State Fund Issues 2002 Financials, Discusses Reserve Estimates

July 23, 2003

California’s State Compensation Insurance Fund has issued its audited statutory-basis financial statements as of Dec. 31, 2002. Net premium written for 2002 was $5.3 billion, an increase of 49 percent from $3.6 billion in 2001. State Fund’s cash and invested assets as of Dec. 31, 2002, was $11 billion, or $2 billion more than State Fund’s carried reserve liabilities, net of reinsurance. State Fund’s investment portfolio consists entirely of high-grade fixed income securities. State Fund has no exposure to junk bonds or common stocks.

After significant rate increases, early evaluations of current year results have been positive, and State Fund expects current policies to make a positive contribution to surplus. Without substantive workers’ compensation reform, further rate increases are inevitable. The Workers’ Compensation Insurance Rating Bureau (WCIRB) has already indicated that another double-digit rate increase will be necessary effective Jan. 1, 2004. This trend is rapidly leading to an intolerable situation for California employers.

“California’s workers’ compensation system continues to be in crisis. State Fund did not create the crisis but we will continue to work very hard to remain an available market for California employers,” said State Fund president Dianne C. Oki. “We also continue to work cooperatively with the California Department of Insurance (“CDI”) on measures designed to reduce the volume of business we are writing and to increase policyholders’ surplus as part of a comprehensive business plan.”

State Fund’s capital position must be raised to support the amount of business it is writing. California needs capacity to return and if carriers again participate in this market, the growing premium pressure on State Fund will be reduced.

Growth in premium volume was caused primarily by severe contraction of the California workers’ compensation market since 1999, as 28 private carriers became insolvent and other carriers limited the amount of California business they write. As a result, thousands of employers turned to State Fund for coverage. This growth, in combination with benefit and medical cost increases, has generated significant financial challenges for State Fund.

PricewaterhouseCoopers (“PwC”), State Fund’s independent accountants, stated that in their opinion State Fund’s net loss and loss adjustment expense reserves should have been increased to $9.8 billion, or by $1 billion, from the $8.8 billion shown in the financial statements. The CDI concurs that State Fund should increase its reserves to the level estimated by PwC. State Fund does not agree.

State Fund estimated its reserves using actuarial methods and assumptions about medical and indemnity utilization and costs for as much as 30 years into the future using its best judgment and its significant knowledge and experience of California workers’ compensation insurance. Milliman USA – State Fund’s Appointed Actuary – issued its actuarial opinion in which Milliman stated that State Fund’s reserves were reasonable, in conformity with actuarial standards, and met the requirements of California insurance law.

“We take this issue very seriously,” said Oki. “Accordingly, we will be engaging another independent actuarial firm to provide additional analyses and advice as we reconcile the divergent estimates. Based on that independent supplemental review, we will make any appropriate changes to reserves in 2003.”

State Fund reported policyholders’ surplus at year-end 2002 of $1.45 billion. If reserves had been increased to PwC’s estimate, State Fund’s policyholders’ surplus would have been $450 million. Based on either reserve estimate, State Fund is solvent and, considering future investment income on its investment portfolio, has a significant solvency margin of anticipated cash flow in excess of estimated loss and loss expense payments.

“State Fund strongly supports the efforts to enact fundamental, systemic reforms, control and stabilize costs and to restore healthy competition to ensure the system works for all of its stakeholders,” said Oki.

State Fund’s officials concur that action is urgently needed to resolve the current crisis in California’s workers’ compensation system which serves more than half a million employers and 13 million workers.

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