If we can prevent the government from wasting the labors of the people under the pretense of taking care of them, they must become happy. — Thomas Jefferson

California's Workers' Compensation System has been awarded PRI's Golden Fleece Award for the second time this year. Below are PRI's suggestions for fixing this program.

How to Fix California’s Broken Workers’ Compensation System

Despite the recent passage of legislation to reform California’s workers’ compensation system, skyrocketing system costs remain a major obstacle to job creation and economic growth in the state. California Insurance Commissioner John Garamendi, a Democrat, and Gov. Arnold Schwarzenegger, a Republican, have each released reform plans. The governor convened a special session of the state Legislature on November 18 to address the workers’ comp crisis, and legislation has been introduced modeled after the governor’s plan.

Clearly, both political parties recognize the gravity of the problem. But what steps should be taken next? This paper provides recommendations in five key areas for immediate, effective, and common sense reform of the workers’ compensation system.

The problem
California’s workers’ compensation was created in 1913 as a “no-fault” system to provide medical treatment and disability benefits, as prescribed by law, to employees injured on the job and to protect employers from liability and litigation. Employers are required to purchase insurance, or to self-insure, to cover the medical costs of injured workers and to indemnify workers disabled by work-related injuries for lost wages and impairment. The system has worked well, until recently.

Workers’ compensation premiums paid by California employers have skyrocketed due to doctors, lawyers, and unscrupulous workers and employers using the rules to legitimately bilk the system of billions of dollars. Workers’ compensation costs in the Golden State have tripled since 1997, accounting for up to 40 percent of payroll expenses. California employers now pay the highest premiums in the nation, yet injured-worker benefits rank almost last, proof that middlemen are profiteering.

Thomas Magowan, president of San Francisco-based Club Minibar, reports that his company’s workers’ compensation rates in California went from six percent of payroll in 1999 to a hefty 17 percent in 2002—a nearly 200-percent increase in only three years, despite having just one claim in that period for less than $2,000. Differences between states are even more telling.

In 1999, Magowan paid 11 percent more in California than he did in Illinois. In 2003, he paid 408 percent more in California than Illinois and 520 percent more than in Washington, D.C. According to Investor’s Business Daily, this cost difference applies to neighboring states as well.

California companies pay, on average, $5.85 in workers’ comp premiums per $100 of payroll. This is 94 percent more than Nevada, 184 percent more than Oregon, and a staggering 259 percent more than Arizona.

Given these cost differences, it is no surprise that California has lost 250,000 manufacturing jobs since 2000. Rather than pay these steep premiums, firms are moving out of state or going out of business. Buck Knives, Countrywide Financial, Fidelity, and 3Com have sought greener pastures outside California, citing soaring workers’ comp costs. Whether for-profit, nonprofit, or government, almost every entity has been hit by staggering premium increases.

Round one of reforms
Responding to outcries from California employers, the state Legislature passed a reform package in the final days of the 2003 legislative session. Former governor Gray Davis signed the bills, AB 227 and SB 228, on October 1, just days before voters recalled him from office. The reforms become law on January 1, 2004.

The first round of reforms targeted skyrocketing medical costs, which account for nearly 60 percent of workers’ comp premiums. Limits were placed on the number of allowable chiropractic visits and physical-therapy treatments. Guidelines for medical treatments were established and employers required to monitor compliance with usage guidelines. Fees for outpatient surgery centers were tied to Medicare rates and pharmaceutical prices were tied to Medi-Cal rates.

The savings
According to the Workers’ Compensation Insurance Rating Bureau (WCIRB), the agency designated by state officials to compute premium recommendations, the 2003 reform package will provide $4.2 billion in ongoing annual savings for employers. This is a good first step. As a result, WCIRB recommends pure premium rate cuts of between 2.9 percent and 5.3 percent on January 1, 2004.

The problem is that on July 1, 2003, the WCIRB recommended that rates be hiked by 7.2 percent to cover rising system costs, including scheduled benefit increases over the next three years mandated by AB 749 in 2002. So the new reforms simply reduce the rate of increase; on net, premiums will still climb.

Evidence of this is found in the 2004 pure premium rates filed by insurance carriers with the California Department of Insurance in November 2003. Only one carrier submitted a rate reduction in line with Commissioner Garamendi’s recommendation. Most carriers filed increases or made no change.

Employers who purchase workers’ comp insurance from private carriers will see their costs rise $700 million next year, from $21.1 billion in 2003 to $21.8 billion in 2004—up from $14.5 billion just three years ago. Most employers will not see any reduction in their premiums. Struggling businesses deserve more significant relief.

The first round of reforms will help contain out-of-control medical costs. They are an important first step in re-establishing a robust business climate in California, but they are not enough to lower premiums.

