The Michigan Accident Fund: A Need for Privatization

Though prevailing legal opinion had concluded that the Accident Fund, a workers' compensation insurer, had been operating as a private insurer, Attorney General Frank Kelley ruled in 1976 that the Fund was in fact a state agency. Smith examines the controversy ignited by Kelley's ruling, culminating in a state takeover of the Fund in 1989. His powerful case for privatization of the Fund is just as relevant today and, in fact, is a major reason why the Engler administration planned to do just that in 1994. 31 pages.

I. Introduction

To Frank Nerat, the issue is clear, "The Accident Fund of Michigan is a privately operated workers' compensation insurance company... The Accident Fund's success is exemplary of what private business can do without government control."[1]

To Harry Iwasko, however, the issue is equally clear. "They [The Accident Fund'; are a state agency. They are the tool to be used to create competition in the marketplace."[2]

Nerat, assistant manager and general counsel for the Accident Fund, and Iwasko, Michigan's assistant attorney general, are the point men in a battle that former Commissioner of Insurance Nancy 8aerwaldt termed "like nothing I've ever seen in state government before."[3] At stake in the battle is an enterprise with $310 million in assets and $85 million in surplus (capital)—an enterprise that is now Michigan's largest underwriter of workers' compensation insurance. The antagonists do not even agree on the name of the organization over which they wrestle for control—Accident Fund officers refer to it as "The Accident Fund of Michigan," while state officials know it as "The Michigan State Accident Fund."

To state officials, the Accident Fund is a state agency established by the legislature and operated under the auspices of the State Insurance Commissioner. They argue that a state-controlled Accident Fund is necessary to maintain competition and encourage low workers' compensation rates in Michigan. The current dispute, they argue, results from the state's attempt to reassert control over what rightfully and lawfully is its creation and property. Such control is necessary, they add, to improve Michigan's business climate.

To Accident Fund officers and their allies in the insurance industry, state efforts to gain control of the Fund are nothing less than state appropriation of private property. The Accident Fund, they argue, is a private organization, established by employers under enabling legislation that gave the insurance commissioner a minor role in facilitating the Fund's creation. They claim state efforts to control the Fund are eliminating competition by driving other insurers from the market, and may ultimately produce a monopolistic workers' compensation system operated more for short-term political advantage than for the long-term interest of employers and employees.

Both sides agree that the answer to the question, "Who controls the Accident Fund?" will profoundly affect the shape of the workers' compensation insurance market in Michigan for years to come. If the Accident Fund is brought under state control, politicians and bureaucrats will likely use the Fund to shape the state's workers' compensation market to meet political goals. Ultimately, state control of the Accident Fund could be the catalyst for the creation of a state-run workers' compensation insurance monopoly.

If the Accident Fund is made independent of state control, workers' compensation insurance in Michigan will for the foreseeable future be provided by private carriers competing with each other, and with employers' self-funding options, to provide the best price and service. Though the immediate focus of the battle is the courts, ultimately state policymakers in the legislature and the governor's office will have to decide which market configuration will best meet the needs of Michigan employers and injured employees.

This study attempts to shed light on the current debate by exploring the origin and history of the Accident Fund. It examines the role of the Accident Fund in the market to see what effect it has had in the state. Most importantly, it looks at the primary policy options available to state policy makers and suggests the possible effects of various courses of action on the cost and availability of workers' compensation insurance in Michigan.

This study does not attempt to resolve the myriad of legal issues now surrounding the Accident Fund. Instead, it attempts to clarify the options available to policy makers, and to identify the option most likely to meet the long-range goals of lower costs and greater availability in the workers' compensation market.

II. History of the Accident Fund

A. Legislative Origins

Capitol legend says it was a spring day in 1967 when then-Governor George Romney, reviewing a sheaf of papers on his desk, turned to an aide and asked, "What is this 'Accident Fund,' and why does its manager make more than I do?" It may seem humorous that the three-term governor and architect of the Michigan constitution should ask such an apparently simple question about state government, yet the root of the present legal dilemma is that the question has never been answered to the satisfaction of all parties involved.

The Accident Fund's foundation was laid in 1911, when the Michigan legislature established a "Commission of Inquiry" to investigate "compensation for accidental injuries or death [due to] employments."[4] In the absence of a workers' compensation system as we know it today, such injuries were settled on a case-by-case basis in the state's civil courts under the rules of its tort system. The Commission's report recommended that a uniform workers' compensation system be established, and that employers be allowed to provide compensation to injured employees by four means: self insurance, by which benefits would be paid from the employer's assets; insurance purchased from private mutual companies; insurance purchased from private stock insurers; and insurance purchased through an "accident fund" to be established by the State Insurance Commissioner.

The Commission of Inquiry clearly viewed this "accident fund" as something distinct from a private mutual insurance company. The Commission supported an accident fund managed by the state on the grounds that "It has been asserted... that these [workers' compensation] funds can be collected and disbursed more efficiently through the instrumentalities of the State than in any other manner."[5] The Commission described this "accident fund" as one in which "The Commissioner of Insurance is given practically the same powers ...as the board of directors of employers' mutual associations" (i.e., mutual insurance companies).[6]

As recommended by the Commission, the 1912 workers' compensation statute passed by the legislature provided that "whenever five or more employers... shall in writing request the Commissioner of Insurance to do so, he shall assume charge of levying and collection from them such premiums ...[as] necessary to pay the sums which shall become due their employees... and also the expense of conducting the administration of such funds."[7] To hold these premiums until needed to pay claims, the Commissioner was further ordered to "cause to be created in the State treasury a fund to be known as the accident fund."[8] The Commissioner was given authority to classify employers by risk, to "determine the amount of the premiums or assessments which such employers shall pay to said accident fund," to maintain records, and to "employ such ...help as may be necessary... for the proper administration of said funds."[9] These and similar passages in the law seem to support the claim that the Accident Fund is a state agency.

Yet the question of the Accident Fund's status is not quite so simple. The Commission of Inquiry, in the same paragraph in which it likened the powers of the Commissioner of Insurance to those of a board of directors, noted that under this system, "it is expressly provided that the State shall not assume responsibility for the payment of any amount beyond the funds so collected [from employers]."[10]

The Commission explained that "it will thus appear that the State is not engaging in the insurance business in the sense that it is assuming any liability... [T]he plan thus proposed differs in many respects from the various schemes of State insurance..."[11] This philosophy—that the state commit no money and assume no liability—was included in the law authorizing creation of an accident fund.[12]

It is also worth noting that the bill that passed the legislature in 1912 did not itself establish the Accident Fund, but only authorized its establishment if requested by employers.

The question of whether the Accident Fund was intended to be a state agency may be simply a matter of semantics. The Accident Fund was clearly established as a public operation—one through which state officials, using "the instrumentalities of the State," would manage a plan for the private good of employers. In this sense, it could be called a state agency. But it seems equally clear that the Accident Fund was not intended to "belong" to the state. The following facts suggest that the Fund was intended to benefit private employers who purchased insurance through the Fund, and that Fund assets were to be used only for the benefit of these employers: the Fund was in no way made mandatory; it would exist at all only upon employers' request; it was created on the theory that it would be the least expensive way for employers to obtain workers' compensation insurance; and the state would assume no liability.

