SENATE BILL NO. 276 "An Act relating to the Alaska Insurance Guaranty Association; relating to joint insurance arrangements and assessments to the association; relating to the powers of the Alaska Industrial Development and Export Authority concerning the association; and providing for an effective date." And CS FOR SENATE BILL NO. 276(L&C) "An Act relating to the Alaska Insurance Guaranty Association; relating to the powers of the Alaska Industrial Development and Export Authority concerning the association; and providing for an effective date." This was the first hearing for this bill in the Senate Finance Committee. Co-Chair Wilken stated this bill "increases the Alaska Insurance Guarantee Association's ability to pay workmans' comp claims of insures that become insolvent." Co-Chair Wilken noted bill would not be passed out of Committee at this hearing. He announced the original version of the bill would be discussed first, followed by discussions of the changes proposed in the Senate Labor and Commerce committee substitute. Co-Chair Wilken directed attention to a spreadsheet titled, "Alaska Insurance Guarantee Association, Workers' Compensation Account, Cash Flow Projection as of 12/31/2003" [copy on file] prepared by the Division of Insurance. LINDA HALL, Director, Division of Insurance, Department of Community and Economic Development, testified as follows. I would like to give a brief explanation of the situation that has caused the need for some form of funding mechanism to clear the deficit in the Alaska Insurance Guarantee Association. The Alaska Insurance Guarantee Association is formed under statutes. Its members are insurance companies who write property casualty business in Alaska. The purpose of the Association is to minimize financial loss to the claimants or policyholders when there is an insolvency of an insurance carrier. Assessments are done by the guarantee association to provide funds to pay the claims of insolvent insurers. The guarantee fund does not have money set aside to do that; it's called a "post loss assessment". So there's no money-they don't bank money in case there's an insolvency. They do assessments after they receive claims from an insolvent insurance company. In July of 2003, Freemont Indemnity was declared insolvent by the Los Angeles Superior Court and while they had not actively written workers' compensation for almost three years, our original claims were estimated to have long-term payouts of approximately $60 million. When Freemont originally stopped - their certificate was pulled in Alaska - they had approximately 27 percent of the Alaska marketplace. The magnitude of that Freemont insolvency far surpassed any prior insolvency and exceeded the resources of the Association, which is the creation then of the cash flow deficit. Insolvencies are not new in Alaska in the insurance industry. There have been insolvencies for 20 years. Currently today, there are three other insolvent insurance workers' compensation carriers in the Guarantee fund. Nationally there have been 46 insolvencies over the last three years, so this is not a unique Alaska problem. I would also submit to you that as of February 12, we had another insolvency of an insurance company. They in fact had not written business here actively since 1991, so this is 13 years old [and] adds another $1.6 million to claims that need to be handled in the Guarantee Association. When there are insufficient funds in the Association, the current statute allows for the pro rating of claims payments. In August, as the director of the Division of Insurance, I received a formal letter from the Guarantee Association indicating since they were not anticipating having sufficient monies to pay claims in full, they would be pro rating payments to injured workers. Everyone involved felt that that is a very objectionable solution and an objectionable action. But when there was no money, there was no money. It would mean that injured workers would receive less than their - some pro rated amount of their weekly wage payments; medical providers would be paid a portion of their bill. As of February 2 of this year, there are 598 open claims in the Guarantee Association from the four insolvent carriers. So we're dealing with a substantial number of injured workers. The other piece to that however, the workers' compensation obligation is that of the employer, who generally satisfies that obligation with the purchase of a workers' compensation policy. When the carrier becomes insolvent, the claims are transferred to the Guarantee fund of the State. When the Guarantee fund has no funds to continue to pay claims, the obligation for those benefits will fall back to the employers. These are employers who, in good faith, purchased a workers' compensation policy to meet their obligation. They now are going to be faced with an additional, unanticipated costs-the cost of those workers' compensation benefits. Again, as of February 2 of this year, we have 380 Alaskan employers who are exposed to this potential financial obligation. I believe on the second page of the handout I've provided you, there's a chart giving you some idea of the magnitude of those claims. Generally, we find most businesses in Alaska - not all by any means - are small employers. The prospect of a small employer receiving back benefits totaling $100,000 for an injured worker, it's fairly daunting. The pro ration of claims was averted by a couple [of] loans the Guarantee fund received. [The] California Office of the Liquidator provided a $5 million loan: $4.5 million from the estate of Freemont [and] $.5 million from the estate of Paula Insurance, another insolvent carrier. In December, [the State of] Pennsylvania provided $2.6 million as a distribution of assets from the Reliance estate. Between assessments that are currently allowed under statute and loan proposals, we did have enough money that we have not, to date, had to pro rate claims or stop paying them totally. Senate Bill 276 - and you've asked me to speak, Mr. Chairman, to the original bill, which I will do - the goal was to find a funding mechanism to avert the disastrous outcome to injured workers and employers. We attempted to find a method of securing a stream of funds without requesting a bailout of the industry by the State. With the fiscal issues being faced by Alaska, we looked for something other than general fund revenues to fill this gap. The philosophy behind the original bill was that all employees and employers across the state are involved in workers' compensation regardless of how that obligation is met; whether its through insurance, whether its through self insured, or whether its through other funding mechanisms. The proposal in this bill spread the cost of the funding across the entire workers' compensation environment. There is no question a proposed solutions are not popular. As first consideration, I don't know anybody who steps up and says, "oh, let me pay." But we do have a painful problem and in the long run and in the short run I thing the solutions are painful. The Guarantee fund is a safety net. Not only the Alaska Legislature has adopted this safety net, but every other state in the country has adopted as public policy the creation of a guarantee fund whose goal is to protect claimants and policy holders. The mechanism to provide that safety net is the assessment capability. As a general overview of the Guarantee fund, I would like to point out one aspect of it that will become clearer as I talk about specific bill proposals. There are three accounts in the Guarantee fund. One is workers' compensation, one is auto and one is labeled "other". "Other" includes everything except, of course, work comp and auto. Each separate account is assessed when there is an insolvency of a carrier writing that line of business. As an example, when Reliance was declared insolvent about two and one half years ago, they wrote workers' compensation, they wrote general liability, so two accounts were assessed for those lines of business. SB 276 proposes three things. One is an increase and a change in the methods of assessment. The first piece of that would be to increase the current two percent cap to four percent in the account where there is a shortage of funds to pay claims. In this particular case that would be the workers' compensation fund. If that did not produce sufficient monies to pay claims, the other two accounts could also then be assessed up to a maximum of two percent. These provisions expand the current statutory provisions for assessments. Taking this approach however, is not unique in other states and is not unique in Alaska. SFC 04 # 23, Side B 09:54 AM Ms. Hall continued as follows. Any insolvency should mean any insolvency could be spread over all lines of property casualty business. Today in Alaska, we have the "other" account, and I'm going to call it a bucket, because it's an easier term. Today currently, we have a [one- half] percent assessment in that other account. That means every policy - your homeowners policy, general liability, boats, commercial property, anything that's not work comp and auto - that is with an admitted insurer, is being assessed today a half a percent to cover the cover the insolvency - primarily the insolvency of a medical malpractice insurer. So I would submit to you that it's very unpopular to discuss somebody's auto policy for the insolvency of a workers' compensation company. We do that today. Your homeowners' policy is being assessed for an insolvency of a [medical malpractice insurance] carrier. So it's not something that is particularly unusual even under our statute today. The second piece of the assessment process in the original bill proposes to assess other entities that are not traditionally assessed. This is probably even more controversial than the first provision. It is to assess the self-insures and the JIAs [Joint Insurance Arrangement]. These entities do not receive the benefits of the Guarantee fund. We have considered bringing them into the Guarantee fund. We have looked at other states who have self-insured Guarantee Funds. The latter has not been particularly successful; there are no legs to enforce payment into those funds. It's also my personal point of view - we have no oversight ability in the Division of Insurance of those entities. With a traditional insurance company, if we see signs of financial distress, we can stop them from doing business here. We can pull their certificate of authority. We can't do that with a self-insured or the JIAs. So it's something that I think is appropriate to bring them under the Guarantee Fund statute. I realize they did not create this situation; they are not part of the Guarantee Fund. What we looked at was finding the broadest possible base to make this assessment to make it not as cumbersome to anybody. The traditional theory of insurance