adjustercom.com Exclusive: SCIF Letter Provides Details to Recent Rating News
By Robert Warne - May 3, 2002There's been substantial ink generated over A.M. Best Co. downgrading State Compensation Insurance Fund from a B+, very good to a B-, fair, April 30.
The rating company said it downgraded the Fund's rating because of its substantial growth in the California workers' compensation market.
The following day the Fund said it no longer wished to participate in the rating process, prompting A.M. Best to withdraw its rating.
The letter below was obtained by adjustercom.com May 3. In it the Fund addresses recent concerns about its growth and rating status.
SETTING THE RECORD STRAIGHT ABOUT STATE FUND
May 2, 2002
Dear Producer:
You are no doubt aware that State Fund remains a focal point of ongoing discussions
about California's workers' compensation insurance system. You may also have
heard reports about our financial strength.
As your business partner, State Fund believes you deserve the complete picture.
We want you to know that you can count on the same service, strength and stability
you've always received. Moreover, we want to allay any concerns stemming from
rumors or misleading press coverage.
Following A.M. Best's announcement that they were lowering our rating from
a B+ (Very Good) to a B- (Fair) this week, we have withdrawn from further participation
in their rating process. This decision was consistent with our withdrawal from
the Standard & Poor's Rating Service. Our current A.M. Best rating is NR-4,
not rated.
A.M. Best is understandably concerned over the volatile conditions in the California
workers' compensation market and the impact those conditions have had on State
Fund. State Fund's job is to be the shock absorber in the system. Our mission
is to guarantee the availability of workers' compensation insurance for employers,
to provide coverage at a reasonable cost, to operate as a prudently financed
insurance company, and to assure a competitive workers' compensation insurance
market. In ordinary times these are not incompatible goals. But these are not
ordinary times.
When over 25% of the private market disappeared into insolvency or regulatory
supervision, State Fund was faced with a challenge. We could have decided to
limit the amount of business we wrote. That is what a private carrier would
have done and many did. We could have decided to raise prices faster than we
did. That is what a private carrier would have done and many did. And it was
appropriate for private carriers to take these measures.
But State Fund is not a private carrier. We remain an available market. We
increased prices, but tried to do it in a way that made sense to our customers.
And as private carrier after private carrier either fell by the wayside or stood
by the wayside, we began to grow: 44% in 2000 and 108% in 2001. This of course
taxed our human resources, and it taxed our financial resources as well.
Let us be clear about our financial position. At yearend 2001 we had assets
of $9.6 billion and liabilities of $8.1 billion. The difference ($1.4 billion)
was policyholder surplus. We were not insolvent at yearend 2001; we were $1.4
billion solvent.
But insurance is a risky business and it is not enough for an insurance company
just to be solvent. Insurance companies are expected to maintain a cushion of
policyholder surplus over and above their known liabilities as protection against
the very real risks insurance companies are subject to (more on that later).
How much surplus is enough? Several years ago the National Association of Insurance
Commissioners addressed this question with the development of a Risk Based Capital
(RBC) system. The underlying principle was that the amount of surplus a company
is required to have should be reasonably related to the amount of risks it is
subject to. For example, a company writing products liability insurance is subject
to greater risk than a company writing homeowners insurance; therefore the products
liability company should be required to maintain a greater cushion of surplus.
Under the RBC system each insurer has a calculated risk based capital requirement
based on its own unique mix of risks; and the risk based capital requirement
changes over time as a company's risks change. As of yearend 2000, State Fund
surplus was $462 million above the RBC requirement and our available capital
was $1.4 billion. After premium growth of 108% in 2001, our RBC requirement
as of yearend 2001 was $1.556 billion; and our available capital (still $1.4
billion) was now 8% below our RBC requirement. To put some perspective on this,
with earned premium of $3.6 billion in 2001, if we had been more profitable
in 2001 by an amount equivalent to 3.5% of premium, we would have met our yearend
2001 risk based capital requirement. We see this as a manageable challenge.
There are three principal risks that an insurer is subject to. The first is
that the amount it has set aside to pay claims will turn out not to be enough.
The second is that the price it is charging on current policies will not be
enough to pay claims and expenses on those policies. And finally there is the
risk of a major catastrophic event. In California this would be a major earthquake
during working hours, and now we must also take into consideration the possibility
of a terrorist event. This is the bad stuff that can happen to an insurance
company, and it is surplus that allows an insurance company to withstand such
contingencies.
With our premium doubling in 2001 and our surplus staying essentially flat,
it means that our surplus is spread more thinly and there is less protection
against the bad stuff. It does not mean that we are not able to pay claims,
that our rates our inadequate or that we could not withstand a catastrophic
event such as an earthquake. The lack of availability of terrorism coverage
is a major issue for all companies.
The need for additional capital is real; and neither the NAIC RBC system nor
A.M. Best are the enemies here. But both of these entities are one-dimensional,
focused on capital adequacy. Our job as outlined above is more multidimensional:
including providing an available market and rational price movements. Under
the RBC and A.M. Best models you don't get extra credit for guaranteeing that
employers can get a workers' compensation policy when they need one.
In the clearly atypical market that we find ourselves, growth has pushed our
capital requirement beyond available surplus. That has been the price for us
to remain an available market for employers and brokers. So part of the reason
that we withdrew from the A.M. Best rating process is that we have come to recognize
that the responsibility of providing an available market will inevitably, periodically,
force us to act differently than a private insurer trying to protect their A.M.
Best rating. (Even though there is no legal requirement for State Fund to meet
RBC requirements, our RBC status will continue to be published in our Annual
Statements filed with the Department of Insurance and will continue to be a
major State Fund fiscal goal.)
Finally, here's what are we doing to improve our capital position. For a policyholder
financed insurer, as we are, the principal way to generate additional surplus
is by increasing the profit margin in our rates. Any amount that's left over
after paying claims and expenses becomes policyholder surplus. And to that end
we increased rates 22.5% as of January 1st of this year. We are also working
with the Insurance Commissioner's Office to encourage the voluntary return of
more private insurers to the market.
The bottom line is this: State Fund is financially strong. Recent audits -
including those performed by the California Department of Insurance (DOI) as
well as MillimanUSA - validate State Fund's solvency and adequacy of reserves
- the true test of a carrier's ability to pay claims. We have $10 billion in
assets and our investment income in 2001 reached $521 million. We are finalizing
plans to transfer some of our loss portfolio that will increase current and
future surplus. In short, be assured that State Fund has the financial strength
to fulfill its mission to California's employers and injured employees as it
has done for more than 88 years.
In summary, State Fund has met the challenges stemming from our unparalleled
growth due to the chaotic California workers' compensation market the last two
years and remains financially strong.
Thank you for trusting us with your business and making State Fund California's
'carrier of choice.'
State Compensation Insurance Fund
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