It’s not often that a major U.S. corporation blames lower net income on workers’ compensation claim costs — and in a single state, to boot. But that’s what Costco CFO Richard Galanti did in the second quarter of fiscal 2003: despite an 8 percent increase in net sales from the previous year’s second quarter, net income was down 5 percent because of a pretax charge of $26 million that had been set aside to absorb projected workers’ comp expenses in California.
While the Golden State represented just over a third of Costco’s U.S. operations, it accounted for almost three-quarters of its workers’ compensation costs, “even though the types of injuries and their frequency and severity in the state were no different when compared with the 37 other states in which we did business at the time,” says Galanti.
Galanti says the average claim in California was more than two and a half times higher than the average in other states. “It worked out to an additional $30 million in just one state for just one policy year,” he says. “The system was set up for abuse.”
Insurers felt the pain as well. Twenty-eight companies went bust, according to the California Division of Workers Compensation, while those remaining either pulled up stakes or pulled back their capacity to write business. Their departure left the California State Compensation Insurance Fund, the so-called market of last resort for acquiring workers’ compensation insurance, owning a 52 percent market share in 2003.
The lack of insurance competition, among other factors, forced many companies to reconsider whether and how to do business in California. “We saw costs rising 22 percent a year,” says Robert Edwards, executive vice president and CFO at $43 billion Safeway Inc., the Pleasanton, California-based grocery retailer. “We’re headquartered here, so there was no way we could just close our 530 California stores and move elsewhere. But we did think very hard about our resource allocation in the state — the return on investment from further expansion or upgrades to existing stores.”
Costco faced the same dilemma. “We couldn’t take our retail locations out of the state, but there was no way we could continue to invest in our stores with these costs spiraling out of control,” Galanti says.
Employers were so rattled by the system’s inequity that they began to cry foul. Their pleas attracted the attention of Arnold Schwarzenegger, then considering a run for the state’s highest office. As improbable as it may sound, Schwarzenegger made workers’ compensation reform a major pillar of his gubernatorial campaign.
Once elected, Schwarzenegger came through on his pledge, signing a series of legislative reforms beginning in 2004 and continuing to the present that have reduced average rates by almost two-thirds (from $6.46 per $100 of payroll in 2003 to $2.44 per $100 of payroll in 2007), according to the Workers Compensation Insurance Rating Bureau of California.
Costco, Safeway, Walt Disney, Marriott Hotels, and other companies proved that a recalcitrant legislature can be compelled to take action if the chorus of voices is loud enough and the message is consistent. When California lawmakers balked at reforming the system, employers bypassed them and began collecting signatures on three petition initiatives that put workers’ compensation reform on the ballot for a statewide vote.