In recent months, we’ve heard nothing but praise for Arizona’s workers’ compensation system, especially when compared to the trouble California system. Wondering what all the hoopla was all about, I contacted Don Smith, president & CEO of the Arizona State Compensation Fund after hearing him speak at a recent forum in San Diego. Smith has been heading the Arizona fund since 2000, with 26 years of private and public sector management and insurance experience.
He served extensively with New York-based Continental Corporation before joining the Commonwealth of Pennsylvania’s Department of Labor and Industry in 1995. There, Smith was appointed Deputy Secretary for Compensation and Insurance by the Governor of Pennsylvania, where he served until his appointment in Arizona.
Smith took some time out of his busy schedule to share with me his thoughts about workers’ compensation in Arizona, and offered his suggestions for rehabilitating the California marketplace. But Smith cautioned that while the Arizona system works well, we shouldn’t be quick to compare apples to oranges. The demographics that make up each state are on separate sides of the scale, and play a big part in whether or not each state’s respective system works.
Despite the differences between these neighboring states, Smith emphasized that a healthy California workers’ comp market is important to Arizona’s own well-being. To find out why, read on below.
Insurance Journal: What makes the State Compensation Fund of Arizona stand out?
Don Smith: We are an organization that’s really quasi-governmental in nature. As quasi-governmental, our employees are not state employees; we have our own personnel system. We also operate under all of the insurance codes here, so we meet every single one of the insurance requirements of any other insurer in the state. We are self-supporting; we don’t get any government money. All the money that we get is from premiums from policyholders and investments. In essence, we are a government-created insurance company that operates in the same fashion as any other insurance company would operate in California. What we really try to do is to achieve a mission over here of presenting an alternative source to the private sector insurers, and to the assigned risk pool, that will allow Arizona businesses to obtain workers’ compensation insurance at the lowest possible cost, and with full availability.
IJ: Are you referred to as the “insurer of last resort” as the State Fund is in California?
Smith: Actually, no. Our statutory provisions don’t require us to be the market of last resort. Our Board passed a resolution about 10 years ago asking us to be a guaranteed market, meaning we’ll write anyone who comes to us. We also go and solicit people that we want to write because they are good accounts and we think we can provide a good program for them. When you think about a market of last resort, you think that a policyholder has to look elsewhere before they can come to you, and that’s not the way we’re set up over here.
IJ: How many policyholders do you have?
Smith: 57,000. We estimate that would be roughly between 65 and 70 percent of all of the businesses in Arizona. In a sense, over here, we’re in the same kind of relationship with the business community that the California State Fund is, because as I understand it, they have a predominantly large number of the employers now because of the problems in workers’ comp over there.
We really don’t have problems with our system. But because we are a smaller state, California is very important to us. Most of the insurers in the private sector that write in Arizona are California-based insurers. When California’s market is not doing too well, Arizona’s doesn’t either. Four years ago, when I arrived here, we had companies like Fremont General, HIH Great States, Superior National, Reliance—all of these companies were directly behind our organization as the largest writers of workers’ comp in Arizona. All of them are out of business today. They are insolvent. Our feeling over here in Arizona is that we like a healthy California market, because that makes our market over here healthy too. We don’t want to write 70 percent of the business, but there is no other real viable alternative to the business community if the private market is sick.
IJ: Do you have an open rating system?
Smith: No. We have what’s called an administered system. It’s the old-fashioned filed rates in this state. We did not go to open rating, which was kind of the rage over the last 10 years in a lot of other states. There is good and bad with an administered rate system. The good of it is that it pretty much ensures the integrity of rates in the state. The open rating system in California permits a significant deviation from Filed Loss Costs, depending on what the company thinks its particular book of business will do. Unfortunately, if the design of the open rating system is such that it permits carriers not to behave in a disciplined manner, it can affect the whole marketplace. It can drag rates down to levels that are inadequate. When the rates get to be inadequate, the companies run into solvency problems.
I think open rating is a good thing, but it needs to be designed so that it can protect the integrity of adequate rates in the system, and not allow individual companies to act irresponsibly and drag the whole rating structure of the state down into a black hole, like I believe happened in California. Here in Arizona, you can’t do that because the rates that are filed are the rates that everyone has to use. All a company can do then is file deviations against those rates, which have to be approved by the insurance department. And I can tell you from my own experience, the Insurance Department of Arizona doesn’t simply rubberstamp those deviation filings. It wants evidence as to why you want to deviate from what appears to be the appropriate rate to be used in the state.
The downside to the administered rate system is that it stymies competition. Obviously if a company wants to come in and aggressively write workers’ comp, they can’t really differentiate their pricing all that much from anybody else. So in that sense, I think it may help the integrity of rates in a state, but it may also stymie competition, which isn’t the best thing for the policyholder.
One of the things I would tell California to do is to look at their open rating system and restructure it so that the insurance department has more control over the actual filed rates that the insurers are using. Maybe do it on a file and use basis where they can go ahead and file their loss cost multipliers, which is their factor against the loss cost filing, and allow it to go into use until deemed inappropriate or unacceptable to the insurance department. Give the insurance department some ability to maintain the integrity of the ratings system. The insurance department really has no control over the rates. I think that is something that needs to be addressed separately from the whole issue of the benefits and coverage and the abuses and all the other things that people have already identified in the system.
IJ: Are there any similarities between Arizona’s workers’ comp system and California’s?
Smith: It would be easier to talk about the dissimilarities. I think all work comp systems are similar in that we all have, to some degree, the same challenges as well as some of the good things that both systems have. The California system isn’t all bad.
