July 1, 2004
QUESTIONS & ANSWERS:
California’s System for
Setting Workers’ Compensation Insurance Premiums
How did California's rate-making process change, when legislation was enacted in
1993 to replace a “minimum rate” system with a “file and use” rating system?
As a result of legislation enacted in 1993, California’s so-called “minimum rate” system
was replaced with a “file and use” rating system, which went into effect January 1995.
Under the “minimum rate” law, insurers were not permitted to charge a rate lower than
the rate approved by the state Insurance Commissioner. The approved rates included the
projected cost of claims as well as a uniform provision for expenses and profit. Through
policyholder surcharges, insurers could charge higher rates than those approved by the
commissioner. More efficient insurers — those with lower expenses or lower claims
costs — could not share those efficiencies, however, with their customers until after the
close of the policy period, and then only through policyholder dividends. Many
employers were unhappy with a rate-making regimen that prevented them from getting a
discount at the front end of the policy period, instead of at the back end through
dividends.
Under the “file and use” rating system, insurers may set their own rates, as long as the
premiums charged based on those rates are not unfairly discriminatory, do not threaten
the insurer’s solvency or tend to create a monopoly. This system also provides for a
standard classification system that is developed by the Workers’ Compensation Insurance
Rating Bureau (WCIRB), the state Insurance Commissioner’s designated statistical agent,
and is approved by the commissioner. The WCIRB uses the data it collects from insurers
to develop and recommend advisory pure premium rates for approximately 500 industry
classifications (e.g., automatic sprinkler installation and wood preserving).
What are pure premium rates?
An advisory pure premium rate is approved by the state Insurance Commissioner for each
industry classification to reflect the average projected “loss” costs and “loss adjustment”
expenses for that particular classification per $100 of payroll. There are approximately
500 industry classifications. Losses include benefit payments to injured workers as well
as medical treatment costs. Loss adjustment expenses include claims processing costs,
such as claim investigation and legal costs and costs, medical bill review, and other costs
directly related to the administration of claims. Loss adjustment expenses do not include
an insurer’s administrative and other overhead costs, brokers’ fees and commissions,
state and federal taxes, or a margin for profit.
Pure premium rates are an estimate, arrived at using actuarial principles and
methodologies and based on historical experience, of what an insurer will need to collect
July 1, 2004
to pay the cost of claims arising under a policy, for as long as those claims are open.
Claims’ payments often extend for many years beyond the time a policy is written.
Claims may be filed against a policy long after it has expired; and an insurer cannot
collect additional premium from a policyholder on an expired policy if it turns out later
that insufficient premium was collected while the policy was in force. For these reasons,
workers’ compensation is often referred to as a “long-tail” line of insurance; the legal
obligations imposed by the workers’ compensation law and the insurance contract may
extend for many years and, for some claims (e.g., long-latency occupational disease) may
not arise for many years.
In addition, an aggregate pure premium rate level is approved by the commissioner to
reflect change in the average statewide “loss” costs and “loss adjustment” expenses for
all industry classifications.
How are pure premium rates set?
The WCIRB – the Commissioner’s licensed statistical agent -- develops an estimate of
future losses for the ensuing policy period, employing actuarial methodologies which rely
on estimates of loss development and loss trending from current cases. The WCIRB also
factors in any changes in the law or regulations that would affect costs. The WCIRB
obtains its data from all insurers writing workers’ compensation insurance in California,
pursuant to the Commissioner’s order. Data integrity is ensured by requiring insurers to
report the same data, pursuant to the Commissioner-approved Uniform Statistical Plan.
The Commissioner is required by the rating law to review the WCIRB’s filing and to
issue an order advising carriers of what he or she believes is the actuarially appropriate
pure premium rate. Being advisory only, insurers are not required to use these rates.
Insurers employ their own actuarial judgments, informed by their own experience and
book of business. An insurer is not required to obtain separate approval for using a pure
premium rate that differs from the Commissioner’s “advisory rate.”
