by Les Boden

I’m going to answer this question. But before I do, I’m going to have to explain a few things about (ugh!) insurance.

If something bad happens to an insured person or company, the insurer is supposed to help soften the financial blow. You need a $50,000 operation and your medical insurer is supposed to cover most, if not all, the cost. A restaurant burns to the ground and the property/casualty insurer is supposed to cover much of the cost of the damages.

But insurers also are investment institutions. We pay the premium, they invest it, and then they pay it back to those of us who suffer losses. During the time between when we pay the premium and insurers pay us for covered losses, the insurers invest the premium and get a return. In effect, for the months or years between premium payment and insurer payout, they borrow our money without paying us interest.

If insurers, on average, pay out 100% of premiums, it’s a good deal for them. They have borrowed money interest-free and made money investing it. Of course, if they can pay out less than 100%, they have even a better deal.

Now for the news.

On July 19, the California Workers’ Compensation Insurance Rating Board (WCIRB) released a report on insurer premiums and payments that describes the recent experience of that state’s workers’ compensation insurers. (Sorry, IE or Netscape only.) In 2004-2006, these insurers paid benefits amounting to 33%, 27%, and 37% respectively of the premiums paid to them. The WCIRB report reports this percentage back to 1978, and in no other year were benefits less than 50% of premiums.

If benefits for injured workers were well under 40% of premiums, where did the rest go? Well, some went to processing claims (including fighting them), some went for lights, electricity, executive salaries, and so on. In 2006, for example, loss payments were 37% of premiums and expenses were 28% of premiums. So for every dollar paid for lost wages or medical care, 76 cents went to insurer expenses. Wow.

With this very high cost of delivering benefits, you might imagine that overall insurer expenses would soak up all the premiums received. However, when we add these expenses to benefits paid, the total comes to 56%, 50%, and 65% of premiums in 2004, 2005, and 2006 respectively. In other words, an industry that could make a substantial profit paying out 100% of premiums is doing much better than that. Much, much better. Last year, California workers’ comp insurers borrowed over $10 billion and will repay only 65% of what they borrowed. That’s a really good deal.

How does this compare with past years’ payments for losses and expenses? The WCIRB tells us that from 1993-2003, this percentage was below 80% in only 1 year and below 90% in only 1 other year.

How did insurers get so lucky? Well, it wasn’t exactly luck. The precipitating event was Governor Schwarzenegger’s 2004 California workers’ compensation reform. This reform made it harder for injured workers to get permanent disability benefits, and it slashed those benefits for those lucky enough to get them. Benefits fell over 40% between 2004 and 2006. This was a tremendous setback, especially for permanently disabled workers, whose benefits were meager even before the 2004 legislation.

This benefit cut was presumably designed to reduce employer costs, and it did. Insurers reduced premiums, but not nearly fast enough to keep pace with the reduction in insurer costs. As a result, insurers got a windfall. A huge windfall.

Why are California workers’ compensation insurers smiling? You know why.