THIS WEEK IN SACRAMENTO

PERSPECTIVES 2004

January 9, 2026

Looking forward to 2004

The unthinkable happened in 2004 - a second-term governor was dumped mid-term. Pundits are still pontificating about what the recall election means, especially for moderate Democrats whose constituents voted for Arnold Schwarzennegger and are frustrated with "business as usual." Many political observers expect the new Schwarzenegger Administration to upset how the Capitol works and finally begin working on the state's many festering and intractable problems.

Our assessment, however, is a bit more sanguine. Now that the initial shock of the recall election has worn off, partisan intransigence is rapidly replacing the short bipartisan honeymoon. The fact remains that most or a great majority of legislators come from absolutely safe legislative districts that were creatively drawn to protect partisan seats. No more than a handful of legislators are likely to be subject to the wrath of the "Governator's" shock troops if they don't fall in line with the Schwarzenegger agenda.

This is not to say the changing of the guard in the Capitol executive suite is not a good thing. We've all seen firsthand these last several years that one-party control, regardless of the party, leads to dangerous excesses. A Republican governor will be able to impose some discipline on the democratically controlled Legislature. We now have a veto strategy. However, the euphoria over the ability to be proactive legislatively has started to wane. It's going to be tough moving various reforms and important legislation through the Legislature. Progressive Democrats just don't agree with Governor Schwarzenegger on a lot of issues, and won't bend because they aren't worried about losing an election. This means the Governor is going to have to go to the more moderate voters via the initiative process for the "biggies" in his agenda. This process is expensive, complicated and uncertain. He won't be able to go back to this well too often.

Thus, our projection for next year and the years to follow is that while we will be able to stop the worst of the worst with a veto from the Governor, anything we want will have to come from old-fashioned hand to hand combat in the Legislature. In a way, it's still business as usual.

The following is a synopsis of the issues we expect to see next year.

Homeowners/Fire Insurance Issues

· Underwriting Restrictions: Legislation to restrict insurer underwriting flexibility and to strictly regulate the grounds upon which a policy can be non-renewed was defeated in the Legislature last year. We anticipate this issue to be back in 2004. Under existing law, insurers have no ability to adjust rates without prior approval of the commissioner. Restricting underwriting flexibility, combined with current prior approval laws as well, severely limits the ability of insurers to manage their loss exposure and creates a strong disincentive for insurers to write homeowners’ insurance in California.

· Credit Scoring: An attempt to prohibit the use of credit based insurance scores in rating and underwriting insurance risks failed last year. The Department of Insurance and consumer groups believe the use of credit in determining rates and insurability is inherently discriminatory and a form of "redlining." There have been several studies showing a correlation between a person's insurance score and their risk behaviors. Several insurance groups are willing to support a compromise based on a model law developed by the National Conference of Insurance Legislators (NCOIL) to ensure credit scores are used fairly and in a nondiscriminatory manner. We expect the Department of Insurance and consumer groups to continue to pursue a complete ban, increasing rates for many low risk policyholders.

· Loss History Reports: Legislation to restrict the ability of insurers to utilize prior loss history information from databases such as CLUE and APLUS in evaluating new risks will also likely be introduced. Information on the loss history of a property is actuarially relevant in evaluating the risk of future loss and in accurately rating a policy.

· Southern California Fires: Based on past experience with similar disasters, the recent devastating fires in Southern California are likely to result in legislative proposals on a number of issues. Many of the issues of concern that followed the Oakland Hills fire in 1991 were resolved with legislative and regulatory changes that were implemented after that disaster. For example, new disclosure requirements and policy choices were mandated. Nevertheless, legislation may be introduced dealing with issues related to the claims adjustment process, whether homes were adequately insured, additional living expenses, additional disclosures and loss valuations.

· FAIR Plan: As a result of the fires, legislators may once again focus on the California Fair Access to Insurance Requirements (FAIR) Plan. While the FAIR plan did not suffer significant losses, some have proposed expanding the area covered by the FAIR Plan. It is too early to tell whether the fires will result in any proposed changes to the FAIR Plan policy.

· Mold: Legislation was introduced last session to mandate insurance coverage for household mold, commonly referred to by trial lawyers and the media as "toxic" mold. That bill failed passage because legislators feared it may cause a further restriction in the availability of insurance. However, legislation enacted three years ago directed the Department of Health Services (DHS) to perform a study on mold standards. The study was never performed due to the state budget deficit. Insurers and other interested parties offered to help fund the study and met with the DHS earlier this year to discuss the proposal. However, to date no further action has been taken on the study. As the mold hysteria has started to wane, the allegations of severe health affects have largely gone unproven, and the number of lawsuits related to this issue have decreased. However, some trial lawyers have started raising concerns about alleged “bacteria” which may be generated when a home is damaged by water. It is likely that legislation will be introduced related to insurance coverage for “bacteria” and mold which may grow in a home as a result of a water claim. Trial lawyers view mold and bacteria claims as the new asbestos - one trial lawyer seminar on the topic was titled: "Mold is gold."