This view of the Accident Fund as a program operated for the benefit of private employers is supported by reference to the political climate of the time. In 1912, there was no history in the United States of workers' compensation insurance being supplied in the market, simply because there was no history of workers' compensation laws. To the extent workers' compensation systems existed, they were generally financed by governments, whether in Europe or in a handful of U.S. states such as Ohio. Michigan's Commission of Inquiry, with little information available to determine the most cost-effective means of providing insurance, hedged its bets, saying "The Commission has thought it advisable to permit... the use of any one of these four methods [self insured, insured through mutual insurer, insured through stock insurer, and the Accident Fund], with a view of enabling the State to determine as the result of actual experience which of these methods is in fact best adapted to the needs of employers and employees..."[13] The Commission accepted that changes could, and probably would, be made over time. "If it develops that any particular one of these methods is unsuited to the needs of the State, then the law can be readily amended in that respect..."[14]

B. 1912 through 1976

Throughout most of its history, the Accident Fund has operated in relative obscurity. As expected, after the passage of the state workers' compensation statute in 1912, employers petitioned the Insurance Commissioner to organize an accident fund, which he did. Shortly after, additional legislation required the State to have its self-insured workers' compensation plan for state employees administered by the Accident Fund.

In 1917, a further step toward an independently operated Accident Fund was taken when the legislature created an "advisory board" to advise the Commissioner of Insurance on the Fund's operation. This Advisory Board consists of employers elected by policy holders at the Accident Fund's annual meeting. The governor "appoints" those Advisory Board members elected by the Fund's policy holders, but he does not select them. Hiring and compensation of Accident Fund personnel is subject to Advisory Board authorization, but the Board has little explicit authority vis a vis the Commissioner other than to "advise."[15]

During its first two decades of operation, the Accident Fund functioned much like a private mutual insurance company. The Fund's general manager functioned as chief operating officer, and the Advisory Board as a board of directors. As required by law, the governor issued appointments to elected Advisory Board members and the Commissioner, when required, certified actions and decisions of the Board.

Over 90 percent of employers in Michigan either self insured their workers' compensation or bought policies from private insurers. The idea that "these funds can be collected and disbursed more efficiently through the instrumentalities of the State" was discredited by actual experience. Like any private mutual insurer, the Accident Fund had to fund losses, keep reserves for incurred but not yet reported claims and growth, maintain a surplus for unexpected claims, and cover administrative expenses. If efficiencies existed, the Fund was unable to manifest those efficiencies in lower rates or increased market share.

The Fund was not, and currently is not, required by law to provide insurance to those unable to obtain it in the private market. Despite a broad perception to the contrary, the Accident Fund was not designed as an insurer of last resort. In this respect, too, it has always functioned as a private insurer, refusing those risks its underwriters deem unsuitable.

Through the late 1920s, the market was defined by free-wheeling competition and rate cutting by insurers hoping to increase market share. By 1930, rate competition, coupled with the growing national depression, had shifted the state's primary worry from the rates employers paid for insurance to the solvency of insurance companies in the state. In July 1934, the Commissioner of Insurance ordered all companies writing workers' compensation insurance to standardize classifications and rates. With the Commissioner's active support, a cartel system of rates evolved, effectively ending price competition in Michigan until 1983. Under the cartel system, the rates of all insurers, including the Accident Fund, were developed and filed by the Michigan Compensation Rating Bureau and its successor, the Workers' Compensation Rating and Inspection Association of Michigan (WCRIAM). (Michigan law requires all insurers to put their rates on file with the Commissioner prior to using them in the market. The Commissioner may disallow the use of "inadequate" or "excessive" rates.)[16]

It was also during the 1930s that the status of the Accident Fund emerged as a source of public debate. The catalyst that brought the issue to the public eye was not so much any action taken by the Accident Fund itself, but a related debate over the implementation of a civil service system in Michigan. Many politicians bitterly opposed civil service, and questioned whether Accident Fund employees should be subject to a civil service act. In 1935, Attorney General Harry S. Toy issued his opinion that the Fund was an independent insurer rather than a state agency. However, after adoption of the state Civil Service Act of 1937, Attorney General Raymond Starr ruled that Accident Fund personnel were state employees. Starr's successor, Attorney General Thomas Read countered Starr in an unpublished opinion issued in 1939. Read argued that the Fund was controlled by the Advisory Board, and its employees were not subject to civil service. This opinion was echoed in the 1941 opinion of Attorney General Herbert J. Rushton, issued after civil service was enshrined in the state constitution, and again in 1945 by Attorney General John R. Dethmers. Dethmers held that the Fund was not a state agency, its employees were not state employees, and its assets and liabilities were not the responsibility of the state.[17]

While the attorneys general argued among themselves, the Accident Fund's operations drew little attention. The Fund purchased a building and initiated a supplemental pension system for its employees. State insurance commissioners took a hands-off approach to the Fund. Examinations of the Accident Fund by the State House in 1955 and the insurance commissioner in 1958 were generally laudatory and encouraged the Fund's continued independence. Occasional publicity, such as that occasioned by Governor Romney's 1967 remarks, did little to raise public or legislative awareness of the Fund.

By the 1970s, the Accident Fund had developed into a peculiar entity with a lengthy history. Advisory Board members were not selected by the governor, but were given gubernatorial appointments to carry out their duties. Fund employees had their own pension plan, but were also eligible to participate in the state's civil service pension—provided the Accident Fund paid the state for their benefits plus an administrative fee. The Fund paid state and local taxes, but it did not have a federal tax number. It paid social security taxes for its employees to the state government, which in turn paid the federal government. These administrative facts remain true today.

In the marketplace, the Accident Fund was a significant but hardly dominant player by 1975. The Fund was not able to compete for most large employer accounts, since these employers would often require multi-state coverage the Fund could not legally provide. Thus the Accident Fund tended to develop a specialty, serving the small business market. The Accident Fund ranked as one of the ten largest workers' compensation insurers in the state, though its market share was generally under five percent. Its $16 million surplus was dwarfed by that of most private insurers.

Then, Attorney General Frank Kelley thrust the Accident Fund into the spotlight.

C. 1977 through 1987

The relatively tranquil existence of the Accident Fund came to an abrupt end in December 1976. Not only was the Accident Fund a state agency, ruled Kelley, but its employees were subject to the civil service code and its assets—including its office building, reserves for unreported claims, and policy holders' surplus—belonged to the state government.[18] Insurance Commissioner Thomas Jones immediately ordered the Fund to discontinue its supplemental pension plan and turn all assets and claim files over to the state.

The Accident Fund officers refused to comply with these directives and the issue moved into the courts, where it has remained since. There is little to be gained by a detailed account of the struggle—a series of suits, countersuits, injunctions, and restraining orders. Two particular rulings should be highlighted, however.

In August 1982, Federal Judge Richard Enslen issued a preliminary declaration that Accident Fund assets were not available for general state purposes, but held in trust for Fund policy holders. Judge Enslen later declined to hear the case, ruling in January 1984 that the dispute should be settled in state court.

In August 1986, Ingham County Circuit Court Judge Carolyn Stell ruled that the state had no interests in the assets or surplus of the Accident Fund. That ruling is currently being appealed by state officials.

The lengthy court struggle has had little impact on the day-to-day operation of the Accident Fund. Its employees remain outside the Michigan civil service system. The rates charged and dividends paid by the Fund are still determined by the Fund's management and Advisory Board. The Michigan State Senate has passed bills in each of the last four legislative sessions to clarify the Accident Fund's status, but the bills have died in the State House each time.

Over ten years of fierce legal and political warfare have failed to resolve the fate of the Accident Fund. The battle has tended to focus on legal concepts and political ideologies. Notably absent from the discussions has been a dispassionate analysis of the likely long-term consequences of the options available to dissolve the dispute.

D. The Accident Fund in a Competitive Market

In addition to endeavors to gain control over the Accident Fund, a major thrust of state policy since 1983 has been an effort to force the Accident Fund to lower its premiums. After the insurance commissioner's 1934 policy that all workers' compensation insurers should file their rates jointly, price competition had been largely lacking in the market. Under the joint pricing system, rates for all insurers were filed by WCRIAM. The primary reason this system was established, with state government approval, was to protect the solvency of insurers by preventing price wars. By 1981, however, the cost of workers' compensation insurance was so high as to be viewed as a major stumbling block to business expansion in Michigan. The legislature chose to shift its emphasis away from protecting insurers and toward protecting employers, and tried open price competition as a means to reduce workers' compensation costs.