Unlike the old “minimum rate law,” which required the WCIRB to develop a “full rate” –
a rate that encompassed not only prospective losses but an industry-wide uniform
allowance for expenses and profit -- whether or not an insurer elects to use the
commissioner’s pure premium rates, the insurer is required to add its own expense and
profit modifiers (“loads” (i.e., in its own business judgment, how much it will need to
collect to run the business and provide an adequate rate of return). In fact, the rates filed
with the state Department of Insurance are known as “filed” rates, including their rates
for all job classifications to cover “loss” costs and “loss adjustment” expenses as well as
their expense and profit loads
Any insurer’s filed rates may not be used in the market for at least 30 days after they’re
filed with the state Department of Insurance. Thus, this rate approval process is referred
to as “file and use.”
July 1, 2004
How often are pure premium rates adjusted?
As a matter of practice, the WCIRB recommends pure premium rates for all job
classifications and an aggregate statewide pure premium rate level at least once a year to
be effective in January. The state Insurance Commissioner may or may not adopt these
recommended pure premium rates. For the last three years, there have also been pure
premium rate adjustments approved to be effective July 1.
What is the scope of the state Insurance Commissioner’s regulatory authority over
the setting of rates?
Pursuant to legislation enacted in 1993, the state Insurance Commissioner was given the
power to disapprove an insurer’s rate filing, if he or she were to determine the premiums
charged would be unfairly discriminatory, threaten the insurer’s solvency or create a
monopoly in the state. In 2002, these powers — particularly the power to assure that
rates are adequate to pay all claims — were strengthened by the enactment of AB 1985
(Calderon). This measure also expanded the information individual insurers are required
to file and gave the commissioner power to disapprove individual insurer rating plans.
How do successive premium rate adjustments affect policies?
Because workers’ compensation insurance policies are established with employers
throughout the year, their anniversary dates for renewals occur on different dates. So,
when premium adjustments are made to job classifications, the new rates are in effect for
policies incepting or renewing on or after their effective date, typically January 1 or July
1. If there is a premium rate adjustment that takes effect on or after January 1, and a midyear rate adjustment, a policy’s renewal or inception date will dictate when that
policyholder will see the rate adjustment. For example, if a policyholder has a renewal
date of July 30, 2004, that employer will see the impact of both the January and July rate
adjustments at once.
The rate filings made by insurers before July 1, 2004, however, only indicate their change
in rates from those rates in effect on January 1, 2004. In other words, policyholders
whose renewal anniversary dates occur on or after July 1 would see a rate adjustment
different than what is reflected in the 2004 mid-year rate filing, unless it represents the
insurers’ first rate adjustment in the previous 12-month period.
Why are insurer rate filings different?
Like any business in a competitive market, each insurer establishes rates relative to its
unique mix of job classifications, each of which has its own manual rate. Insurers must
set rates to cover the projected liability for all of its policyholders statewide.
July 1, 2004
Each insurer must also make its own actuarial assessment of its anticipated losses for
policies incepting or renewing on or after a certain date, as well as its own assessment of
the cost impact from any newly enacted laws or regulations and how they will affect
those policies.
Insurers’ individual rate filings also reflect administrative and other overhead costs,
brokers’ fees and commissions, state and federal taxes, and a margin for profit.
How does competition affect pricing?
Under California’s regulatory framework, insurers are able to compete in the market on
the basis of services and price, as long as their premiums charged are (1) adequate to
cover their claims costs, (2) nondiscriminatory and (3) not monopolistic. Not only can
they use rates for industry classifications that reflect their own analysis of projected
claims costs, but they can build into their premiums expense and profit loads that
comport with their business model.
How can the WCIRB project greater cost savings due to enactment of Senate Bill
899 than the Insurance Commissioner, yet recommend a pure premium rate
adjustment for policies incepting or renewing on or after July 1, 2004 that is smaller
than the Insurance Commissioner’s?
While WCIRB projects cost savings of $3.3 billion as a result of SB 899, compared to
Insurance Commissioner’s estimate of $2.5 billion, the WCIRB recommended a pure
premium rate adjustment of -17.4% for new or renewal policies on and after July 1, 2004
and the Insurance Commissioner’s advisory pure premium rate for the same period is 20.9%. The difference in their respective advisory pure premium rate adjustments
primarily lies in how they evaluated the combined impacts of legislation enacted in 2002,
2003 and 2004. In the final analysis, even though the Insurance Commissioner and the
WCIRB attribute savings from reforms enacted in 2003 designed to control medical
costs, the Insurance Commissioner’s estimate of those savings is higher than the Bureau's
by approximately two percent of system costs.