· California Earthquake Authority: Legislation may be introduced to modify the make up of the CEA Governing Board by increasing the number of voting members from three to five to include legislative representatives. Other more drastic changes to the structure and mission of the CEA could also be proposed. Unwise changes to the CEA could adversely affect the stability of the homeowners’ and earthquake insurance markets, and even jeopardize the tax-exempt status of the CEA. There has been no significant legislative change to the CEA since it was created in 1996, and it continues to be a source of controversy with some regulators, legislators and consumer groups.

Auto Insurance

· Mandatory Financial Responsibility: In 1997, then Assemblymember Jackie Speier authored AB 650, which required drivers to submit proof of financial responsibility (insurance) to DMV at the time of registration. To reduce the cost and fraud involved in drivers submitting paper proof of insurance, the DMV has been working with insurers on voluntary electronic reporting of policyholder information. As of November 2003, 18 carriers representing 55% of the auto insurance market are reporting their data electronically to the DMV. Senator Speier would like to enhance enforcement of the mandatory financial responsibility law by requiring all insurers to electronically report policyholder information to the DMV and mandate suspension of vehicle registration when insurance lapses or is cancelled. It is estimated almost 25 percent of California motorists are uninsured. The number is much higher in certain urban areas.

· Auto Body Repair: Legislation was enacted last year placing restrictions on insurer referrals of policyholders to auto body repair shops. The prior year, legislation was introduced that prohibited an insurer from having any ownership interest in an auto body shop. It was defeated in the Assembly. This issue will likely be back again, along with the issue of auto body repair shop fraud.

· Aftermarket Replacement Parts: In recent years, the use of non-Original Equipment Manufacturer (OEM) parts to repair damaged automobiles has become the subject of public debate. The Insurance Institute for Highway Safety has found that the source of a car’s cosmetic crash parts is irrelevant to crash worthiness. The real concern over cosmetic non-OEM parts is cost. OEM parts, if auto manufacturers are allowed to monopolize the market, will drive the cost of cosmetic parts much higher than they are today, increasing the cost of claims and, in turn, causing insurance premiums to increase. Despite studies to the contrary, there continues to be a belief that non-OEM parts are not as safe, nor do they fit as well as OEM parts. We expect legislation on contractual provisions and disclosures regarding OEM parts.

· Low-Cost Auto Insurance: In 1999, a low-cost auto insurance pilot program was established in Los Angeles and San Francisco Counties. Eligibility and the amount of premium are established by law. Legislation was enacted last year decreasing the annual premium to $347 in Los Angeles and $314 in San Francisco. In addition, eligibility was expanded to families with an income at 250 percent of the federal poverty level, or about $44,500 for a family of four. As of June 2003, 4,999 policies have been sold and only 2,503 are currently in force. The renewal rate is only 23 percent. Despite the apparent failure of the program, there may be an effort to expand the pilot project to other counties or even statewide. In addition, there may be an effort to increase the "affordability" of the low cost policy by requiring other insured drivers to subsidize the product.

· Persistency: Legislation was enacted last year to allow drivers to keep their persistency, or "loyalty" discount for being previously insured even when they change companies. The legislation was necessary to counteract recent Department of Insurance regulations to the contrary. The Foundation for Taxpayer and Consumer Rights has recently filed a lawsuit contending the new law violates Proposition 103. Depending on the outcome of the case, we could see further legislation related to this subject matter.

· Definition of Agent/Broker: Mercury Insurance and the American Agents Alliance is supporting AB 1297 (Frommer), which is still before the Legislature, to clarify issues regarding defacto agency that became evident as a result of the Krumme litigation. The purpose of the bill is to eliminate ambiguity over whether an insurance producer is acting as a "broker" to an insurance consumer, or as an "agent" of an insurance company. Opponents of the legislation are concerned because they believe it would lead to imposition of administrative or legislative caps on broker fees. Negotiations between supporters, opponents and the Department of Insurance are continuing.

