In a scathing report released this week, California Department of Insurance Commissioner Steve Poizner slammed the state's workers' compensation fund -- known as State Fund -- stating that the organization contained "serious structural and operational issues."

Created by the California Legislature in 1914, State Fund describes itself as "a nonprofit, self-supporting, fairly competitive public enterprise that guarantees a permanent workers' compensation insurance marketplace for California employers." It has approximately 220,000 policyholders.

The review marks the culmination of an intensive review and investigation that began back in the spring of 2007. Ordered by Commissioner Poizner, the audit included both an operational review and a financial examination. It looked at governance and management practices, group association programs, information technology, district offices and claim processing centers -- including an initial operational review of four district offices and three claim processing centers-- and business services.

Poizner's report contains everything from management conflicts of interest to an out-of-control budget at the state-run organization. It reveals a company that lacked oversight and the ability to govern itself through established and appropriate business procedures, which frequently resulted in the payment of millions of dollars in penalties.

Other objections noted in the report included:

The State Fund board of directors lacks sufficient resources to provide the oversight necessary for an insurer of State Fund's size and complexity.

Management structure is inadequate and lacks several key positions, including: Chief Financial Officer, Chief Operating Officer, Chief Information Officer and Chief Investment Officer.

Potential conflicts of interest with two past members of the board of directors. State Fund paid in excess of $500 million in group association administration fees from 1997 through Jan. 2007. Of this amount, more than $140 million was paid to an entity controlled by a person who was a board member from 2003 to 2006. In addition, more than $125 million was paid to associations with whom another past board member had a business affiliation. Group administrative fees paid to associations were incorrectly classified as legal and auditing fees in State Fund financial statements. This classification was misleading to users of the financial statements.

Lack of controls over material expenditures and IT systems.

The audit also noted several other troubling details about State Fund's operations, including that the organization:

Paid $19.5 million in penalties (from Jan. 2007 to July 2007) due to late payments on medical bills and indemnity bills.

Maintains a significant reliance on IT vendors. State Fund currently has approximately 200 outside IT consultants, at a cost of approximately $321 million since 2004.

IT internal control deficiencies were noted in IT governance, logical security, and computer operations.

Allowed inappropriate access of lower level employees into IT systems, such as the organization's Oracle payments system.

Paid invoices without a purchase order or contract.

There are more than 2,000 fleet vehicles for a total of 8,000 employees. In spite of the significant cost of acquisition and maintenance of this vehicle fleet, State Fund has not performed an audit of fleet management since 2003.

Has not performed adequate background checks on IT vendors to ensure the legitimacy of the vendor. During the examination, background research was performed on certain State Fund vendors, which revealed that one vendor, while working as an insurance lobbyist, was convicted of a felony in 1993.

State Fund engaged in inappropriate business practices that allowed additional expenditures to be made to vendors which were outside of the Board approved budgetary process. This practice allowed State Fund to purchase goods or services, and make charitable contributions, which were neither known nor approved by the board.

Has no established procedure to ensure that company-issued equipment, property, or records are returned upon an employee's termination or resignation. Due to these lack of controls, terminated employees may still have access to State Fund systems.

Had inadequate oversight of the group administration fees. In some cases, little-to-no safety services, or any other services, were provided to the members of the associations being paid these administrative fees. Although the standard contracts authorized State Fund to audit the use of these fees, no audits were ever performed. Further, despite the magnitude of these expenses, these agreements did not require board approval.

"Our thorough, top-down review of the State Fund revealed what we expected -- serious structural and operational issues," said Commissioner Poizner, in a release. "Fortunately, we have identified important issues, communicated our recommendations, and we expect that the State Fund will continue to work to make necessary reforms. As State Fund regulator, I will continue to monitor their activities and work with them. Given its size, the company's fiscal health is integral to ensuring a healthy and competitive workers' compensation marketplace."

More information is available at www.insurance.ca.gov.

Interested in more workers' compensation news and in-depth articles? Head over to Claims' workers' compensation channel for more information.

Special Reports /

Calif. Insurance Commissioner Slams State Fund

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