Round two of reforms
The California Labor Federation thinks price controls on insurance premiums should be the next step. Federation president Tom Rankin backs price controls because he believes “there is not much else that can be done in other areas [of workers’ comp reform] without hurting injured workers.”

State Senator Richard Alarcon, a Democrat and chairman of the Labor and Industrial Relations Committee, which handles workers’ comp legislation, has threatened to provide regulatory authority to the insurance commissioner to force carriers to lower premiums. He added that he would “like to see voluntary rate reduction, but if you force our hand, we will do it.”

But price controls always create more problems than they solve. Instead, further structural reforms are urgently needed that will cut premiums for employers, yet not reduce benefits for deserving injured and disabled employees.

This objective can be achieved by bringing together the best features of the Garamendi and Schwarzenegger plans and incorporating ideas from legislators and system insiders. The following blueprint provides recommendations in five key areas for practical, immediate, and cost-effective reforms.

1. Benefits, eligibility, and administration
The first action should be to defer scheduled benefit increases until average premium rates in the state equal the national average. Further actions must include:

• Only compensate injuries that are “predominantly caused” by the workplace—meaning more than 50 percent caused by the job—not “proximately caused.” Under the current standard workers must only show the injury was “proximately” caused by employment, a vague standard prone to abuse. The “predominant” standard would eliminate non-work-related injuries from the system, which was the original intent of the 1913 act.
• Prohibit prisoners from receiving workers’ compensation.
• Eliminate the provision in SB 228 that forces insurers to inspect the safety program of every business in the state. Scrapping this requirement would save $750 million a year.
• Change insurance laws to allow for more self-insurance by small groups of employers thereby allowing these pools to circumvent more costly private insurers and create more competition in the insurance market.

2. Medical
Since 1997, average medical costs per California workers’ compensation claim have increased nearly 20 percent per year compared to a yearly average increase in the Consumer Price Index for medical services of less than 4 percent. Further reforms must be made to control medical costs.

• The medical-care standard should be changed from “cure and relieve” to “medically necessary,” the same standard that applies to group health insurance. The utilization schedules (protocols) should also be changed to reflect this new standard of care, which would then effectively define what is meant in the law by “reasonable medical treatment.” These changes would help solve the problem of identical injuries costing up to five times more to treat in the workers’ comp system than in the group health system.
• Grant employers the right to select the medical providers for 365 days, rather than 30 days. The first evaluating physician should determine the diagnosis, appropriateness and extent of treatment (using protocols), disability level (using American Medical Association guidelines, see below), and ability to return to the former job. If the claim is contested, the workers’ compensation judge assigned to the case should select the evaluating physician, and physician payments should be based on an hourly rate. This impartial system works well in Utah.
• Grant employers the right to insist on a second opinion by a physician of their choosing before any non-emergency medical treatments or disability benefits. Michael D. Rosco, M.D., a workers’ comp doctor in California for more than 25 years, told the Los Angeles Times (June 1, 2003):

Right now, applicant lawyers (those who represent the worker) orchestrate a scenario that results in unending chiropractic treatment; unending physical therapy; “pain management,” a new cottage industry; discograms; surgery with questionable indications; unending temporary disability; multiple MRI, CAT and other studies; Vicodin usage, creating a whole new generation of addicts; and persistent subjective complaints with no objective findings to substantiate them. Applicant physicians can say what they want, e.g., “Water runs uphill.” The judge reads the report (they are mostly applicant-oriented) and says, “Well, if Dr. X says so, it has to be true.” By requiring a second opinion, I predict that the medical costs would tumble.

• Link fees for all medical services, including physician services, to the Medicare fee schedule. Fees would then be updated regularly and reflect the cost of care.

3. Disability
The number of disability claims in California is almost three times the national rate—1,221 claims per 100,000 workers in California in 2002 compared to 434 nationally. Likewise, permanent disability payments per injured worker in California are three times the national average. Reforms must be made to the disability system.

• Restructure the permanent disability rating system along the American Medical Association guidelines for determining physical impairment used by most states. Current methods to determine the extent of an injury are too subjective and lead to fraud, excessive litigation, and unequal settlements where seriously injured workers often receive less benefits than those with minor injuries. The proposed method would limit subjectivity and create a more objective, fair, and uniform standard for deciding how severely a worker is injured or disabled and the appropriate medical treatment and disability benefits to award.
• Require objective medical findings by medical physicians to determine permanent disability. California is the only state that pays permanent disability benefits without “objective medical findings” such as an x-ray or range-of-motion test. Of the $3.5 billion paid in indemnity benefits in 2001, nearly half were for permanent disability benefits, many paid on subjective complaints of pain—a boon to chiropractors, who are now the leading medical providers in the system.
• Reduce permanent disability benefits for those who return to their previous job or who are offered, but refuse, their previous job or refuse an equivalent-paying job.
• Require apportionment. Under current law, if an employer causes, contributes to, or aggravates a condition, the employer pays the full disability and medical treatment for the condition. For example, assume a person has smoked three packs of cigarettes a day for 40 years and has a breathing problem. If that person suffers an aggravation of his condition from dust in the workplace, the employer pays for the full condition. An employer should only pay for the disability and medical treatment that they cause, or portion thereof.