The Business of Insurance

· Community Investments: There are community activists and other critics that believe the insurance industry should be "doing more" to invest in low-income communities – like banks have done under the Community Reinvestment Act (CRA). Assembly Insurance Committee Chairman Juan Vargas and Commissioner Garamendi both continue to have a strong interest in this issue. Some argue the California Organized Investment Network (COIN) has been and continues to be ineffectual in increasing the level of community investments by insurance companies. There is an ongoing need to educate these critics and members of the Legislature that insurers are not banks and do not invest like banks. Insurance companies have strict investment rules to prevent insolvencies. The industry must continue to dialogue with the Commissioner to fix the inconsistency between the desires of COIN and the regulatory requirements of the Financial Analyst Division to monitor and limit the types of investments that insurance companies make.

· Premium tax increase: There may be an effort to increase the insurance premium tax. This tax is the fourth largest source of state general fund revenue behind such major taxes as those on income, sales, and banks and corporations. The California Constitution sets the gross premium tax rate for insurance companies at 2.35 percent, although that rate can be changed by a two-thirds vote of the Legislature. Because the rate is levied against the gross premiums of an insurance company (as compared with taxation of other businesses that is based upon net income), the insurance industry bears a tax burden that far exceeds that of other California businesses. At times, the effective rate of taxes on insurers has been double that paid by other businesses. In addition, any increase in the California premium tax would result in other states imposing "retaliatory" premium tax increases on California domiciled insurers doing business in those states.

· Limits on Department of Motor Vehicles fees: The DMV has over the last few years attempted to increase fees on insurers for accessing DMV records and services. These fees are well in excess of actual costs, and thus violate the "in lieu" provisions of the California Constitution. We expect DMV to continue to view insurers as a source of general revenue, thus indirectly increasing premiums for drivers.

· Privacy: After four years of intense struggle and negotiation, California adopted SB 1 (Speier), one of the toughest privacy laws in the nation. However, Congress has preempted the law. In addition, prior to the enactment of SB 1, the Department of Insurance adopted privacy regulations that now conflict with state and federal law. We expect further legislative and regulatory action given all the turmoil and confusion in this area.

· Federal Regulation of Insurance: There is an effort by some insurers and members of Congress to eliminate the existing structure of state regulation of insurance and replace it with federal regulation, or a hybrid system such as an optional state and federal charter. While this is not necessarily a state legislative issue, California insurance regulators and policymakers will be engaged in the debate, and implementing legislation may be necessary.

· Licensing Categories: There has been an effort in the last few years to extend regulation to all persons selling insurance, not just traditional agents and brokers. This includes licensing company employees who transact insurance, rental car and credit insurance agents, and those who sell insurance for telecommunications products. This trend of expanding licensing regulation may continue. However, businesses and groups selling marginal insurance products will probably introduce legislation to exempt their industry from licensing requirements.

· Insurance Regulation Reform: The enactment of Proposition 103 in 1988 has spawned an unwieldy and unresponsive regulatory structure. Consumer groups argue Proposition 103 has lowered insurance rates. There is consensus in the business and insurance community, however, that the expensive and slow rate regulation process imposed by Proposition 103, and the huge bureaucracy at the Department of Insurance, has actually decreased competition, slowed innovation, and kept premiums high. If turmoil in the insurance marketplace continues, there may be an effort to give voters the option of revising some of the more egregious portions of Proposition 103. This must necessarily be an initiative effort as the Legislature cannot directly reverse or modify the initiative, except to clarify ambiguous portions of the law.

· Home Warranty Insurance: There is an ongoing effort by financial services companies to avoid regulation by the Department of Insurance. By avoiding regulation, the cost of the product is decreased. However, some of the consumer protection achieved by regulatory oversight is also lost. The Insurance Code regulates home warranty insurance. However, some companies are trying to provide similar products using warranty law, thus changing the competitive landscape for a similar product. Retailers and service contract firms are trying to obtain an exemption from selling what essentially amounts to home warranty insurance by classifying such products as extended warranties. Bills on this subject have been defeated each of the last three years. However, we expect another try in 2004.

Tort Related Issues

· Unfair Competition Lawsuits: We anticipate legislation to reform Business & Professions Code §17200 to be introduced again in 2004, although there is little hope on the part of the business community that substantive reform can be achieved in the Legislature. Section 17200, the "Unfair Competition Act," allows trial lawyers to file lawsuits for anything they deem "unfair," even if they don't have a client and are instead representing the "public interest." Bills offering substantive reform are routinely killed, and this past year trial lawyers sponsored legislation offering a few weak reforms. These bills were also unsuccessful. Consequently, this issue will probably be decided at the ballot box through an initiative.

