cost of the policy: $544,320.

Actuarial calculations by the Hartford indicate that Westcom should have workers compensation losses of $1.3 million this year, but the company is hoping its aggressive worker safety program will radically reduce that.

“We are now in charge of our life,” Esser said.




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