DENNIS AIGNER, Dean, Graduate School of Management, UC Irvine

Eighteen months ago, the California Legislature established a commission to study how workers’ compensation rates are set by insurance companies in this state. The commission, chaired by Dennis Aigner, has come out with a recommendation after studying systems in several other states. The recommendation: deregulation as a way to reduce employers’ costs. Aigner spoke with free-lance writer Anne Michaud about his commission’s proposal, which the Legislature is expected to consider along with at least two other reform bills.

What was the purpose of your commission?

Our commission had a rather narrow charge, which was to look only at the rate-making system and not at anything else. Now it’s hard to ignore the anything else, because in the minds of most people it’s the anything else that’s probably responsible for the huge cost escalations in workers’ comp in California.

But we looked at this system because profitability for insurance companies in California is above the national average, costs for employers are above the national average and benefits for workers are below the average. That’s not a very good situation.

The situation is tied to the so-called minimum rate law, which has not been changed in substance since it was enacted almost 80 years ago. When I say the rate that’s somewhat of a misnomer, because there are about 450 different rates. But I use the word rate to make it simple.

What recommendations did you make?

After studying the matter for about 18 months and hearing lots of testimony and getting lots of good research done, we concluded that it would be better for California to go to a more openly competitive system of rate-making.

Our recommendation really is to get rid of the minimum rate law and install, instead, a scheme of up-front competition. There are about 25 different states in the United States that use some form of competitive rating.

What is the attraction of that system?

The attraction of that is that you know exactly what your policy is going to cost the minute you sign the contract. There’s no guesswork about what you might pay.

And that doesn’t happen now?

No. Insurance companies compete on the basis of dividends after-the-fact, service, quick adjustment of claims and willingness to fight fraudulent claims. That last element now is really at the top of the news.

We studied this, and it’s clear dividend payments are related to loss performance. Companies with good safety records are the ones that get dividends. On the other hand, critics of the current system would argue that dividends are only available to very large employers, and that smaller employers are getting discriminated against because of this particular system.

Do you expect that there would be a lot of price competition under your proposal?

I expect so. Some of the members of the commission were concerned that if we opened it up completely, there would be the possibility of predatory pricing. You can see some of this going on now in the airline industry, where companies are essentially undercutting the competition in an effort to garner a bigger market share and put the others out of business.

So our proposal is not complete deregulation, but a sort of moderate attempt to open it up. We would build in a floor, below which insurance companies would not be able to price (policies) except with the permission of the insurance commissioner. The floor is this so-called pure premium which builds in no expense for profit whatsoever. It’s our estimation that very, very few insurance companies would be able to charge the floor rate and make money.

What was the justification for the original minimum rate law?

The main justification was to make sure that the insurance companies would be in business when it came time to pay the claim. The main concern in 1913 was the solvency of insurance companies, to make sure that premiums were adequate because some workers’ compensation claims go on forever.

What has been the reaction to your proposal?

Well, the insurance companies don’t like it much at all. We’ve had quite a bit of criticism. That was to be expected.

But I would think the employers would be happy with our scheme. We’re getting some support from small companies. We’ve tried to build in some extra safeguards for them.

Although I believe small companies that now do not participate in these retrospective dividends will naturally benefit. Because as a small employer, I can argue my case with the insurance company. I can say, ‘Look, here’s my record, I’ve got a good safety program, and yes, I had an unfortunate accident last year, but that’s not typical.’ (Under the current system, the premium automatically rises with an accident.)

It seems that insurance companies that are used to the old way of doing business won’t have much incentive to stay in business after this is passed.

If you look at the experience in Michigan, which has had 10 years of experience of open competition, the same arguments were made there before they adopted the open competition law: The big companies are going to corner the market. People are going to exit the state. It didn’t happen.

I believe that a more open competition system will force adequacy in profits and it’ll eliminate excessive profits. That’s what competition’s supposed to do.

There are about 50 bills before the Legislature now hoping to change the workers’ compensation system. What are some other proposals?

The employers have a bill on the table, which doesn’t talk at all about rate-making. Then there is the Margolin bill (Assemblyman Burt Margolin, D-Los Angeles). The main difference from ours is that the insurance commissioner must approve every rate.

On tensions between the industry and its commissioner. . .

“Up to the time when we went to an elected insurance commissioner, rate increases were averaging about two-thirds of what the industry requested. Commissioner (John) Garamendi approved approximately 10% of what was requested.”

On insurance industry profitability. . .

“The law says you can charge more than the set rates, but nobody does. That, it seems to me, is evidence to suggest that the insurance industry is doing just fine, thank you very much.”

On the insurance companies’ reaction to his committee’s proposal. . .

“Insurance companies are yelling bloody murder. They don’t want this to happen because it really threatens their bottom line. But it will hopefully make them more competitive.”