Legislative reform, adopted in December 1981, left the joint pricing system intact for a full year, but required insurers to reduce rates by at least 20 percent. Beginning in 1983, the reform opened up the market, requiring each insurer to file its own rates with the Commissioner. The Accident Fund was specifically included in this requirement.

The act that re-established market price competition in workers' compensation is one of the most successful pieces of legislation in Michigan history. In 1983 alone, the first year under open rating, competition accounted for an estimated 28.4 percent decline in workers' compensation premiums in Michigan.[19] Open competition is generally recognized to have saved Michigan employers over $1 billion since its inception.

Despite this success, state officials maintain that the Accident Fund will not compete under the new system unless the insurance commissioner can require it to lower its rates. Private insurers, they say, will also avoid price competition unless such competition is initiated by the Accident Fund. The insurance commissioner has made repeated efforts to force the Accident Fund to lower its rates, and to block rate increases proposed by the Fund. The commissioner's efforts have not succeeded. The rates charged by the Accident Fund since open rating was initiated have been those rates determined by the Fund's actuaries.

The Accident Fund has been among the most successful competitors under open rating. Table 1 charts the explosive growth of the Accident Fund since open competition.

Table 1

Growth of Accident Fund
1982 to 1986

*"Premiums Written" is that amount paid by policy holders to keep policies in force, and is compared by insurers to a "claims paid" figure to determine the profitability of an account. The "State Premiums Written" figure includes assigned risk premiums written.

Source: Compiled by the author from figures supplied in April 1987 by the Accident Fund. "Total State Premiums Written" figures and "Surplus" figures derived from "Final Report on the State of Competition in the Workers' Compensation Insurance Market," issued annually by Michigan Commissioner of Insurance.

At the close of 1982, the Accident Fund's market share as a percentage of voluntarily written premiums in Michigan was 3.4 percent, its lowest level in several years. By the close of 1986, however, the Accident Fund's market share had increased over 400 percent to 15.6 percent of total market. Its written premiums (not including those written as a part of the state's assigned risk facility, described later) had increased from just under $20 million to over $100 million.

It may be argued that state efforts to manipulate the Fund have led to the Fund's success, at least in part, by causing private insurers to withdraw from Michigan. This is discussed in some detail in Part III. Even with these withdrawals, however, competition exists in the Michigan market. The Accident Fund has filled a gap left by withdrawals, but it has had to compete on its merits for the new business. That the Fund has competed successfully—while ignoring government attempts to control pricing—should give pause to those who argue that, without state control, the Fund would not compete in the market.

III. Policy Options

Since the state's attorney general in 1976 found the Accident Fund to be a state agency, the Fund has spent an estimated $750,000 in legal and lobbying fees.[20] While it is difficult to determine the number of hours and the expense incurred by the attorney general's office and Michigan Insurance Bureau arguing the Fund's status, it is likely that the state has devoted resources at least to the same extent as has the Fund itself.

The Fund's 200 employees and 30,000 policy holders exist in a condition of perpetual uncertainty, affiliated with an organization whose structure and policies could change dramatically on any given court date.

It would be easy for the legislature to wash its hands of the matter, allowing the dispute to be resolved in the courts. However, if state policy makers believe a state-run Accident Fund best suits the needs of Michigan employers and injured employees, it is time to make that opinion clear. While an effort to expand state control over the Fund will result ultimately in a court challenge by Accident Fund officials, it would behoove state legislators to make their intentions known and to begin revising state statutes to avoid future controversy similar to the current legal morass. It is also appropriate that the courts be aware of how the current legislature interprets the history of actions taken by past legislatures with respect to the Accident Fund.

Conversely, if state policy makers favor an independent Accident Fund, they could end the current controversy by amending the Workers' Compensation Act and the Insurance Code with language specifying the Fund's independent status. In fact, the State Senate has taken the latter course in each of the last four sessions, most recently in March 1987. The House has never acted on Senate legislation nor produced a proposal of its own.

Inaction on the part of the legislature has contributed to a situation where neither the state nor the market is able to function properly. Governor Blanchard has made clear his belief that reducing workers' compensation costs is a top economic development priority, and that such reductions can best be achieved by state government manipulation of the workers' compensation insurance market. While this study has found that state efforts to manipulate the market and politically lower workers' compensation rates are Iikely to be unsuccessful and counter-productive, it is nonetheless true that the Governor's ability to implement such activist policies has been thwarted by the state's inability to control the Accident Fund. Yet, so long as the possibility of heavy government intervention exists, the working of the market is frustrated. Insurers and employers are unwilling to make commitments to the Michigan market that may be rendered inoperable by government action. Thus, insurers may refrain from entering the market, updating procedures, expanding sales forces, or spending money on long-term safety or educational programs. Other insurers decide to leave Michigan rather than face continued uncertainty.

Improvements in the workers' compensation insurance market so painfully won in 1981 could be lost if the Accident Fund situation is not resolved. Three policy options are available to state policy makers: a state-con- trolled Accident Fund competing with private insurers in the market; a monopolistic state fund that would legally bar private insurers from selling workers' compensation coverage; or a private Accident Fund placed on equal footing with the state's private mutual insurers. Each of these options is discussed in some detail below.[21]

A. A State-Run Competitive Fund

The stance of the state insurance commissioner and attorney general is that, by law, Michigan has a state-run competitive fund. (Although its rates may be set according to political rather than market conditions, such a fund is "competitive" in that it does not have a monopoly on the sale of workers' compensation insurance, and so competes with private insurers for business.) They hold that the Accident Fund, by refusing to yield to state control, is usurping the state's rightful authority. If the state prevails in current litigation with the Accident Fund, Michigan will indeed have a competitive, state-controlled fund.

Twelve other states—Arizona, California, Colorado, Idaho, Maryland, Minnesota, Montana, New York, Oklahoma, Pennsylvania, Utah, and Washington—have state-run competitive workers' compensation funds. As in Michigan, most of these funds were established in the early part of this century, at the same time state workers' compensation laws were passed. For the most part, the funds were established because no one was certain private insurers could, or would, offer such insurance. Further, nine of these states were at the time dominated by mining industries, thought to be particularly unlikely to be able to obtain workers' compensation in the private market. Representatives of mining firms lobbied hard for state funds that would guarantee coverage and, if necessary, could be made to subsidize rates.

A notable exception in this history is Minnesota, which established its fund as part of its move to open rating in 1984. The reasoning behind the establishment of the Minnesota fund was similar to that which insurance commissioners have cited in attempting to exert state control in Michigan: a state-run fund is necessary to assure that competition will take place under open rating, and to force private insurers to reduce profits by lowering rates.[22]

Statutes in nearly all of these twelve states are much more specific than Michigan's as to the nature of the state fund. In California, the fund's status is specified in the state constitution. In most states, fund assets are clearly identified as belonging to fund policy holders, not to the state. The degree to which these funds are subject to political control varies from state to state. The recent trend, however, has been to move in a direction opposite that favored by the Michigan Insurance Bureau; most states are moving away from political control of the funds and toward independence, although most funds remain part of state government. In Oregon, for example, the state fund was reorganized as a public corporation in 1980, effectively placing it on the same footing as private insurers, although the state retained control of fund assets. In Colorado, the fund was reorganized in 1985 and given further independence; the Colorado state insurance commissioner today has less control over the state fund than over private insurers.

Most of the managers of state-run competitive funds see significant advantages to this option. Among the most frequently mentioned are:

Claim #1 — State-run competitive funds serve as insurers of last resort.