· Expansion of Hospital Lien Rights: SB 494 (Escutia), which is pending in the Assembly Health Committee, would expand the amount hospitals could recover from third party tortfeesors who may be responsible for injuries to a person treated by that hospital. The bill is opposed by the insurance industry because it will increase claim costs. This bill sponsored jointly by the trial lawyers and hospitals will most certainly return next year.

· Construction Defect Liability: Soaring construction defect liability costs have resulted in a severe shortage of construction defect liability insurance coverage. As a result of these costs, construction of new condominiums and other affordable housing in California has all but stopped. Recent reforms have done little to address the problems with the current system, in particular the liability exposure for subcontractors. Legislation will likely be introduced on this subject again in 2004.

· Confidential Settlements and Documents: We expect the trial lawyers to continue their effort to make confidential business documents public whenever litigation is initiated and to prohibit "secret" settlements. These efforts, under the guise of "full disclosure" merely encourage mass claims and fishing expeditions by trial lawyers if certain protections for legitimate privacy issues are not maintained.

Life, Health & Disability Insurance

· Health Insurance Rate Regulation: There is an effort underway to impose Proposition 103-style rate regulation for health insurance. Now that employers are mandated to provide health insurance pursuant to SB 2 (Burton), consumer groups argue the cost of that insurance should be regulated. Our experience with Proposition 103 is that it increases regulatory costs, decreases competition and provides little consumer benefit other than to provide a source of revenue to a cottage industry of consumer groups involved in rate filing litigation and proceedings.

· Sale of Annuities to Seniors: There has been an increase in the number of complaints regarding attorneys and insurance agents involved in establishing trusts and selling annuities to seniors. Many legislative proposals are draconian in nature, such as simply banning the sale of annuities to seniors or imposing such severe limitations on dealing with these products that compliance is prohibitively expensive. Despite comprehensive legislation last year, SB 620 (Scott), this continues to be a hot-button issue that will garner continued legislative interest.

· Suitability Standards for the Sale of Annuities: The National Association of Insurance Commissioners ("NAIC") has just adopted a model regulation establishing standards for insurers and agents in determining if a particular annuity is a suitable product for a senior. Many insurers believe the model regulation went too far. Insurance Commissioner John Garamendi does not believe it goes far enough, and voted against the model regulation at the NAIC. We expect insurers and the Department to sponsor competing versions of the NAIC model suitability law.

· Life Settlements: Last year the Department of Insurance sponsored AB 1103 which proposed to apply California statutes regulating viatical settlements to life settlements as well. In response to AB 1103, there will be an effort this session to create an entirely new and separate regulatory structure for life settlements. Life settlements involve the assignment of life insurance policies for financial planning purposes, but are different than viatical settlements because they do not involve terminally ill policyholders and they only involve institutional investors.

Workers' Compensation Insurance

Governor Schwarzenegger has called a special session on workers' compensation insurance reform, formally referred to as the Fourth Extraordinary Session. The benefit of a special session is the normal procedural rules do not apply, thus allowing for the expedited passage of important policy initiatives. Bills introduced in the special session do not have to wait 30 days to be heard and votes can be taken immediately in recognition of the crisis at hand.

The Governor introduced a single comprehensive bill to reform the workers' compensation insurance system. The bill, 134 pages long, was introduced in the Assembly as ABX4 1 by Assemblyman Abel Maldonado (R-Santa Maria) and in the Senate by Senator Chuck Poochigian (R-Fresno) as SBX4 3. Both bills are identical and have numerous Republican co-authors.

According to the Administration, the goal of the legislation is to bring California's premium costs in line with what other states are paying. California employers pay on average $5.85 in workers' compensation insurance premiums per $100 in payroll, compared to the national average is $2.46. In addition to the approximately $5-6 billion in savings from AB 227 and SB 228, this year's reform package, another $11 billion will have to be taken out of the system to meet this goal. The bill's authors, however, acknowledge that none of the reforms in the bill have been "costed out" yet, and the $11 billion in savings is a goal, not an estimate of actual savings.

Republican legislators were ready to immediately vote for the bill. However, Democratic legislators were openly skeptical of taking another $11 billion out of the system without harming injured workers. While they voiced their general support for the Governor's proposals and desire to work with him, they said there were many unanswered questions that would take time to sort out.

Insurance Commissioner John Garamendi says he generally supports the Governor's proposals. However, he is urging a two-step approach. He recommended the Legislature immediately pass a bill to correct technical errors in AB 227/SB 228. He said without the technical clean up, the cost savings which he based his 14.9 percent pure premium advisory rate cut would not be realized.

