Governor Schwarzenegger and the California Department of Insurance have agreed to legislative amendments that likely will end the ongoing legal skirmish between the Department and State Compensation Insurance Fund. Inside sources say the deal was forced down SCIF's throat. The deal is a classic example of the give-and-take game in Sacramento, with both the governor and the commissioner yielding somewhat.

But the bill is chock full of gems for the Department of Insurance to crow about, particularly compared to its nemesis over the past few years, State Fund management, led by interim president Jim Tudor, who comes out with only an affirmation that SCIF can't be seized and management replaced only by the governor, under existing law. Tudor is a candidate for the permanent position but one whose star may be falling.

The language also confirms that the Department has authority to manage State Fund, like any other insurance carrier, through the various risk-based capital levels, and even to control and limit management's priorities under RBC. The changes affirm the decision by Superior Court Judge Alvarado, who ruled against SCIF management in December 13, 2004, saying that SCIF is in fact subject to RBC statutes.

To read the amendments, go to Resources section at: www.wcexec.com/Resources.aspx

The proposed language serves up at least one unintended consequence by indirectly removing SCIF from guaranty fund coverage. It also expands SCIF's investment authority, a move that's stirring up discomfort in the industry. Either of the issues could at least delay, if not torpedo, the language, but changes are already in the works and were discussed during an industry teleconference late last week.

The proposed amendments would be part of the Department's cleanup bill, AB 2125, authored by Juan Vargas (D-Chula Vista), which is set for a hearing date with the Senate Banking, Finance and Insurance Committee this week.

On their face, the amendments appear to give SCIF exactly what it was seeking during its costly 18-month legal battle, including a provision that prevents the insurance commissioner from conserving and liquidating SCIF in the event of a "Mandatory Control Level Event" under risk-based capital statutes. But industry experts point out that the small win for SCIF comes at a price.

According to Department legislative analysts, the proposed language clarifies the commissioner's authority over SCIF, already granted in the statute, including authority to regulate SCIF just like any other California workers' comp carrier. Section 739.5 of the Insurance Code would be amended to say that the commissioner can take such actions as are required under Section 739.4 regarding an insurer with respect to a regulatory-action-level event.

The language also confirms that SCIF is a creation of the legislature and as such the commissioner is required to issue a report to the governor, senate pro tem and the Assembly speaker in the event of a financial crisis at the insurance company.

Although one could argue that this language merely reaffirms the commissioner's authority over State Fund, defenders of the state enterprise say the level of management the language calls for is more authority than should be given to an insurance commissioner over a state-created entity.

Still, this proposed language is probably the best SCIF can hope for. In 2003, SCIF sued the Department to prevent the insurance commissioner from taking it over under the guise of risk-based capital statutes. In December 2004, a judge ruled that SCIF was indeed subject to the RBC statutes, a ruling State Fund vowed to appeal.

Industry experts say that the new language will keep the legal battle from proceeding, likely all the way to the California Supreme Court.

"I think it's important for the market that this is settled. The process of dealing with the impairment of State Fund is similar to the process in Arizona," says an industry source. "There is some precedence."

But it's not there yet. The language still has to get by the formidable Senator Jackie Speier (D-San Mateo), chairwoman of the Senate Banking, Finance and Insurance Committee. She already has SCIF in her crosshairs over management's recalcitrance about her bill, SB 1452. SB 1452 would subject SCIF to the same audit standards as other state agencies. Speier will no doubt have questions.

Committee staff director and consultant Brian Perkins would not comment on the language, saying he's reserving comments for the analysis he's putting together.

"We're recommending to the Rules Committee that it be sent back to us. It's a large enough change to the bill that it should have another hearing," he says.

One potential deal breaker is the additional flexibility granted SCIF on its investment income. Although it's still not what other carriers have or even what SCIF would like, say sources in the Department, amendments to Section 11797 of the Insurance Code would allow SCIF's Board of Directors to invest "all moneys that are in excess of current requirements to be invested and reinvested from time to time," read the amendments.

"The amendments themselves give the State Fund some additional authority to invest in instruments such as corporate bonds. SCIF is restricted to investments such as T-bills and other federal debt instruments, but there are other safe investments that can be made. This is still a very limited change."
—Richard Figueroa,
Department of Insurance

But State Fund does not pay taxes as other carriers do, nor is it required to post mandatory deposits as other carriers do. Some carriers feel this section provides an unfair advantage to a competitive State Fund. Others in the industry think its investments should be a matter of public record.

The Department says the investment authority is still very limited and would prohibit the purchase of stock, or investments in mortgage loans, or Canadian stock.

"The amendments themselves give the State Fund some additional authority to invest in instruments such as corporate bonds," says Richard "Fig" Figueroa, Department of Insurance legislative director. "SCIF is restricted to investments such as T-bills and other federal debt instruments, but there are other safe investments that can be made. This is still a very limited change."

Industry experts agree that it's narrowly tailored but say there is at least some concern that any investment that allows them a risky or higher yield could move them closer to the market fluctuations experienced by other carriers. This in turn could put the market of last resort in danger if it had a lot riding in such investments, one theory goes.

Concerns About CIGA

The proposed language also amends Section 1064.12, the Uniform Insurers Rehabilitation Act, which addresses the receivership of conserved carriers. The amendment makes it clear that this act does not apply to SCIF. In other words, the commissioner cannot conserve SCIF.

Although the provision is a win for State Fund, what it really does is confirm the authority of the legislature and governor over State Fund. Industry experts point out that by removing SCIF from the Act, the proposed amendments remove SCIF from the coverage afforded by the California Insurance Guarantee Association. If the unthinkable happens and SCIF reaches the point of insolvency, where do the claims get paid?

"It's an unintended consequence, but a big unintended consequence," says one industry source.

In addition to concerns about CIGA's previous financial woes, experts say SCIF policyholders pay an assessment with the understanding that they have guaranty fund coverage. If the coverage is removed, then employers are paying a tax with no basis. Without the assessment, CIGA's revenue base drops 38 percent.

The Governor's Office was made aware of this problem after the amendments were issued. The interested parties do not regard this issue as a bill killer but rather one that needs to be resolved with some clarifying language.

"We believe that it was a drafting glitch. It was never the intention to alter the relationship between SCIF and CIGA," says Russell Noack, lobbyist for CIGA.

Noack says language has been submitted to interested parties, including the Department, the Governor's Office and the legislature, clarifying that removing SCIF from liquidation statutes does not abrogate CIGA coverage.

SCIF refused comment for this story.