Thirteen years ago, the largest workers' compensation market in the country–California–set aside its historical rate regulation system for one that favored open competition. That move coincided with the beginning of a nationwide soft market cycle, and the decade of industry turmoil that followed is now legendary.

New York–the second-largest market in the country–enacted legislation in March that will similarly change the direction of the state's workers' comp rate regulation. The timing of the change, in the midst of another soft point in the cycle, raises the potential for a repeat of the California experience.

The similarities between the current environment and the one that existed when California changed its rate administration system are indeed striking.

Now as then, the property-casualty insurance market has turned–pricing has been dropping since late 2004, while losses, driven by medical severity, trend in the wrong direction. Loss ratios have turned already, and the potential for reserve releases from prior years may be drying up.

Prior to the repeal of California's minimum rate law in 1993 and opening of the market to competition in 1995, insurers were unable to charge rates below those approved by the commissioner.

Price competition then was limited to dividends. The California State Compensation Insurance Fund–then and now the number-one writer of workers' comp business in that state–was home to almost 20 percent of the premiums.

Fast forward to today's New York, where approximately $4 of every $10 of workers' comp premium are written by the state fund.

In fact, over 85 percent of the insured workers' comp premium in New York is written by the top-10 insurers in the state–including, of course, the state fund, and mostly large national writers–operating in a market cycle where top-line premium growth is proving difficult to come by.

However, as in California, existing New York rate regulation was perceived as hindering market competition, and needed to be changed.

Let's see how well that went in California: Premium volume dropped by 25 percent in the first year of open rating, driven almost exclusively by price decreases.

The lure of the large premium base was quite tempting, and the SCIF's market share remained fairly constant. The Competitive Rating Law provided the tool for the market to find its own place, as unprofitable as that place might be.

As the decade neared its end, flourishing competition continued to drive prices down, while at the same time loss costs were increasing rapidly–driven mainly by rising medical costs and higher frequency of severe claims, which in turn were compounded by the effects of key court decisions.

Combined ratios that hovered just under 100 for accident-year 1995 exploded to over 180 for 1999 (note accompanying chart). Carriers that could reduced their exposure. Those that could not–mainly local carriers–had to stay and play.

Many did not survive to reap the profits of the hard market that eventually followed. The country's largest workers' comp market was in shambles. The SCIF's share of the market had grown to over 50 percent, as insolvencies and legislative uncertainties had even the largest of national carriers reducing their commitment to the market. The promise of competitive rating met face to face with unintended consequences.

Could it happen again in the Empire State? Perhaps, but there are some important differences to consider between the California and New York scenarios.

First, about one-third of the California workers' comp premiums at the onset of the reform were placed with local companies that could not rely on the mitigating effects of business results in other states. As a result, holding on to business at any cost was a common strategy.

In contrast, local companies play a smaller role in New York, where the commercial market is dominated by national writers that can arguably find other profitable growth areas if the New York market opportunities erode.

Second, rather than using the California system of a file-and-use rate administration (where rate filings are assumed to be approved unless challenged on grounds of being unfairly discriminatory), New York will maintain a prior-approval mechanism.

Because the regulations for New York's competitive rating system have not yet been promulgated, if and how the system will work to mitigate the risk of another marketplace meltdown is unknown.

The crisis in California was accelerated by increases in loss costs, fueled by expanding benefits. New York also increased certain benefits as part of its recent reform.

Several other aspects of the New York reform are similarly waiting to be fully defined and valued, but they will clearly play a part in a competitive pricing environment. Whether benefit expansion will be a factor in New York will be seen in the coming months and years, as the benefit structure is regulated and individual case law established.

The California experience, which cost the industry over $15 billion between 1995 and 1999, should be fresh in the industry's mind. Insurers and regulators would be well advised to follow the situation closely, or risk a repeat of the wild days of California–and the subsequent hangover.

Alejandra Nolibos is a senior consultant with the Tillinghast insurance consulting business of Towers Perrin in Atlanta. Bruce Hockman is executive vice president/specialty client development manager with the reinsurance business of Towers Perrin in Philadelphia.

Special Reports /

Will New York Feel Same Growing Pains As California On Workers' Comp Reform?

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