This is not true of all state-run funds, and would not be true in Michigan regardless of who controls the Accident Fund. The Accident Fund never has been required to accept an employer that did not meet its own underwriting standards. Employers unable to purchase insurance in Michigan's private market are assigned to the Michigan Workers' Compensation Placement Facility, a pool through which all workers' compensation insurers writing business in Michigan subsidize the losses from providing coverage to the employees of uninsurable employers.

Still, many supporters of state-run competitive funds believe that the very nature of a state fund allows it to serve the public interest better by keeping businesses out of the placement facility, even where the fund is not legislatively the insurer of last resort. Workers' compensation experts frequently offer Oregon as an example. Like Michigan, Oregon has a placement facility to which all employers can turn and be guaranteed coverage. The facility is a money-losing entity subsidized by insurers. Gary Raid, manager of the Oregon state accident fund (SAIFCO) speaks proudly of the role his fund has played in insuring employers previously insured at a higher cost by the state's placement facility. Working with the governor and insurance commissioner, SAIFCO (organized as a public corporation) has developed a method by which the number of insureds entering the placement facility is significantly reduced, and many of those currently covered by the facility are being removed to SAIFCO coverage. Jim Berquist, an actuary who has worked extensively with SAIFCO, notes, "I don't think the governor of a state could exert the same leverage on a private carrier to help meet this public policy goal."[23]

Is SAIFCO truly meeting a "public policy goal" that could not be met by a private insurer? Although SAIFCO has been removing employers from the state's placement facility, it has not been underwriting these employers at a loss. Says Raid, "We discovered many risks in the pool for the wrong reasons—for example, due to their insurance carrier pulling out of Oregon and the business not looking for a new carrier."[24] While it is true that Oregon's governor exerts more control over SAIFCO than he would over a private insurer (he appoints the members of SAIFCO's board of directors), he cannot legally require SAIFCO to follow a given course of action, any more than he could require that of a private insurer. Ultimately, the governor is limited to the influence of his office and his persuasive abilities.

In Oregon, then, it appears that too many insureds who would have been able to find insurance elsewhere were being placed in the facility (the state's insurer of last resort). SAIFCO's success in moving insureds from the placement facility may have little to do with management skill or a willingness to serve public policy, and more to do with inadequate shopping by businesses and the failure of insurance agents to search diligently for insurers other than the placement facility. Moreover, by recruiting new insureds who were incorrectly labeled as "high risk," SAIFCO has done nothing that could not be done by a private insurer—that is, the state-run fund has been acting in its own interest, and not solely at the behest of the governor.

Michigan history is replete with instances in which private businesses of all types have worked with political leaders to achieve public policy aims. Michigan's governor could certainly work with private insurers to remove good insurance risks from the Workers' Compensation Placement Facility. The primary obstacle to such an effort is probably the bad blood existing between the governor's office and the industry, fueled in part by the governor's efforts to increase taxes on insurance companies, and by certain comments such as this emanating from the attorney general's office: "[Insurers] must be good citizens by controlling their avarice."[25]

Even without the intercession of the governor's office, the Accident Fund in Michigan periodically moves employers out of the Placement Facility. In 1985, the Accident Fund removed 77 employers from the Placement Facility and insured them at lower cost. In 1986, another 188 employers were voluntarily removed from the Facility and insured at lower cost by the Accident Fund.

The Accident Fund is not, and never has been, the insurer of last resort in Michigan. The Michigan Workers' Compensation Placement Facility will remain regardless of whether the Accident Fund is brought under state control. There is little reason to believe that state-controlled funds are more likely than private carriers to voluntarily attempt to insure employers found in the Placement Facility.

Claim #2 — State-run funds guarantee availability of insurance.

Proponents of state-controlled funds in Michigan and elsewhere frequently assert that state funds are valuable because they guarantee the availability of insurance during "hard" markets. During periods of high loss ratios, workers' compensation insurers often must restrict the amount of business they write. Allegedly, when private carriers restrict their premium writings, the state fund can fill the gap and keep insurance available at relatively low cost.

This argument is based on one of two theories: state-controlled funds are not subject to the same market pressures as are private insurers; or private insurers are likely to restrict more sharply their writings in Michigan than in others states in which they do business, while the state fund's capacity is "locked in" in Michigan.

The first argument is patently false. State-run competitive funds, by definition, operate in the market. Assuming no tax subsidies are made available to finance its activities, a state-controlled fund is not immune to market downturns. Of course, some well managed state-controlled funds are able to perform better than the industry as a whole and need not restrict their premium writings in hard markets. The same can be said of many well managed private insurers.

The second argument is more complex. Typically, when insurers begin to restrict their premium writings, they first limit writings in those markets deemed less important to the company's long-term goals and prospects, or in less profitable markets. It is true that the Accident Fund, because it is limited to writing only workers' compensation insurance and only in Michigan, would be forced in hard markets to use all of its capacity to write insurance in Michigan.

However, other variables affect this simple equation. First, while a state-controlled fund would use all of its capacity in Michigan, that capacity itself could be limited by losses incurred in the market. Private insurers, on the other hand, typically write policies in many states, and poor performance in one state can be temporarily sustained by good performance in others. Second, if the state-controlled fund were looking after the best interests of its policy holders (as most observers believe it should), it might choose to restrict its writings, rather than to write business at a loss. Such a policy would work to protect existing policy holders at the expense of new business seeking insurance, but such a tradeoff is inevitable, even for the state-controlled fund. Finally, because the Accident Fund is "captive" in Michigan and may not write insurance in other states, it is unable to provide insurance, in hard or soft markets, to large employers with employees outside of Michigan.

Perhaps a better means by which to guarantee the availability of insurance in hard markets would be to encourage the growth of domestic insurance companies. Insurance companies, for reasons of both pride and simple logistics, tend to regard their home state as a vital market, and tend to restrict premium writings in that state only as a last resort. Similarly, efforts to improve Michigan's insurance climate will make it less likely that multistate insurers will restrict their premium writings here. Indeed, a better-than-average insurance climate would tend to increase the capacity devoted to the Michigan market in both soft and hard market cycles.

Traditionally, Michigan has not been perceived as having a favorable climate for insurers. Many market observers feel the very presence of the state-controlled Accident Fund is a significant barrier to an improved market climate. These observers claim that insurers are reluctant to commit to Michigan so long as the possibility exists that the insurance commissioner will order the Accident Fund to write insurance at what private companies believe are below market, actuarially unsound rates. It is widely believed that the current confusion surrounding the Accident Fund has hampered private companies' interest in writing workers' compensation business in the state.

Data from the insurance commissioner's office shows a slight decline in the number of private insurance companies writing workers' compensation in the state in recent years. As is depicted in Table 2, a net of twelve insurance groups withdrew completely from the Michigan market between 1983 and 1986, with a net of seven groups leaving the market in 1986 alone. (A group may include several insurance companies in some form of consolidated ownership.) Other companies have reduced their premium writings while remaining active in the market.

Table 2

Exit from and Entry into Michigan's Workers' Compensation Market by Private Groups

*of previous year's groups

Source: 1983 unit statistical reports of insurers and 1984-86 policy declarations of insurers, as cited in "Preliminary Certification of the State of Competition in the Workers' Compensation Insurance Market," Commissioner of Insurance, January 15, 1987, p. 15.

Deputy Insurance Commissioner Dominic D’Annunzio, the Michigan insurance Bureau’s designated representative to the Accident Fund, disputes the notion that Department efforts to control the Fund and its rates are causing insurers to pull out of Michigan. "I don't see any evidence to support that contention, no evidence whatsoever." D'Annunzio points out that no insurers have made public statements to that effect.[26]

Fritz Lewis, president of the Independent Insurance Agents of Michigan, disagrees with D'Annunzio. Lewis spent October and November of 1986 traveling the country with Insurance Commissioner Herman Coleman in an effort to convince private insurers to write more business in Michigan. Says Lewis, "Michigan has turned itself from a state perceived as one of the worst to one perceived as a good place to do business. Still, many of the insurance companies we talked to cited confusion over the Accident Fund as one of the remaining problems in Michigan."[27]

The burden of proof would seem to fall on those who claim that a state-controlled fund is necessary to assure workers' compensation insurance availability in a hard market. State-controlled funds are neither more nor less vulnerable to capacity shortages than are private insurers. The state-controlled Accident Fund is, however, unable to serve a significant number of Michigan employers with employees in other states. It is also a fact that the number of private insurers writing workers' compensation in Michigan has declined since the state stepped up its efforts to control the Fund and lower its rates. It appears unlikely that the presence of a state-controlled accident fund has any positive effect on capacity available in a state.

