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An Insurance Premium HeadacheWorkers compensation insurance premiums present a huge expense and a confusing weave of regulations By Arthur J. Levine
This year, California employers will pay nearly $15 billion for workers compensation insurance. Although premiums — the price insurers charge for coverage — have dropped by half in just four years, they remain a major expense and an occasional severe headache for many companies. Yet few business attorneys have more than a passing acquaintance with how their clients' workers compensation insurance costs are determined. Nor, perhaps more importantly, do most attorneys know how to represent clients effectively when premium disputes arise. This article highlights the system basics and touches upon some of the finer points. How insurers determine rates Workers compensation insurers may charge any premium that does not tend to impair or threaten their solvency or tend to create a monopoly. State Compensation Insurance Fund v. Superior Court (Schaefer Ambulance) 24 Cal 4th 930, 103 Cal Rptr 2d 662 (2001). The old "Minimum Rate Law," under which most insurers charged the identical premium and then paid dividends, was repealed in 1995. Nevertheless, virtually all workers compensation insurers still use the same base rates, which they apply to standardized employment classifications. Insurance Department regulations known as the Uniform Statistical Reporting Plan (or "USRP"), 10 California Code of Regulations 2318.6 et. seq. require workers compensation insurers to report policy data (rates, payroll, employment classifications, claims, etc.) to a private, licensed trade organization to which they must belong. Insurance Code 11751.4. This organization is the Workers Compensation Insurance Rating Bureau of California, often called "the WCIRB" or simply "the Bureau." The WCIRB serves as the Insurance Commissioner's statistical ratemaking agency. Insurance Code 11750 et. seq. It aggregates and analyzes all of the data received from insurers. The WCIRB then projects the rates that insurers will need to charge per $100 of payroll in one or more of 400+ "classifications" in order to pay projected claims during the coming year. These claim-cost-only rates are called "pure premium rates." Insurance Code 11730(f). The WCIRB recommends them to the Insurance Commissioner, who "approves" or modifies them in an advisory capacity as "adequate" following a public hearing. Insurance Code 11750(b). The WCIRB has statutory immunity in connection with most of its rate-making-related activities. Insurance Code 11752.7(f), 11759. It is at this point that market competition begins to factor into the pricing system. Each insurer calculates its own margins for non-claim expenses (sales expense, overhead, profit margin, etc.) and decides how much to load the advisory pure premium rates. Since they are only advisory rates, insurers are also free to deviate from them by filing actuarial support for their deviations. Rates must be adequate to cover an insurer's losses and expenses, not tend to create a monopoly in the market, and not be unfairly discriminatory. Insurance Code 11732-3. Insurers also develop rate modification plans applicable to individual policyholders, with rate credits and debits for such characteristics as housekeeping, financial strength, safety training, etc. These would be reflected in "scheduling rating" pursuant to Insurance Code 11730(j). All of these rate loadings, pure premium rate deviations and rating plans are filed with the Insurance Commissioner and are open for public inspection. Insurance Code 11735. Thus, the first reason why market competition is structurally, although not legally, limited, is that every insurer begins its premium calculations with the WCIRB-calculated uniform loss costs and the commissioner's advisory pure premium rates. They then apply their somewhat modified rates to a uniform regulatory employment classification system. Experience modifications The second factor limiting market rate competition is "experience rating." Insurance Code 11730(c). When insurers report claims under the policies they issue, the WCIRB compares each employer's claims history to that of its industry competitors. This calculation produces a merit rating called an "experience modification" for every employer large enough to have a minimally statistically credible claims history. The purpose of experience (aka "merit") rating is to provide an economic incentive (or penalty) for safety. Indeed, employers with high experience modifications are assessed to pay for special Cal/OSHA inspections and consultations. Labor Code 62.7, 6314.1, 6354(a). An employer may not enter into an employee leasing arrangement (Labor Code 3602(d)) to evade application of its experience modification. Insurance Code 3600(d). The WCIRB's calculation of experience modifications is governed by the California Experience Rating Plan, or "CERP," 10 California Code of Regulations 2353.1. Rather than making their own projections of a policyholder's likely claims experience, as they do for most other types of insurance, insurers must apply to their policy the WCIRB-promulgated experience modification for the policyholder. Insurance Code 11734(a). Generally, an employer receives its first experience rating at the beginning of its third year in operation. Soon thereafter, the WCIRB inspects the employer's premises and operations to confirm that the insurer is reporting the employer's payroll under the correct classification(s). The USRP also governs both insurer reporting and classification assignments. Both the CERP and the USRP