$1B Shortfall Is Calif. State Fund Worry

"It's not uncommon for there to be differences of opinion over reserves," noted Jim Zelenski, State Fund spokesman. "The bottom line is that Milliman said that our reserves were reasonable and met the requirements of California insurance law and actuarial standards."

The State Fund said in a July 22 statement that it had issued audited 2002 financials and that PwC stated in its opinion that State Fund's net loss and loss expense reserves should have been increased to $9.8 billion from the $8.8 billion shown in the financial statements.

"The California Department of Insurance concurs that State Fund should increase its reserves to the level estimated by PwC. State Fund does not agree," a State Fund statement said.

State Fund added that it 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?of California workers' compensation insurance."

PwC, however, explained in its audit report that its higher estimates were derived using actuarial methods that differed from Milliman.

Norman D. Williams, a spokesperson for Commissioner John Garamendi and the California Department of Insurance, told National Underwriter, "Our own exam concurred with the PwC audit in that they needed to increase their reserves by $1 billion. And our exam is very similar to an audit." He added that the department's exam was also conducted during the same time period as PwC's in 2002.

Jim Bartie, vice president and senior analyst with Moody's in New York, explained that typically several methodologies are used by actuaries to come up with their results.

"We can all probably be pretty sure that each of the firms looked at multiple methods and so it becomes a question of which method you put more reliance or credibility in," he said. "There are reasons on both sides to want to use one method versus the other."

Particularly in a line of business like workers' compensation, and in a state like California, he noted, the methods can produce "pretty dramatic differences, as far as answers."

What affect would a shortfall of $1 billion have on the California workers' comp market? "Ultimately that shortfall has to be reflected in premium rates," Mr. Bartie said. "That's probably the short-term effect–that premium rates would be pressured to be higher."

Commissioner John Garamendi said in a statement he would construct a plan to address State Fund's "immediate problems." He also said that, by July 29, he will notify State Fund "of the steps it must take to address its reserve shortfall," adding that the department looks forward "to a cooperative effort with the board and management."

Mr. Williams declined to say what type of recommendations Mr. Garamendi might make. "The plan that we work with State Fund to put together, by law, is a confidential plan. So I can't discuss what it may entail," he said.

He said that the issue with State Fund "illuminates the need for system reform," and that State Fund's condition will not be resolved until the workers' compensation system is reformed because costs are too high.

On July 10, the Assembly Insurance Committee and the Senate Industrial Relations Committee moved all pending workers' comp bills?about 20?to a bipartisan Conference Committee that will consider broad reforms to the system.

The panel, he said, consists of three Assembly members and three Senate members, who will "take all of the good ideas from the bills and put them together in a piece of legislation."

In the meantime, he said, Mr. Garamendi wants to see that State Fund is operating and that reserves are adequate. "The reserves are very troubling," he said. "One billion dollars is a lot of money and this is something we've been working with State Fund on since Mr. Garamendi took office."

Early in March, Mr. Garamendi also devised a plan with the State Fund to address some of its financial problems, noting that its premium writings had grown too rapidly because of reduced business in the state by private insurers.

Specifics of the plan included putting through a rate increase, reducing broker commissions and scrutinizing business submitted by brokers as well as putting stronger underwriting practices in place.

Meanwhile, a legal action filed by the State Fund accusing the Department of Insurance of improper efforts to control its operation is on hold until a hearing scheduled for early August.

In a statement announcing the lawsuit filed in the state Superior Court in San Francisco on May 27, State Fund said its complaint seeks to "clarify [the commissioner] and CDI's authority as well as to determine the applicability of risk-based capital statutes to State Fund."

"I really can't comment" on the lawsuit," Mr. Williams said. "There is a hearing scheduled for Aug. 5 at which point they will hear State Fund's injunction and also our demur on that issue."