Claim #3 — State-run competitive funds provide insurance at the lowest possible cost.

Perhaps the most frequently heard argument in favor of state control of the Accident Fund is that the state can use the Fund to assure low rates for workers' compensation insurance, particularly in an open rating system such as Michigan's.

Michigan's open rating law provides that the insurance commissioner will file an annual report detailing the state of competition in the workers' compensation market. If the commissioner finds competition to be inadequate, he is authorized to order the Accident Fund to develop "mechanisms to create competition or availability where it does not exist."[28]

In the more moderate view of most supporters of a state-controlled fund, this power to "create competition" is a safeguard provided in case the market fails to function. In the more radical view, which dominates the Michigan attorney general's office, this power is an absolute necessity—a precursor to competition. Says Assistant Attorney General Iwasko, "It is rather naive to believe that insurance companies will compete simply because you set up a competitive atmosphere."[29]

Since open rating took effect in 1983, this philosophy of contrived competition has motivated the insurance commissioner's and attorney general's efforts to require the Accident Fund to lower rates. In September 1983, Insurance Commissioner Nancy Baerwaldt ordered the Accident Fund to reduce its rates by 17 percent, which would result in the Fund's writing insurance at "pure premium" rates, sufficient only to cover current losses. Administration and contribution to surplus were to come from investment income. Accident Fund officials refused, but voluntarily lowered rates by 10 percent (as recommended by Fund actuaries) in January 1984. In 1986 and again in 1987, Commissioner Herman Coleman attempted to block rate increases by the Accident Fund. The propriety of his efforts is currently being litigated. In the meantime, the Accident Fund has been allowed to collect the higher rates, though it places the funds in trust pending a final ruling.

Would open rating more effectively lower costs for workers' compensation insurance if a state-run competitive fund were required to lower its rates? The evidence is admittedly scant, but to the extent it exists, it contradicts the notion that a state-controlled fund is needed to make open rating work.

As previously noted, it was the presence, not the absence, of intense competition in the market that first prompted the state government to promote joint pricing through WCRIAM. Further, Michigan has clearly benefited from the open rating system that replaced joint pricing in 1983, even though the Accident Fund has not been used to "create competition."

The best analysis of the effects of open competition on the market was included in a 1985 study by John F. Burton (a Cornell University professor and the nation's leading authority on comparative workers' compensation cost analysis), H. Allan Hunt (Upjohn Institute for Employment Research), and Alan B. Krueger (an associate of Burton). In the study, prepared for a review of Michigan's workers' compensation costs conducted at Governor Blanchard's request by University of Michigan professor Theodore St. Antoine, Burton analyzes the net impact of open competition in the eight states having open competition in 1984. Table 3 presents his results.

Of the states presented in Table 3, Minnesota and Oregon are of particular interest to Michigan policy makers, as they are the only states with both open competition and a state-run competitive fund writing workers' compensation insurance. In Oregon, rates fell 36.3% after the move to open competition, a greater decrease than that recorded in any other state. In Minnesota, conversely, open competition had less effect than in six of the other seven states. Michigan, despite the commissioner's inability to control Accident Fund rates, benefited more than any state except Oregon.

Table 3

Estimated Net Impact of Open Competition on Workers' Compensation Costs in Eight States with Open in Effect on January 1, 1984

* States with state-run competitive funds. For purposes of this table, Michigan was not considered to have a competitive state fund, since the state was unable to exert control over Accident Fund rates.

Source: John F. Burton, Jr., et al., "Interstate Variations in the Employers’ Cost of Workers' Compensation, with Particular Reference to Michigan and the Other Great Lakes States," p. 71. Burton's calculations were made using data prepared in November 1984 by the National Council on Compensation Insurance.

The Minnesota data is probably not meaningful, since the Minnesota state fund was newly created in 1984 and did not have enough market presence to significantly affect rates. However, the Oregon case is also misleading, and a more careful analysis of that state fund suggests the long-term negative consequences of political rate setting.

When open rating took effect in Oregon on July l, 1982, SAIFCO adopted a policy of writing insurance at pure premium rates, exactly what the Michigan attorney general and insurance commissioner have tried to require the Accident Fund to do. SAIFCO, which controls almost 50 percent of the insured Oregon workers' compensation market, slashed its rates by over 40 percent. John Lewis, a workers' compensation consultant in Oregon, notes that private insurers no longer able to compete "left the market in droves."[30] Of 293 insurers licensed to sell workers' compensation in 1985, 104 wrote no business at all in the state; another 74 wrote less than $100,000 annually.[31]

In 1984, an independent audit found SAIFCO's reserves inadequate, and that year the public corporation increased its rates by 7.8 percent. A 14 percent increase followed in 1985, a 26.7 percent increase (half of which was due to changes in benefit levels) in 1986, and a 14.5 percent increase in January 1987.[32] Other insurers, chased out of the market in 1982 and 1983, were not immediately available to counter SAIFCO's rate increases. By the spring of 1987, two years after the Burton study, Oregon's savings from open competition have been almost entirely lost.

In Michigan, on the other hand, rates increased just eight percent in 1985 and 15.2 percent during the period January 1986 to June 1987.[33] These figures, based on an average of rates filed by all carriers, actually overstate the Michigan increases. Michigan employers have over 100 insurers from which to choose, and no insurer dominates the Michigan market; employers who shop around can often avoid all but minor increases. The possibility for rate-shopping is limited in Oregon, where SAIFCO writes nearly half of all workers' compensation business.

State control of Michigan's Accident Fund is likely to result in a less competitive market, as happened in Oregon. According to the commissioner's "Final Report on the State of Competition in the Workers' Compensation Insurance Market" (January 1987), the Accident Fund held a 15.6 percent market share in 1986. Another 13.5 percent of the market was in the Placement Facility, over which the commissioner has significant control.

With the Accident Fund's market share still growing rapidly, state authority over the Fund would give the commissioner control of over 30 percent of the Michigan market.

The statute authorizing open competition in Michigan specifically provides that a finding by the commissioner that a single insurer controls over 15 percent of the market would be considered evidence of inadequate conditions for competition. While the statute specifically excludes the Accident Fund from the 15 percent limit, the possibility of the commissioner's rate-making authority extending to over 30 percent of the market should be cause for concern among those who fear concentration in the industry.

According to professor Burton, "A competitive state fund can shape competition. But there are various ways to put pressure on the market. A lot of pressure is put on carriers through open competition."[34] Adds the Upjohn Institute's Hunt, "It basically comes down to whether you believe in the market or not. If you believe that carriers are subject to market pressures, you have to question the need for a state fund to reduce rates. The evidence seems to clearly indicate that open competition has reduced costs in Michigan."[35]

The notion that a state-run competitive fund can force lower rates in the market, yet remain actuarially sound, is not supported by logic or experience. The Oregon experience suggests that efforts to artificially force market rates down through a state fund can create long-term market distortions that lead to higher costs and more limited consumer choice.