As an example, if an employee works for 30 years and is exposed to asbestos during that time from multiple employers, and thereafter suffers disability from the asbestos exposure, each employer should pay his or her share of the disability and medical treatment. Currently, the employers in the last year of injurious exposure pay everything. Apportionment should also be used when injury occurs to a previously injured body part. This will eliminate duplicate benefits for previously compensated injuries.

By overhauling the disability system, abuse will be cut, allowing benefits for truly disabled workers to be increased while total costs fall. According to the U.S. Office of Workers’ Compensation Programs, California currently pays relatively skimpy benefits to employees who have suffered a permanent partial disability—a maximum payment of $230 per week for up to 619 weeks. In contrast, Arizona pays $374 per week for the duration of the disability, New York pays $400 per week for the duration, and Nevada pays $581 weekly for the duration.

4. Vocational rehabilitation
AB 227 repeals the previous vocational rehabilitation benefit for disabled employees and replaces it with a $4,000 - $10,000 education voucher for those who are not offered re-employment.

• This new provision should be repealed as well because disabled employees are fully indemnified for lost earnings by disability benefits. Therefore, the employee, not the previous employer, should pay for any retraining or skills-enhancement education. To do otherwise would allow some to gain from their disability. If employees pay for their own vocational rehabilitation, retraining success rates would also rise.

5. Litigation and penalties
California’s workers’ compensation system was originally designed to minimize litigation. Something went wrong along the way. Of the roughly one million workers’ comp cases filed each year, about 20 percent are contested. In contrast, Arizona litigates only six to seven percent of its cases. Worse yet, 76 percent of California’s permanent disability cases end up in litigation.

Implementing the above recommendations on medical and disability benefits would inject greater objectivity into the system and help reduce litigation costs. Other changes must be made.

• Part of the problem is rules that encourage litigation and that benefit lawyers. A statutory provision entitles employees to reimbursement for legal fees incurred to prove a contested claim. Employee attorneys received nearly $200 million in 2000 and again in 2001. Insurers paid defense attorneys $294 million both years. Sixty percent of legal expenses arise from claims with minor injuries. Also, the provisions of SB 228 that authorize the construction trades to use Alternative Dispute Resolution procedures should be modified to allow all industries to take advantage of this successful approach to conflict resolution, thereby lowering litigation costs.
• Attract the best and brightest workers’ compensation attorneys to become workers’ compensation judges. First, the governor should appoint judges after review and recommendation by a balanced panel of workers’ comp lawyers. Second, other options such as raising the pay of workers’ compensation judges should be considered.
• One problem faced by the system for years has been attracting high-quality judges due to low pay. As a result, the great majority of judges have been former employee attorneys or state workers. Having a preponderance of former employee attorneys raises an issue of bias. Having a number of state workers who have never practiced workers’ comp law raises an issue of experience. Increasing the pay of judges to attract attorneys who have represented employees and employers for many years would mitigate both of these potential problems.
• Rationalize penalties. The newly enacted laws reduce the time to pay medical bills from 60 days to 45 working days from the date of complete billing. And they increase the penalty for late payment from 10 percent to 15 percent of the total medical treatment expended in a case, not just that specific medical provider’s bill that is late. This penalty structure is excessive and unfair to insurers, who must often investigate complex claims to know if they are legitimate.

Labor Code 5814 must be amended so that the penalty is a flat 10 percent plus interest of the late amount—not the entire claim—after 60 days from complete billing. One reason for late payments is the avalanche of state-mandated forms. Twenty years ago there were only two forms: Claim and Answer. Reducing paperwork would cut penalties and streamline the system.

A structural solution
Workers’ compensation is a worthwhile program that works well in most states. California’s program, 90 years old, should be salvaged. But lawmakers must rewrite workers’ comp rules before more damage is done to the state’s economy. Every dollar spent on increased workers’ comp insurance premiums is one less dollar available to hire new employees or to provide better benefits to existing employees.

The blueprint offered here constitutes a comprehensive structural solution to the state’s workers’ compensation crisis without the need for price controls on insurance premiums. If enacted, it would save employers billions annually and put the workers’ compensation system on sound financial footing. This would encourage new hiring, return luster to the Golden State’s business climate, and promote future prosperity for all Californians.

About PRI
For more than two decades, the Pacific Research Institute for Public Policy (PRI) has championed individual liberty through free markets. PRI is a non-profit, non-partisan organization dedicated to promoting the principles of limited government, individual freedom, and personal responsibility.