are posted on the WCIRB's website, www.wcirbonline.com. Insurer data reports to the WCIRB under the USRP, called "unit statistical reports" or "USRs," reflect data deemed accurate as of 18 months after insurance policy inception. Since premium is based, in part, upon the employer's actual payroll during the policy term, final premium can't be determined until the insurer conducts an "audit" or physical examination of the employer's books a few months after policy expiration. Insurers must then submit updated USRs, typically tracking developments in claim value estimates, annually for nine more years, as necessary. Premium disputes With these basic processes, laws and procedures in mind, categories of common premium disputes begin to emerge. Most premium disputes involve one (or more) of the following five issues: 1. Did the insurer use the correct USRP employment or industry classification(s), and therefore apply the correct pure premium and deviated rates? If not, did the employer, agent or broker report the wrong classification(s)? Did the insurer use the wrong ones? Did the WCIRB assign the wrong ones? WCIRB classification assignment changes that increase premium are usually not retroactive. Insurance Code 11753.2(b). By contrast, the USRP states that payroll reallocation among existing classifications on a policy is retroactive to the policy's inception. The USRP directly governs data reporting only, not premium. Nevertheless, given this rule, courts are likely to find additional premium owed under these circumstances unless the facts support contract law defenses. 2. Did the insurer report to the WCIRB, and use for premium calculation purposes, the correct amount of payroll? Did the employer keep proper payroll records? If not, what is the appropriate remedy? How did the insurer treat overtime, bonuses, expense reimbursement, housing allowances, and benefits? Did the employer improperly characterize employees as independent contractors, or did the insurer treat contractors as employees where the policyholder didn't obtain certificates of insurance from the "contractors?" 3. Was/were the WCIRB-issued experience modification(s) correct? Did it/they reflect incorrect classifications and/or payroll? Did it/they fail to recognize an ownership change, thus incorporating or failing to incorporate certain data? 4. Did the insurer's improper claims handling (inadequate investigation, passive acceptance of the employee's doctor's evaluation, failure to pursue subrogation, etc.) result in the reporting of overstated claim value estimates? Did the insurer fail to send to the WCIRB a USR update reflecting a WCAB "take nothing" claim determination, or crediting an allocation or subrogation recovery? If so, one or more experience modifications would have been too high. The result would have been excessive premium and possible Cal/OSHA assessments, as discussed above. 5. Did the insurer previously accept the employer's current arrangements on prior-year audits, but has now changed its opinion of classifications, employment status, recordkeeping sufficiency, etc. and therefore seeks substantial additional premium? Insurers often point to CERP and USRP language to justify their additional premium demands, but these regulations only pertain to data reporting requirements. Ordinary contract defenses such as estoppel, custom and practice, laches and negligence of the insurer's agent and/or contract premium auditor may protect the policyholder from an additional premium invoice, even if the CERP/USRP requires the insurer to file a corrected USR with the WCIRB. Nevertheless, as discussed below, it may be necessary to navigate CERP and/or USRP issues in an administrative setting before raising defenses in court. Administrative review It is often difficult to determine whether an employer must or even should file an administrative appeal with the WCIRB, or with the insurer, or concurrently with both, and then demurrer to a premium collection action rather than simply filing a complaint, cross-complaint, or answer in court. Since failing to file a timely administrative complaint may ultimately prove fatal to a cause of action or defense, counsel's initial false step may prove the first one toward a malpractice action. A party may appeal a WCIRB or insurer decision to the Insurance Commissioner. Insurance Code 11737(f), Title 10, California Code of Regulations, §2509.40. The commissioner designates some of his decisions as precedential: insurance.ca. gov/0250-insurers/0500-legal-info/ 0600-decision-ruling/0100-precedential/index.cfm. The commissioner's decision can then be appealed to the Superior Court by seeking a writ of administrative mandamus under Code of Civil Procedure 1094.5 and Insurance Code 11754.5. The courts have made it clear, however, that the commissioner has broad discretion in interpreting workers compensation premium rules. Simi Corporation v. Garamendi 109 Cal App 4th 1496, 1 Cal Rptr 3d 207 (2003). Employment status issues Employers pay workers compensation premium for their employees only, not for independent contractors. Similarly, experience modifications reflect wages paid to, and injuries sustained by, employees only. It would therefore make sense that any premium dispute involving the alleged employment status of "workers" would require administrative review. This is not the case, however. If the dispute is whether individuals are employees, neither the WCIRB nor the Insurance Department will determine whether the payroll an insurer reports to the WCIRB and the WCIRB uses for experience rating, and which the insurer also uses to charge premium, is correctly reported and