B. A State Monopoly Fund

There are those who argue that a monopolistic state workers' compensation system—in which the writing of policies by private insurers is illegal—yields public policy benefits. Michigan's leading labor unions have long supported a monopolistic state system, as have many politicians. Private insurance companies in Michigan have watched the state's efforts to control the Accident Fund with increasing alarm, viewing those efforts as a first step toward creating a state-run monopoly. Indeed, as early as 1983, Michael Shpiece, then deputy director of the Department of Licensing Regulation, urged Department Director Elizabeth Howe to act to contradict "a fear ...of a 'secret plot' to establish a monopolistic state fund...rampant among insurance companies [and] some legislators."[36]

Despite its growing surplus, the Accident Fund is not now large enough to serve as a monopolistic fund. If this course were pursued, the state would have to be willing to use its general assets to back claims. Any effort to convert the fund to a state monopoly would undoubtedly be subject to a lengthy court battle, even if the state wins current lawsuits with the Fund. Still, private insurers are watching the growing market share of the Accident Fund and the Placement Facility, and state efforts to control the Fund, with trepidation.

1. Workers' compensation costs in a state monopoly fund.

A 1981 report by the United Auto Workers inspired support for a monopolistic fund.[37] This study found that Ohio ranked 11th (with 1st being highest) in workers' compensation benefit levels among the 50 states, yet ranked only 39th in costs. Ohio voters rejected by a four-to-one margin a 1981 referendum to allow private insurers to write workers' compensation business in the state. Five other states—Nevada, North Dakota, Washington, West Virginia, and Wyoming—also have monopolistic state funds.[38]

The UAW report in fact offers a very superficial look at the Ohio fund. In states with private insurance systems, insurers are required by law to be actuarially sound—that is, a given year's premiums are expected to be sufficient to pay for the total amount of all claims arising from that year, not simply for the benefits payable in that year. The distinction is crucial, since the nature of workers' compensation leads to particularly long "tails" on claims. Some occupational diseases are not manifested for years, and disability income payments can continue for decades.

The opposite of a system based on actuarially sound rates is a "pay-as-you-go" system, akin to social security, in which current year's receipts pay current year's payable benefits. This does not eliminate the costs of future benefits due from claims incurred in the current year—it simply shifts them to other employers in the future. The evidence strongly suggests that Ohio's state fund is not actuarially sound, but rather is operated at least partially on a pay-as-you-go basis. This fact was not taken into account in the UAW study. A 1977 audit by Booz-Allen concluded that Ohio's fund had a $1.3 billion actuarial deficit, and was not collecting enough to cover claims incurred that year.[39] Booz-Allen recommended a 25 percent rate increase to put the fund on sound financial footing.[40] A 1980 audit by Arthur Anderson again found Ohio's funding insufficient.[41] In 1981, it was Coopers & Lybrand who found the Ohio fund to be inadequately funded.[42]

Ohio's workers' compensation costs seem low only if one pretends that future employers will not have to pay for today's inadequate funding. Given the present uncertainty and fear over the future of social security, it seems doubtful that injured workers would be comforted to know their future benefits were being funded in the same manner.

The definitive work comparing the cost efficiencies of monopolistic state funds and private insurers was written by John Burton. In a 1984 study comparing costs in Ohio, Pennsylvania, and other states, Burton concluded that "differences [in cost] appear to be much more influenced by factors such as relative levels of benefits than by the particular form of insurance arrangement used to provide these benefits."[43]

Burton feels much more strongly about competitive, open rating. "The evidence indicates open competition significantly lowers rates. Open competition had a significant impact on lowering costs in Michigan," he says. Burton also feels Michigan's open competition system is quite efficient, adding "Michigan's benefits-to-cost ratio certainly looks fine. The bottom line is Michigan gets a lot of bang for the buck."[44]

Those who would urge a change to a monopolistic state fund, then, would trade a proven cost-saving mechanism—open competition—for a government mechanism that has not proven itself able to keep true costs below those charged by private insurers.

2. Control of assets in a state monopoly fund.

One issue that must inevitably arise in any proposal to create a state-controlled workers' compensation insurance fund concerns control of its assets and reserves. The most commonly held view is that assets should be held for the benefit of policy holders in the fund, as is the case with a mutual insurance company. In this view, surplus exists to assure the solvency of the fund and to avoid large rate increases following a year of abnormally high losses. Surpluses beyond those needed to support future growth and loss can be returned periodically to policy holders through dividends. Most states with state-controlled funds provide that assets and surplus are to be held for the benefit of fund policy holders. This protection is not only best for the policy holders, but it also helps to keep politics out of fund management, assuring well run, actuarially sound programs.

Inevitably, however, the presence of a large sum of money, at least nominally belonging to the state, will prove a tempting lure for state politicians. Again, we can find an interesting example in the Oregon experience.

Like Michigan in 1982, Oregon's primary industries were riddled by recession, and unemployment rose and state revenues dropped sharply. Unwilling to increase taxes or reduce spending, the Oregon state legislature found an escape in the form of SAIFCO. In 1982, the legislature appropriated $81 million of SAIFCO's surplus for the state's general treasury, a move challenged but eventually upheld in court. Coupled with SAIFCO's decision to write workers' compensation at below-market rates, this appropriation resulted in the inadequate surplus that has caused SAIFCO to increase rates by 50 percent since 1984.

Michigan officials have, from time to time, cast longing eyes on the Accident Fund's surplus. Accident Fund officials have claimed that in 1982 the attorney general offered to cease efforts to gain control over the Fund if Fund officials would turn $25 million of its surplus over to the state's general fund. Judge Stell's 1986 decision temporarily quieted talk of appropriating the Accident Fund's surplus, but if the state gains control of the Fund, this issue is likely to resurface the next time state government faces a budget crisis.

The availability of surpluses for appropriation by the general treasury remains for some a prime attraction of a state-controlled fund. In effect, however, such an appropriation would amount to a discriminatory tax imposed, retrospectively, on employers who bought insurance from the Fund. Further, as the Oregon experience illustrates, the long-term negative effects on rates and availability can quickly offset any temporary gain.

Even if a state fund's surplus and assets could not be spent for other purposes by the state, proponents of a state fund are often attracted by the possibility of state control of the fund's investments. Tax increases enacted by the Blanchard administration have eased Michigan's financial situation, and such talk has quieted. But in the early days of that administration, the Accident Fund surplus was mentioned as a possible source of investment dollars for a variety of public programs.[45]

While this type of political investing is not so threatening as outright state appropriation of funds, it is still inconsistent with the fund's responsibility to manage investments in the best interests of policy holders. It is questionable whether a private insurance company would be allowed to make unsound investments to meet political goals, and the same logic should apply to state insurance funds.

One of the problems with any state-controlled fund, whether competitive or monopolistic, will be the constant pressure to use the fund’s assets for purposes other than benefiting injured workers and employers who buy insurance from the fund. Court decisions in Michigan have temporarily eased this pressure. It is not far-fetched, however, to imagine the issue arising again. While such actions can yield short-term benefits, they violate policy holder’s trust and will tend to increase costs in the long run.

C. A Competitive Private Fund

The final option open to the Michigan legislature is to end the pretense of state control of the Accident Fund and support a move to make the Fund a private insurer.

1. The logic for a private fund

There is no strong argument for maintaining a state fund. Michigan has another mechanism—the Placement Facility—to serve as insurer of last resort. The other arguments commonly advanced in support of a state fund simply fail to hold up under close examination. A state fund does not lead to lower rates, either in a competitive market such as Michigan's or in a monopolistic market such as Ohio's. It does not increase the availability of insurance, and efforts to use its assets for political goals are likely to do more harm than good.

There is some evidence to suggest that in a setting of open competition the presence of a state workers' compensation fund has negative effects. Only three states—Michigan, Minnesota, and Oregon—have both open rating and state funds. In both Oregon and Michigan the presence of a state fund has been cited as causing a decline in the availability of insurance. Michigan's Accident Fund has never been under effective state control, but the state's efforts to control the Fund—unsuccessful though they may have been to date—appear to have chased insurers from the market.