is to spread the risk. Senator Hoffman interjected to ask the amount the self-insured would be assessed under the original legislation. Ms. Hall listed the total funds for the self insured, including the State, and the JIAs would have been approximately $1 million. Senator Hoffman asked the assessment percentage. Ms. Hall answered two percent of the cost of all claims as reported to the Department of Labor and Workforce Development. She noted that because these entities do not have policies they do not pay premiums. Senator Bunde noted that the three insurance accounts (workers' compensation, auto and other) would be assessed and asked the percentage of the contribution would be assessed to the workers' compensation account. Ms. Hall responded that the workers' compensations account is the smallest by a significant margin. She stated the workers' compensation account currently generates approximately $4.2 million based on a two percent assessment. She compared this to the auto and other accounts, which are "more closely aligned in total premium volume" and would each generate approximately $7.5 million. Senator Bunde commented that the beneficiaries of this proposal would pay the smallest amount, and those who are not beneficiaries would pay the largest amount. He agreed that the broadest possible base must be utilized for a successful resolution. Ms. Hall continued with her testimony as follows. Generally, I've been asked, "is this fair" in speaking to the self-insured and JIAs. Our point was to spread the cost as equally as possible and at this point we have an ugly situation. I'm not sure if fairness enters the equation at this point. Is it fair for an injured worker to have at least a minimum a termination of benefits? Is it fair for an employer to get back a $100,000 claim? Is the whole concept of the Guarantee Fund fair? I'm not sure any of it's fair. I think there has to be a safety net. I think there has to be a policy. The last component of the bill would, as a final safety net, propose to allow AIDEA [Alaska Industrial Development and Export Authority] to provide guarantees for the Association to obtain loans to meet their cash requirements. The Guarantee Fund currently under statute has authority to borrow but they're not a viable commercial loan prospect. They have no assets. The only assets they have are a stream of future assessments, which in current estimates are probably needed until about 2008. There was a substantial amount of work done exploring other options, from bonds to loans. When you approach a commercial lender to talk about a loan to somebody who's knowingly not going to have any money to start paying it back until 2008, they don't get a very positive response. At any rate, the third part of this would be to allow AIDEA to do a guarantee of loan, which would ultimately be paid back. Maximum principle balance outstanding at any one time would be $30 million. We worked with some financial experts to find the most economical, efficient way to provide access to money to pay claims. I believe you indicated, Senator Wilken, that Mike Barry is on the phone. Mr. Barry is the chair of AIDEA and he has worked with me very diligently to help me understand the intricacies of the financial world and to find ways to provide funding. My close typically, which won't be today, is that this bill contains some painful, expensive and very unpopular provisions. I don't think the provisions are nearly as painful as the consequences of no action. I would urge you to focus on the overall need to find a funding mechanism and to consider what will happen if we take no action. Senator Bunde reiterated conversation that occurred in the Senate Labor and Commerce Committee, in which it was determined that a "perfect storm" caused the current crisis. He asked the witness to address the potential for another situation in which the Guarantee Fund would be unable to absorb insolvencies. Co-Chair Wilken also asked the witness to reference the aforementioned table and explain how it relates to the future. Ms. Hall informed that medical compensation claims remain open indefinitely. She qualified that settlements typically address portions of workers' compensation benefits, although the medical provisions remain open. She noted the spreadsheet provides estimates of incoming assessments according to current statutory requirements and "outgoes" for the claims that are currently in the Guarantee Fund. She stated these figures are based on reserves "to the best of the ability of the people who work with claims reserves and actuarial analysis." She pointed out that the figures are subject to changes as claims are settled and as injured workers heal and return to work. She furthered that the data on the spreadsheet reflects the projections of the amount required incoming and outgoing claims for a calendar year. She said the information assumes an increase in payments, which also indicates an increase in assessments as premiums increase. Ms. Hall then remarked that the current crisis was "precipitated by the magnitude of the Freemont insolvency" i.e. the market share held by that company." She noted that other insolvencies have occurred that the Guarantee Fund has been able to sustain over a number of years. She informed that only three insurance companies have a market share near the significance of that Freemont Indemnity had when it became insolvent. She had no reason to surmise that any of