As far as the Governor's proposal, however, he urged a "go slow" approach. He said the measure was so comprehensive it would be better to move slowly and get it right rather than to move quickly and make errors. He said the strategy should not be "ready, fire, aim." Republican legislators generally reject the Commissioner's recommendation. They argue most of the provisions in the Governor's proposal are not new concepts and have already received a hearing in the form of other bills.

In a confirmation of the labor/applicant attorney strategy, labor and applicant attorney representatives have been arguing there isn't a workers' compensation insurance crisis, but an insurer crisis. They point out the repeal of the minimum rate law and the creation of the treating physician presumption at the request of employers and some insurers in 1993 are now credited as one of the reasons for today's problems. Thus, they argue that the current legislation should not be rushed so similar mistakes aren't made. They also argue that rates should be regulated to ensure insurers pass on savings to employers.

The Commissioner's and Democrats' "go slow" approach appears to be winning out as the Special Session on Workers' Compensation Insurance drags into the holiday season. Although several hearings were held on the Governor's plan, there was little progress made toward any legislative solution. All the interest groups and partisan legislators kept to their traditional scripts, leading desperate employers to fear a fast legislative solution to the ongoing workers' compensation insurance crisis is starting to slip away.

The Administration has seen the writing on the wall. In response to questions from Senator Alarcon, an Administration representative in one of the most recent hearings said the Governor prefers fast action since most of these issues were discussed earlier in the year. However, he said he recognized the issues are complex and wanted to work within the legislative process.

Senator Alarcon asked if it was acceptable to work on moving a bill with technical fixes to AB 227/SB 228 immediately, with a broader 2^nd phase reform bill by the Commissioner's suggested date of March 31. The Administration official agreed to this time frame, causing many to wonder what the point of a special session was in the first place. Few believe the warring parties will agree to the Governor's major reforms by March, and expect the issue to drag on through the summer and to the end of the legislative session as is usually the case. It now appears the legislative committees hearing this issue will adjourn for the year without taking any action on a cleanup bill.

The Governor's proposal contains the following provisions, along with the justification for those provisions:

Protecting Injured Workers:

· Bringing Permanently Disabled Worker Benefits Up To the National Average. Under existing law, California’s benefits will increase over the next three years as a result of the passage of AB 749 (2002). The legislation will fully fund those increases without premium increases. Additionally, this proposal goes one step further. If the California workers’ compensation system costs are brought down to the national average, then an additional benefit increase will go into effect for the most severely injured.

· Ensure that Injured Workers Receive the Treatment Mandated by Professional Guidelines. Last year’s legislation established a system that attempted to provide injured workers treatment according to established medical guidelines. However, real savings could be illusory as a result of ambiguities. This measure will address those flaws.

· Mandated Objective Medical Findings. This concept requires awards to be based on objective medical findings which will ensure that workers receive benefits appropriate to their injury.

· Make the System Fair. Today’s system is too arbitrary and subjective - meaning workers with similar injuries may have vastly different awards. This proposal mandates the use of nationally recognized guidelines for physical impairment, like the American Medical Association guidelines, to assure reasonableness and improve consistency of awards.

· Resolve Claims Quickly. This bill will define "permanent and stationary" conditions of injuries so that claims cannot continue unresolved.

Expand Use of Existing Cost Saving Techniques:

· Expand Use of Dispute Resolution. Allow all employees and employers to utilize the cost-effective Alternative Dispute Resolution (ADR) program currently available to the construction trades.

· Clarify the "Cure and Relieve" Standard. In some instances, the "cure and relieve" standard has been used to justify questionable treatment protocols. This bill would clarify that the "cure and relieve" standard requires medically necessary treatment. This definition of "cure and relieve" is currently being used by some employers involving represented workers to reduce workers’ compensation costs.

· Option for Consolidation. This proposal would allow employers that choose to provide health coverage to utilize that system, with its accompanying protocols, to treat injured workers. This optional program could reduce the cost of running two concurrent medical healthcare systems.

Bringing Common Sense Back to the System:

· End the Ability of Workers to Receive More than 100% Benefit. Bring rationality to the disability award system so that a worker cannot receive multiple disability payments totaling more than 100%.

· Limit System to Work-Related Injuries. Ensure that cumulative injuries are work-related by applying the "predominant cause" standard to cumulative injuries. For other specific injuries, apply a 10% standard.

· Ensure that Determinations are Medically Sound. Require a physician to make a permanent disability determination and limit the use of doctors who are mutually agreed upon for 1 year after injury.

· Reduce Excessive Penalties. Limit penalty awards to that portion of the late payment in question and require penalty claims (Labor Code 5814 claims) to be filed in a timely manner.

· Prison Reform. Prohibit prisoners from receiving workers’ compensation.

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