In addition, political rate-setting can be detrimental because it interferes with a flow of information needed to make sound business and policy decisions. For example, the cost of workers' compensation, perhaps more than in any other insurance line, can be partially contained by loss control efforts. Each year, private insurers, employers, and the state spend millions to improve workplace safety and to educate and train employees in safe procedures. When prices for workers' compensation insurance are determined in the market, rising losses will increase prices and spur insurers and employees to spend more on safety. However, if prices are held artificially low due to political manipulation of rates, employers are sent the wrong signal. Their low costs tell them no further expenditures for safety are necessary. The bottom line is that political rate setting, by interfering with the market and the signals sent by rising or falling prices, can lead to less money spent on workplace safety at the times when higher spending is most needed. This misallocation of resources does not benefit employers in the long run, and it certainly does not benefit workers.

Assistant Attorney General Iwasko and Deputy Insurance Commissioner D'Annunzio[46], among others, have said that privatization would make the Fund liable for federal income taxes in every year since its inception. It is claimed that the Accident Fund's accrued federal tax liability would wipe out its entire surplus. The resolution of this question may have to come from the courts; it is important to note, however, that this view does not appear to have much support in the legal community at this time.

None of the currently existing 19 state workers' compensation insurance funds (including Michigan's) has ever been deemed subject to federal corporate income tax by either Congress or the Internal Revenue Service. Although no state fund has ever been turned over to the private sector, privatization of other government enterprises has not created federal tax liabilities for the period prior to privatization. Likewise, nonprofit organizations that have converted to for-profit organizations have not created tax liabilities for previous years by the act of conversion.

Although legislation to privatize the Accident Fund has been introduced in and passed the State Senate as early as 1979, the federal tax liability argument has been raised only recently. The argument cannot be disproved without privatization and a court battle, but if the attorney general convinces the legislature that privatization is too risky to attempt he will have achieved his apparent goal of defeating privatization, regardless of the validity of his argument. State policy makers themselves must weigh both the attorney general's views and the opposing opinions of several attorneys and legal scholars.

The Accident Fund has seen 75 remarkably successful years. The Fund's position as a quasi-state agency has given it three advantages.

First, by law it is the manager of the state's self-insured workers' compensation program for state employees, providing a steady base of revenue. Nothing, however, would preclude a private Accident Fund from continuing to service the state account. The Fund would, however, be required to compete for that account, perhaps saving the state money in the process. On the whole, it is doubtful that this advantage has offset the Fund's inability to compete for other large accounts with employees in other states: In this respect, privatization could improve the Accident Fund's efficiency.

Second, the Accident Fund is currently not subject to federal income tax, but would become so if privatized. There is, however, little reason to believe the Accident Fund's success would be significantly diminished by its liability for federal income taxes.

Third, any licensed insurance agent in Michigan can place insurance with the Accident Fund, without an agency appointment from the Fund. Other insurers are required by law to incur the expense of appointing and "disappointing" agents. Again, however, there is no reason to discontinue this arrangement if the Accident Fund were fully privatized. In fact, all private insurers could and should be granted that privilege, and the state should allow insurers to accept business from any licensed agent in the state.

Since the Accident Fund has always operated free from state control, it simply cannot be argued that its success—and appeal to employers in the market—has been a result of its status as a "state" agency. Since the attorney general's 1976 opinion, Accident Fund policy holders have regularly rallied to support the Fund's independence.

Privatization also appears to be the best mechanism by which to stop the ongoing financial hemorrhage in both the Accident Fund and the attorney general's office, resulting from a court battle with no end in sight. To those who believe the Accident Fund should be under state authority, such an argument may appear to place too little value on state sovereignty. However, since exerting state control over the Accident Fund is more likely to frustrate than achieve the government's aim of assuring affordable, available workers' compensation coverage, it seems the state would be wise to get on with the serious business of improving the state economy.

Privatization of the Accident Fund would:

• end a significant waste of state government resources,

• allow Michigan to realize the full benefits of open competition,

• be an important signal to the insurance industry that Michigan is serious about becoming a good place to do business,

• have the support of current Accident Fund policy holders, and

• cost state government nothing.

2. Privatization options

It should be recognized that the Accident Fund could be made independent without being fully privatized. The current statute could be revised to clarify the Fund's status and establish the Fund as a quasi-state agency indisputably governed by the Advisory Board and beyond the reach of state politicians. Section 24 of the Workers' Compensation Act could be amended to eliminate the commissioner's authority to use the Fund to "create competition."

This would be an improvement over the present uncertainty, but a significantly less than ideal solution. There appears to be no advantage to keeping the illusion of state control, and the possibility of renewed warfare over the Fund would remain so long as that illusion exists. The benefits of an independent Fund can best be achieved through complete privatization.[47]

Several proposals have been introduced to privatize the Accident Fund. The most recent is a package introduced in March 1987 by Senator Rudy Nichols. The Nichols bill would establish the Accident Fund as a private insurance carrier governed by its Advisory Board. The Fund would be subject to all laws applicable to mutual insurers. The Nichols bill would also repeal the existing law requiring that the state's self-insured workers' compensation plan be managed through the Accident Fund.

The Nichols bill, however, would not eliminate an important flaw in the current legislative environment. Rather than simply eliminate any reference to "creating competition," the Nichols bill provides that the Workers' Compensation Placement Facility should be the vehicle for such an exercise of the commissioner's authority. As has been discussed, this authority serves no purpose in a competitive, open rating system. This authority is, in fact, counterproductive, because it provokes private insurers' fears that the state will force actuarially unsound rates on the market or create a monopolistic fund—fears that keep insurers out of Michigan's market.

In any event, it is unlikely that the Placement Facility could ever successfully "create" competition, as it writes business almost entirely for poor risks, and its operations are subsidized by the very private companies with which it would compete.

IV. Summary and Conclusion

The Accident Fund was created in 1912 to provide workers' compensation insurance because no one knew if private insurers could or would provide such coverage, and because many felt that even if private carriers did enter the business, the state could offer the coverage more efficiently. These two assumptions have long since been proven invalid. After 75 years of experience, we now know that private insurance companies can and will write workers' compensation insurance. And although many state funds have proven quite successful, there is no evidence to suggest that a state-run fund is inherently, or even generally, more efficient than private insurers in a competitive marketplace.

Off and on since its inception, but in particular since 1976, Accident Fund officers and state government officials have battled over the degree of control the state should hold over the Fund. Since 1983, the dispute has spilled over into the issue of how best to provide effective open competition in workers' compensation. Evidence suggests that the presence or absence of a state-controlled fund will have little effect on rates in an open market. The presence of a state fund, however, does appear to have a negative impact on the number of competitors and capacity available in a market. Private insurers are reluctant to enter a market with a government carrier that may, for political reasons, write insurance at money-losing rates. Such a practice will lead to higher rates in the long term. Overall, it appears that open rating will be more effective in Michigan if the Accident Fund is privatized than if the status quo is maintained or if the state gains control of the Fund.

Maintaining the Accident Fund as a state agency subjects policy makers to constant temptations to use Fund assets for other purposes. This would be unfair to policy holders and injured workers and, when it has occurred in other states, has contributed to higher workers' compensation rates for employers seeking insurance after an appropriation.

The Accident Fund is not needed as an insurer of last resort. The state's attorney general and Accident Fund officers have spent upwards of $1 million in a fruitless struggle for power that appears to be damaging the state's business reputation and causing private insurers to leave, or refrain from entering, the Michigan market.

Privatizing the Accident Fund—severing its connections with the state and putting it finally on equal footing with mutual insurance companies—would improve the Fund's ability to service large accounts. It would stop the drain of legal fees on the state treasury. It would encourage more insurers to enter the Michigan market and would remove the barriers existing to the proper working of Michigan's open, competitive workers' compensation insurance market.