used. The commissioner's right to refuse making this determination is currently being litigated. Whether insurers can use the disputed "payroll" to calculate premium should not be an administrative issue, except perhaps on the theory that an insurer violates its filed rating plans by doing so. The courts may nevertheless require that administrative expertise be brought to bear on the issue under either the administrative exhaustion or primary jurisdiction doctrines. Jonathan Neil & Associates Inc., v. Freddie Jones 33 Cal 4th 917; 94 P.3d 1055; 16 Cal Rptr 3d 849 (2004). Claim-valuation disputes As the California Supreme Court noted in 2001, numerous Court of Appeals decisions have sanctioned civil claims against workers compensation insurers alleging that their misconduct resulted in unjustifiably higher premiums. State Compensation Insurance Fund v. Superior Court (Schaefer Ambulance Service Inc.) 24 Cal 4th 930, 103 Cal Rptr 2d 662. It's well-established, though, that there is no administrative remedy concerning an insurer's substantive handling and valuation of workers compensation claims. This is so even though claims-handling directly affects the WCIRB-issued experience modification, which the insurer must use to compute premium. Claims handling and valuation disputes that affect workers compensation premium are a matter for the courts. Lance Camper Manufacturing Corp. v. Republic Indemnity Co. 44 Cal App 4th 194, 51 Cal Rptr 2d 622 (1996), Tricor California Inc. v. SCIF, 30 Cal App 4th 230, 35 Cal Rptr 2d 550 (1994). Punitive damages are recoverable for bad faith claims-handling causing inflated premium. A policyholder who suspects claims-mishandling or improper valuation often experiences an initial challenge in gaining access to the insurer's claim file. Labor Code 3762 sets forth employer rights in this area. State Compensation Insurance Fund Although many employers refer to the State Compensation Insurance Fund as their "insurance company" or as simply "the state," it is actually neither. SCIF is a Public Enterprise Fund created by Insurance Code 11773, enacted pursuant to Section 21, Article XX of the California Constitution. It functions, on the one hand, as what is sometimes called the "insurer of last resort." This means that under most circumstances, SCIF cannot refuse to insure any applicant. Insurance Code 11784. On the other hand, SCIF is charged with being "fairly competitive with other insurers" and "neither more nor less than self-supporting." Insurance Code 11775. State coffers do not back-stop SCIF. Insurance Code 11771. SCIF is even vulnerable to punitive damages for the adverse premium impact of bad-faith claims handling, just like private insurers. Notrica v. SCIF 70 Cal App. 4th 911, 83 Cal Rptr 2d 89 (1999). Aspects of SCIF's pricing were discussed in P.W. Stephens v. SCIF 21 Cal App 4th 1833, 27 Cal Rptr 2d 107 (1994) and in Rail Services of America v. SCIF 110 Cal App 4th 323, 1 Cal Rptr 3d 700 (2003), but many other SCIF practices have not been addressed by our courts. Premium fraud Some employers intentionally underreport the amount of their payroll, knowingly report payroll under the wrong workers compensation classification, pay medical bills "under the table" to avoid their inclusion in experience rating, and/or engage in other types of workers compensation premium fraud. Insurers and government agencies have become more aggressive in prosecuting alleged premium fraud. In part, this may reflect the special surcharge upon all workers compensation policies which provides funds (allocated through the Insurance Commissioner) to district attorneys. Insurance Code 1877, et. seq., 8 California Code of Regulations 15607. In any event, attorneys should advise their clients of the severe penalties that exist for premium fraud. These include fines of 10 times the premium difference and up to five years in state prison. Insurance Code 756, 1871.4, 11755, 11756(a), 11760, 11880, and Labor Code 3820. Can an insurer be liable for bad-faith conduct in charging and collecting premium? The California Supreme Court said "no" in 2004 in a case involving automobile insurance premium, Jonathan Neil & Associates Inc., v. Jones, supra. Its reasoning seems equally applicable to workers compensation, and Jonathan Neil was applied, albeit under arguably narrow circumstances, in Tilbury Constructors Inc., v. State Compensation Insurance Fund, 137 Cal App. 4th 466; 40 Cal Rptr 3d 392; 2006. Nevertheless, an insured may sue for malicious prosecution if an insurer (or its legal counsel) engages in bad faith collection tactics. Citi-Wide Preferred Couriers Inc., v. Golden Eagle Insurance Corporation 114 Cal App. 4th 906; 8 Cal Rptr 3d 199; 2003, hearing denied. An interesting, open premium-related question is exposure to punitive damages if an insurer cancels a policy in bad faith, falsely claiming premium is due in order to fall within Insurance Code 676.8's limited reasons for permissible cancellation. Workers compensation insurance premiums are an ongoing, substantial expense for most California employers. As these summary points suggest, the law in this area presents a dynamic and complex weave of statutes, regulations, case law, administrative procedures and rulings, jurisdictional murkiness, market controls, market competition, insurer custom and practice, lofty public interest and economic/political self-interest. • Arthur J. Levine is a Fullerton attorney and litigation consultant/ expert witness specializing in workers compensation insurance premium issues. He can be contacted at art@drlevinelaw.com. Certification
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