I think that both systems have some element of control on the medical providers. California, for whatever reason, perhaps needs more control on medical providers than is the case here in Arizona. We don’t have protocols that a lot of people are calling for over there for things like the number of treatments, or chiropractic care or what have you. And yet we average here informally 12 chiropractic treatments before there’s any real question about continuing treatments. Ours is more like the national standard. California’s has, in my opinion, way too much over-treatment in that particular area of medical care.
We have a fee schedule for physicians here. California is looking at that. They’re looking at some other ideas that we don’t have here that I think have some merit. They’re looking at the idea of having healthcare organizations approved by the state and then employers being allowed to use those systems in order to contain medical costs. I think we are more similar on the medical end with regards to fee schedules, etc., than we are on the indemnity or on the lost wages end. Arizona has a system that’s somewhat older in determining disability. Here we determine disability primarily by a person’s earning capacity, whereas California relies partially on that, but it also relies on some kind of formula determining a person’s physical impairment.
We don’t really have the problem California does with permanent total and permanent partial awards because we really don’t give people permanent total or permanent partial awards based on their physical impairment. There’s a constant process going on here of determining what a person’s earning capacity is, which of course relates somewhat to their physical condition, but also relates to other factors as well, including the economy, and including the overall job market that is available, education to the
I think California has stronger fraud laws than we do in Arizona. But then again, demographically, that may be more necessary because we just don’t have the kind of urban centers that California has, where generally, fraud occurs. That’s an example of something in California’s system that I think is very good. A really neat thing in California’s system to deal with fraud is that they allow penalties to flow to the district attorneys. That’s really pragmatic because one of the reasons district attorneys don’t pursue work comp fraud is because it costs money to run those cases and they’ve got budgets like everybody else. It sounds a little bit crass, but if they know they’re going to get whatever the fines are, which are associated with any kind of fraud in their department, they might be more willing to prosecute those kinds of cases. We don’t have anything like that here in Arizona.
IJ: Excessive litigation is a huge ailment in California’s workers’ comp system. Do you have that same problem in Arizona? What are your suggestions to mitigate the problem?
Smith: I think the issues that are litigated in California are much more complex than in Arizona. That’s because there is no real formal administrative process that you go through in California from the time an injury occurs until a time that the person has either returned to work or determined to be totally disabled.
In Arizona, literally when a worker is injured occupationally and goes to a doctor, the doctor has an obligation to notify the Industrial Commission. And from that point forward, that claim is tracked through the Industrial Commission until it’s closed out. So they can kind of manage if you will, as a neutral third party governmental entity. They can manage that claim and make sure all the parties are playing by the rules from the very beginning.
In the California system, there is nothing like that. The first time the California Bureau of Workers’ Compensation Appeals Board knows of a problem on a workers’ comp claim is when somebody files litigation. In the work comp business, it’s almost akin to what we call on the insurer side, early intervention. The earlier you begin to recognize and manage that injured worker’s claim, the faster and the lower the cost generally of the medical, and the lower the duration of the person’s absence from work. It’s just kind of a known fact because you’re literally managing it from cradle to grave.
In California, the only time that the third party, in this case the Bureau and the Appeals board, gets involved, is after it’s a mess. Can you imagine trying to reconstruct all of the events? If they’re going to litigate, for instance, whether or not the claim is compensable, can you imagine having to go back and try to recreate all of the evidence that is necessary in order to show compensability? A lot of people think this is a simple process, but it isn’t. You’re not only talking about compensability from the standpoint of whether or not the person truly has an injury, but also whether that injury occurred in the scope of employment. It can get very fact specific and very difficult to prove.
One recommendation I would make for California is that you need to have some kind of third party that doesn’t have some kind of stake in the outcome that marshals these claims along and referees the process at every step so that they don’t blossom into these really complex cases.
IJ: You were invited by California Insurance Commissioner John Garamendi to meet with him and discuss the workers’ comp problem in California and how it relates to Arizona. What one piece of advice do you want to give him?
Smith: I have to take it in two steps here. The first piece of advice is: don’t toss your whole system out. It may not be the fundamental system itself that’s flawed. It may be a whole host of other smaller changes that you’ve made in the system, or legal decisions that have occurred in the system that make it look bad. But don’t throw your whole system out.
The reason is really important here: the system, good or bad, has history to it. And since we’re dealing in a highly legal environment here, you have some degree of predictability because of what the legal system has done in interpreting how your system is supposed to work. If you were to completely throw everything out and let’s say put in the laws of Arizona, you have no guarantee that the legal system is going to interpret this new law the same as it was done in Arizona. So you have all this uncertainty. And you see this even with the legislation that you have right now. There’s still a ton of uncertainty and it will take years for it to all play out in the courts and play out in people’s behavior. And these systems are all about behaviors. People think people will act differently because the law changed in some way, but you don’t really observe it in actual practice. So a real problem is, you make a radical change, you think that it’s going to give you a certain outcome, but you have no assurances that it’s going to give you that outcome.
That’s why I think it’s better to take a system that’s already been tried and tested in the court, that you can already observe people’s behaviors in, and make changes to that system. Sometimes incrementally, and sometimes I think you’ve got to really take some risk and make some rather more significant changes, but don’t trash the base system itself.
The other thing I would say to Commissioner Garamendi is ‘Never forget who the system is for.’ It is for the employers and their injured workers. The biggest problem in California is that special interests of all kind have gotten the ear of the Legislature and have built into this system a tremendous amount of value for themselves and not for those two parties.
That’s why California has the highest rates in the country yet some of the lowest benefits in the country. Where’s the money going? Clearly it’s going to all of these third party providers that are feeding themselves and their industries off of this. I would try and identify who really represents the employer community and who really represents the worker community, and sit the rest of them on the sideline.
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