April 2005
An analysis of arrogance: in the opinion of one writer, the reckless and blatant disregard for accountability on the
part of the State Compensation Insurance Fund of California has cost employers billions of dollars in premiums.
The largest workers' compensation insurer in the world, the State Compensation Insurance Fund of California, does not
appear on many published insurer lists. If it did, SCIF and its cousins in New York, Ohio and Washington would be among the
top 10 workers' comp insurers in the nation.
These are all state government-sponsored insurers. Today, most state-sponsored insurers are profitable. A few have begun to
cultivate regional or even national roles. Their combined market share of workers' comp insurance has quite possibly never
been higher, to the detriment of private insurers.
But what is the public benefit of a state workers' comp fund? Can they even be considered a public benefit at all?
Private sector markets for workers' comp insurance are usually highly competitive, and state governments often know little
about running insurance ventures.
So, are state funds an example of bad public policy that was either wrong from the start or terribly outdated at the very
least?
It's not that simple. Private insurers have endorsed intrusive public interventions in workers' comp markets, particularly
in the area of medical price controls.
In addition, there are plenty of successful workers' comp insurance funds. Take, for example, the funds operating in Maine,
Hawaii, Louisiana and Texas.
But one line can be firmly drawn. It is this: State-sponsored insurers should respect basic rules of corporate
accountability. These include financial disclosure, use of independent auditors, inspection by independent rating agencies,
and a candid explanation of public necessity. This kind of discipline will toughen the tenuous grasp of the leading
stakeholders, namely the tax-paying public.
Ignoring corporate accountability invites the abuse of stakeholders' interests. The greater hazard for the public is not
state fund insolvency, but the chronic mishandling of the state economy's work injury risks, which could cost far more.
The behavior of SCIF in the last few years provides many clues about how loose the reins of accountability can be.
SCIF'S WARNING BELL
How was it at all possible? In 2001, SCIF began to sell aggressively. It grew. As the fund grew, its pricing model was
designed in such a way that its surplus could not grow at a commensurate pace. Prices were too low to allow the fund's
surplus to keep up.
As a result, the fund grew topline revenue primarily. By 2002, however, the fund had reached a point where just one bad
year, or a few mediocre years, would have wiped out its surplus.
The ratings agencies, however, had already taken notice. A.M. Best & Co., which had assigned SCIF a rating of A- in 1997,
lowered its rating to B+ in May 2000. In March 2002, the agency further punished the fund with a B- rating. In April 2002,
SCIF decided no longer to be rated by A.M. Best.
Similarly, in 2001, SCIF took a beating from the other big ratings agency, Standard and Poor's, which downgraded the fund
from A to BB+. SCIF responded by terminating its relationship with the agency.
When Dianne Oki, the former president of SCIF, wrote in the 2002 annual report that the "State Fund has become a model for
the industry and other states," she did not disclose the downgrades or the fund's refusal to be rated.
Yet she discussed a dispute with the outside auditor, a quarrel which ultimately resulted in the auditor's termination.
Oki, who resigned Feb. 4, 2005, after just two years, described the fund as a nonprofit, public enterprise fund that
operated "like a mutual insurance carrier."
If SCIF had actually behaved as a mutual insurance carrier, California insurance regulators would most likely have seized
the company and dismissed its top executives. Employers would likely have sought to abandon SCIF on the advice of brokers.
But since SCIF also served at the insurer of last resort, with private insurers exiting the market or failing, employers
were held hostage, as they had no place else to go.
In the space of a few years, SCIF had fired its rating agencies, dismissed its auditors, and sued California insurance
regulators--all the while describing itself as a financially solid, model insurer. SCIF remains a member of the American
Association of State Compensation Insurance Funds. As an insurer, required by law to be self-sustaining and eschew state
subsidies, SCIF would have failed some time between 2001 and 2003.