It is time to quit dickering over whether the Accident Fund is or is not a state agency and decide what it should be. The evidence suggests Michigan taxpayers would benefit most from a privatized Accident Fund.

About the Author

Bradley Smith is a health benefits consultant and has held positions in the insurance industry and with government agencies.

Published jointly by The Heartland Institute and the Michigan Research Institute. Nothing in this Heartland Institute/Michigan Research Institute Report should be construed as necessarily reflecting the views of The Heartland Institute or the Michigan Research Institute, or as an attempt to aid or hinder the passage of any legislation.

Copyright 1987 by The Heartland Institute. For additional copies or reprint permission, contact The Heartland Institute (59 E. Van Buren #810, Chicago, IL 60605; 312-427-3060) or the Michigan Research Institute (800 Michigan National Tower, Lansing, MI 48933; 517-374-9100).

Endnotes

1. Frank Nerat, Jr. "Precedent Pending, Unless Someone Speaks Up," Michigan Business, January 1987, p. 92.

2. Harry G. Iwasko, Jr., to Bradley J. Smith in telephone conversation March 24, 1987.

3. Tim Jones, "Classic Court Fight Pits State, Accident Fund," Detroit Free Press, August 6, 1984, p. A3.

4. Public Act 245, Section 2, adopted 1911.

5. Report of the Employers' Liability and Workmen's Compensation Commission, 1911, p. 26.

6. Ibid.

7. Public Act 10, Section l, enacted 1912.

8. Ibid., Section 2.

9. Ibid., Sections 4 and 5.

10. Report of the Employers' Liability and Workmen's Compensation Commission, op. cit., p. 26.

11. Ibid.

12. Public Act 10, op. cit.

13. Ibid, pp. 26-27.

14. Ibid, p. 27.

15. Public Act 206, Sections 9, 12, and 13, enacted 1917.

16. Amerisure Insurance Company et al. vs. Coleman, brief filed by Michigan attorney general y Circuit Court, August 29, 1986, pp. 25-26.

17. The history of Attorneys' General opinions can be found summarized in a number of briefs, memos, and releases of the Michigan Attorney General's office and the Accident Fund of Michigan.

18. Office of the Attorney General, 1975-1976, No. 5147, p. 695.

19. John F. Burton, Jr., Allan H. Hunt, and Alan B. Krueger, Interstate Variations in the Employers' Cost of Workers' Compensation, with Particular Reference to Michigan and the Other Great Lakes States (Ithaca, NY: Workers Disability Income Systems, Inc., February 1985), p. 53.

20. Frank Nerat, Jr. to Bradley Smith in a telephone conversation, April 24, 1987.

21. It should be pointed out that these three options assume the continued existence of Michigan's current workers' compensation system. Many would prefer some other form of state-provided health or welfare system to aid injured workers; others will argue that the workers' compensation statute should be abolished entirely and the cost for injuries borne by the injured parties, covered by other individual- or employer-provided insurance, or resolved through tort laws. Certainly other options abound. Here, however, we limit ourselves to discussing the Accident Fund under the current workers' compensation system.

22. The idea that competition consists of the state taking action to decrease insurance company profits has been sharply criticized. In a truly free market, profits are no concern of the state. It is quite possible for competition to increase profits--in a competitive market, insurers have incentives to economize their expenses, improve efficiency, and improve their product through, for example, greater emphasis on safety training. These steps could increase profits even as premiums decrease in a highly competitive market. Furthermore, some level of profit is needed to attract insurers to the market, which increases competition and the availability of coverage for employers.

    Nevertheless, every report on the state of competition in the market under commissioners Baerwaldt and Coleman has included a passage along these lines (quoted here from page 25 of Coleman's January 15, 1987 report): "Higher loss ratios would be the expected result of an increase in competition and lower rates, and lower loss ratios would be the expected result of less competition and higher rates." Generally speaking, all of these reports have emphasized reduced profits as the primary sign of a competitive market.

23. Jim Berquist to Bradley Smith in a telephone conversation, April 8, 1987.

24. Gary Raid to Bradley Smith in a telephone conversation, April 9, 1987.

25. Amerisure Insurance Company et al. vs. Coleman, brief filed by Michigan attorney general in Livingston County Circuit Court, October 6, 1986, p. 24.

26. Dominic D'Annunzio to Bradley Smith in a telephone conversation, March 12, 1987.

27. Fritz Lewis to Bradley Smith in a telephone conversation, March 31, 1987.

28. Public Act 8, Section 1, enacted 1982.

29. Harry G. Iwasko to Bradley Smith in a telephone conversation, March 24, 1987.

30. John Lewis to Bradley Smith in a telephone conversation, April 8, 1987.

31. Oregon Workers' Compensation Premium Summary, Calendar Year 1985, Oregon Workers' Compensation Department, December 1986, p. 5.

32. This summary of activities in Oregon between 1982 and 1987 is derived from conversations with SAIFCO manager Gary Raid, consultant John Lewis, Milliman & Robertson's Jim Berquist (who performed the independent audit of SAIFCO), and John Burton of Cornell University. Berquist notes, "I would hesitate to draw conclusions about Michigan based on the situation in Oregon." While it is certainly wise to consider differences of time and place, Berquist, who favors the existence of state funds, offered no reason to suggest Oregon's experience would not be relevant to Michigan.

33. Commissioner of Insurance, "Preliminary Report on the State of Competition in the Workers' Compensation Insurance Market," Executive Summary, January 15, 1987, p. 2.

34. John Burton to Bradley Smith in a telephone conversation, March 16, 1987.

35. Allan Hunt to Bradley Smith in a telephone conversation, March 16 1987.

36. Memo from Michael Shpiece to Elizabeth Howe, September 15, 1983.

37. How to Cut Workers' Compensation Costs in Michigan, United Auto Workers Community Action Program, 1981.

38. It is worth noting that all five of these states have significant mining industries. As discussed earlier, mining interests have tended to favor state-run workers' compensation funds. Traditional manufacturing states that have state-run funds, such as Michigan and Ohio, are something of an oddity.

39. Booz-Allen Consulting Actuaries, An Actuarial Audit for the Industrial Commission of Ohio, January 31, 1977, p. 1.

40. Ibid. at p. 14.

41. Arthur Anderson & Co., Bureau of Workers' Compensation, January 1980.

42. Coopers & Lybrand, Post Review of Actuarial Audit of the Ohio State Insurance Fund as of December 31, 1980, September 1981.

43. John F. Burton, Jr., Interstate Variations in the Employers' Costs of Workers' Compensation with Particular Reference to Ohio and Pennsylvania, January 1984, pp. 100-101.

44. John Burton to Bradley Smith in a telephone conversation, March 16, 1987.

45. In August 1983, the state attorney general ruled that the state does have an equity interest in the Accident Fund's surplus and assets. Tim Jones, in an article headlined "At Work on the State Accident Fund," (Detroit Free Press, September 25, 1983), gleefully discusses state efforts to gain control of the Fund: "Blanchard, recognizing the potential economic impact of its swelling surplus, moved in"; "the governor would like to invest [Accident Fund reserves] in his economic development programs"; and "officials interpret the law to give the state treasurer the authority to invest the funds. '1 convenient receptacle would be the Strategic Fund," Jones also quotes Treasurer Robert Bowman as saying, "If we did take some of the money... it would probably not be until the next calendar year."

46. Dominic D'Annunzio and Harry G. Iwasko, Jr. to Bradley Smith in telephone conversations. See also Sharon McGrayne, "Multi-Million Dollar Tax Bill for Accident Fund?" Crain's Detroit Business, March 30, 1987, p. 43.

47. Alternatively, the Fund could be abolished and its assets distributed to policy holders. Such a legislative move would surely be challenged in court, however, and the issue would remain unresolved.