On Sunday, April 6, the Press Democrat headlined "Workers’ Comp Insurance Program in Crisis." The article quotes small business people complaining of their workers’ comp almost, or actually, doubling "despite an improved safety record." Companies with bad safety records are in even worse shape, with some of their workers’ comp rates tripling.
This lofty macroeconomic analysis is true enough, but it doesn’t reflect the real desperation of small business owners. To find out what’s really happening on the ground, let’s look at one North Bay firm and how it has dealt with skyrocketing workers’ comp rates. It is a textbook case of how a law intended to protect the workers has ended up hurting them.
This company in question is a small service business with $1,250,000 of annual revenue. It’s a minority-owned business with 25 Latino employees. The owner has been in business over 20 years, and many employees have worked for her for years. Now, thanks to workers’ comp, she’s contemplating bankruptcy. Here’s why: A few years ago the company’s workers’ comp premiums were $50,000 or 4% of annual revenues. The company enjoyed a modest profit. Since then, the company’s workers’ comp rates have tripled to $150,000, a shocking increase of roughly $100,000Ñmore than the owner can pay. Instead of consuming merely 4% of gross revenue, workers’ comp now accounts for 12%. That means the company’s cost of doing business has gone up 8%. That’s much higher than inflation and actually higher than the company’s profit plus inflation.
The company’s insurance agent has no solution, perhaps mesmerized by a plethora of complaints from other similarly situated small business owners. The company’s local banker has turned down a loan request. The State Compensation Fund sent notice of default to all of their customers effective April 15. The company paid $30,000 in March but still owes $70,000 with little liquidity. (Business on the North Coast is tepid; customers are stretched and in no mood for price increases.) Then, to add insult to injury, Kaiser, the company’s health provider, informed the company that its health plan will increase by 27%, also an egregious rate hike and poorly timed (as if there ever is good timing for a 27% increase).
What’s a company to do? The first thing this company did was to discontinue Kaiser health care for its employees. After all, providing medical insurance for employees is voluntaryÑworkers’ comp is mandatory. The next forced move was to outsource the employees to a professional human resources company. As California employment regulations continue to become more complex, it was a great relief to leave the State Comp Fund behind. Some say that with all the HR complexity, any company with fewer than 25 employees should be outsourcing. The company’s owner plans to use the extra time to make more sales and to build business so she can pay off the company’s workers’ comp bill and, with luck, stay in business.
How did things get so bad for this and other small business owners? There are no simple answers. Books will be written about how California’s "State Compensation Insurance Fund" spun out of control. Its causes are myriad, and everyone that touches it is getting burned: injured workers, employers, insurers and regulators.
One answer, though, has to do with the government’s tendency to let business owners bear the cost of noble, social experiments and their unintended consequences. A similar phenomenon is happening in the medical field. (Doctors are, after all, just a specialized type of small business person with employees, insurance and all the other headaches attached to small business ownership.) In the comic strip, Rex Morgan, M.D. is outraged by his $40,000 malpractice insurance expense. I call this a "social" expense. Our society has allowed the public to sue for alleged malpractice acts; therefore all doctors, not just negligent ones, must pay to protect themselves from potential lawsuits.
Years ago I was CFO for a medical clinic. It took 50 employees to collect the clinic’s medical claims while it would take only one employee for a similarly sized industrial concern. I call these "claim games" played by health insurers to attempt to disallow or mitigate their expenses. These are "administrative" expenses. It would be interesting if the accounting profession or some governmental body would compute the portion of the medical fee that is composed of social and administrative expenses. If medical premiums could be broken down as followsÑmedical professionals’ expense, social expense, administrative expense and total premium—then society would have information to better judge fee structures and discipline expenses.
In a sense, the crisis in workers’ comp is analogous to the crisis in medical malpractice insurance. The State Compensation Insurance Fund not only has increased its class code rates, but it surcharged its customers for "bad safety records." (This is called an "experience modification.") I would submit that "bad safety records" is a euphemism for either bad luck or egregious abuse by some misusers of the system. The cost of "abusers," in my view, should not be surcharged against the employer, who many times took a chance to give a job to a needy person, but as a "Social Expense" and borne by society at large (read State’s General Fund).
Insurance Commissioner John Garamendi says he’s worried about "rising rates." If he knew what percentage of increase could be attributed to "social expense," he might use such information to mold new regulations and reform the "Social Expense" portion of workers’ comp premiums.
The point of this paper is to help us recognize that drastic price increases cannot be absorbed by small business. I’ve noticed that the Governor of California has been reluctant to raise taxes. Can you imagine him doubling or tripling the state income tax? Of course not. Then how, in good conscience, can he permit such egregious increases in workers’ comp with such widespread damage to the state’s reputation and its small business community?
John Clow is a retired CPA and a part-time CFO-for-hire who works with small business throughout the North Bay, www.johnclowcfo.com.
