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

The statement continued that 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 knowledgeof California workers compensation insurance.”

According to State Fund, Milliman USA, in its actuarial opinion, stated that State Funds carried reserves “were reasonable, in conformity with actuarial standards, and met the requirements of California insurance law.”

PwC, however, explained in its audit report that its higher estimates were derived using “several additional actuarial methods including an incurred loss development methodology.” The report continued that State Fund has consistently relied on “paid loss development and Milliman USA methodologies to estimate loss and loss expense reserves.” Paid loss development is not affected by changes in case reserve adequacy, PwC noted in its report.

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 departments exam was also conducted during the same time period as PwCs in 2002.

A PwC spokesperson said the company could not comment on the situation. Calls to State Fund were also not returned at press time.

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.”

He continued that the difference would be less so in, for example, automobile claims in a state like Illinois where the court system is stable. “What ends up happening, particularly in a residual market, you can tend to get pretty dramatic swings in this case reserve adequacy issue, which could throw off the incurred method, but which would not effect the paid method.”

This could make the case-incurred method “challenging,” he continued, because “as the State Fund grows, and the claims staff gets strained by the workload, they may be unable to have accurate estimates for a particular year on the value or payment of all the workers' comp cases.

On the paid side, he said, “you have similar challenges” because as the State Fund grows, “what tends to happen is the paymentsas a percentage of what ultimately gets paid outcan drag a little bit for similar reasons, which is that the size of the staff doesn't grow consistently with the size of the Fund.”

In this case, he said, you could have paid loss methods that could lag and then have a period of catching up.

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 that he would construct a plan to address State Funds “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.

“The most important part to [Mr. Garamendi] is that there is a conference committee that will convene in the next couple of weeks to take up workers' comp and they must give us some substantial reform,” he said.

On July 10, the Assembly Insurance Committee and the Senate Industrial Relations Committee moved all pending workers' comp billsabout 20to 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.” This way, he said, the “good ideas will be considered and we hope that sufficient reform is put into place.”

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.

Mr. Williams said the department worked cooperatively with State Fund on the plan, adapting it over time.

Mr. Williams continued that he could not comment on what recommendations Mr. Garamendi might make in the future, but reiterated that the department has been working with State Fund on the guidelines.

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 Aug. 5.

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.”

State Fund said Mr. Garamendi's threats to “usurp control” from its board of directors and management were improper because it believes that RBC statutes don't apply 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.”

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, July 28, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.