Sacramento politicians, however, were not going to let SCIF fail. By the time of legislative reforms in 2004, premiums had
already soared to about 815 billion. This was three times the national average and twice that of the next highest-cost
state, Vermont. Employers in California paid at least $10 billion more in premiums due to the delay.
Yet, SCIF could have acted with greater restraint by pricing its policies to allow for an appropriate increase in surplus.
Had SCIF done so, and had it been more forthcoming in its financial disclosures, legislative reforms may well have taken
place in 2002 or 2003, at the latest.
It is safe to assume that over several years, employers paid at least half more than they would have if reforms had been
implemented more quickly.
SCIF's behavior is a bell tolling for all states. Any venture calling itself a state fund is implicitly drawing upon public
faith, if not actual public credit. The threat to private insurers is an uneven playing field. The threat to the public is
excessive injury and disability resulting from the underpricing of policies and the mishandling of claims.
At the very least, state funds should adhere to the same financial standards of private insurers. They should demonstrate
how they are uniquely solving work injury risks.
Executive teams in some state funds are demonstrably self-disciplined, expert in risk, committed to deepening their state's
mastery of injury risk, and aghast at the behavior of SCIF.
Historically, state workers' comp funds are insurers that began life under a unique grant of state sponsorship and continue,
as much as 90 years later, as instruments of public policy. The golden moment for a state-sponsored insurer, or state fund,
comes when the private market for insurance breaks down and a state-sponsored remedy is called for.
EVALUATING STATE FUNDS
Proponents of state funds say they exist--indeed they must exist--to rebalance a permanent crisis or dislocation in the
marketplace for insurance. But after listening to this message for years, it's become clear that no such permanent crisis
exists.
Maybe the public interest could be tied more narrowly to violent cycles or event disruptions in the market. Extreme swings
in the cycle, ruinous price discounting overcompensated by huge price increases and market exits, occurred in the four-year
period from 1989 to 1993, and again from 2000 to 2003. State funds could sound alarms about worsening claims trends and
lead the market faster back to stability.
Private insurers have a problem rejecting this argument completely, as they use a similar argument to lobby for the
extension of the tax-backed Terrorism Risk Insurance Act.
Sometimes a government-sponsored risk-bearing program may be the easiest way to calm high anxiety in the market. But state
funds created for this purpose at some time outlive their initial reason for being.
State lawmakers often address dislocations in the insurance marketplace through the use of assigned-risk pools or residual
markets. Every state has a mechanism in which to place otherwise unacceptable workers' comp risks. Some state funds serve
this function, but private carriers could do it as well.
A dramatic example of an assigned-risk pool success story is in Massachusetts, a state without a state fired. The state
enjoyed the greatest relative decline in workers' comp insurance costs of all states in the past 15 years. It restored its
market to health, in part by launching the assigned-risk pool, a massive incentive program for employers.
Aside from the arguments about whether the existence of state funds are justified by the occurrence of a permanent or
temporary crisis, there is an argument to he made that such funds can influence injury risk at greater depth and breadth
than can most private insurers. The worker and the household, the employer and the trade association, the doctor and the
medical community all influence injury risk.
State funds, thanks to their wall-to-wall focus within a single state, aided often by large market share, are better placed
than private insurers to penetrate deeply into all industry segments and influence injury risk.
Examples include Arizona's contracts with 60 business associations to provide safety and other training services to its
customers, Rhode Island's partnership with Blue Cross, and Ohio's network of competing managed care organizations.
The problem is that few funds use their clout and focus to master injury risk. Nor am I aware of any fund that measures
occupational medical clinics, for instance, or sets targets for injury frequency and severity, or studies the in-state
economy to any depth. If they cannot define and defend their public benefit, why are they with us?
Members of the American Association of State Compensation Insurance Funds:
United States Members
Canadian Board Members
RELATED ARTICLE: Assigned risk pools.
PETER ROUSMANIERE, a Vermont-based consultant and writer, is a regular columnist for Risk & Insurance[R]. |