the current carriers have financial distress and that they are stable, solvent companies. She therefore did not anticipate another situation, but would not guarantee that it would never again occur. Senator Hoffman referenced the witness' earlier comments about notification of the necessity of pro rating benefit payments. He asked if the payments were actually pro rated and if so, why. Ms. Hall answered that pro rating did not occur and again indicated the loans and distributions from solvent states, which provided adequate funding to pay those claims. However, she warned that the Guarantee Fund would run out of money. Senator Hoffman asked whether it was envisioned in August 2003 that the Guarantee Fund would be depleted. Ms. Hall replied that the managers of the Guarantee Fund anticipated such and subsequently notified her. She again told of efforts of the Association and the Division to secure funding to ensure that the pro ration of claims did not occur. She clarified that statute allows for the pro ration of claims if the Guarantee Fund becomes depleted or is predicted to do so. She noted that the Fund had sufficient funds to pay claims through the year 2003 and into a portion of 2004. Senator Hoffman noted that statute allows for the pro ration of funds and asked why pro rationing did not occur. Ms. Hall responded that sufficient funding became available shortly after notification of the shortage from the Association. She stressed that no state has ever prorated workers' compensation claims and that other states assisted in ensuring this would not occur in Alaska. Senator Hoffman wondered why the witness was testifying that the payments must be pro rated, when they were in fact not pro rated. Ms. Hall replied that statute does not mandate that pro rationing occur, but rather allows it to occur. In this instance, she stated, assistance was received from other states and the pro rationing was not necessary. Co-Chair Wilken returned to the spreadsheet and asked if the current assessment rate were increased from two percent to four percent if the figures would be doubled. Ms. Hall affirmed. Co-Chair Wilken asked if the Fund would still be short approximately $20 million if the assessment percentage were increased from two to four percent. Ms. Hall answered that the Guarantee Fund would have a cumulative deficit in the year 2008 of $20, which would be the maximum amount. At this point, she stated the trend would reverse and the assessment income would exceed the "outgo". Co-Chair Wilken requested an updated chart to demonstrate a four percent assessment, as well as another column to indicate the inclusion of self-insures and the JIAs. He added another funding source as an assessment on the "other" insurance account and requested data reflecting this source also be included for comparison. Senator Bunde noted the witness testified that the Guarantee Fund would be depleted and he surmised this would occur "much sooner than later", likely in April 2004. Ms. Hall relayed updated information indicates the Fund would have sufficient monies until June 2004. Senator Olson spoke of the overall affect of this situation on small businesses. He warned that if too much pressure were placed on small business to contribute to the Guarantee Fund in the form of increasing the two percent assessment to four percent, and the assessment of self-insures, small businesses would become insolvent as well. Ms. Hall shared this concern. She informed that as of January 1, 2004, the Division approved a "very needed" rate increase in workers' compensation that added an additional two percent to each premium that applied even to small businesses. She told of separate legislation that would reform the workers' compensation program to reduce costs. She stated this issue was addressed separately because of the importance of acquiring funding in a timely manner. Senator Olson asked if consideration had been given to exempting smaller businesses. Co-Chair Wilken shared that the workers' compensation premium for his business rose 23 percent this year. Co-Chair Green asked if increases to the auto and other insurance account groups would be "passed on" to consumers. Ms. Hall answered the costs would be passed along to consumers and noted this practice is allowed in statute. Co-Chair Green pointed out that this proposal would not only increase costs to small businesses but homeowners, vehicle owners, etc., as well. Ms. Hall affirmed. Senator Bunde asked what portion of the funding would be generated from self-insured entities, such as municipalities and school districts. Ms. Hall replied that an assessment on the total group would be approximately $1 million. MIKE BARRY, Chair, Board of Directors, Alaska Industrial Development and Export Authority, Department of Community and Economic Development, testified via teleconference from an offnet location that AIDEA supports this bill as well as the other legislation to reform the workers' compensation program. He pointed out that SB 276 would resolve the temporary funding crisis, although the other legislation is necessary to avoid future crises. CRAIG NORDTVEDT, Alaska Insurance Guarantee Association, testified via teleconference from an offnet site that the Association considers pro rationing of benefits as a last option. He relayed that the Association has not recommended implementation of pro rationing for the current year only because it has been advised that the Legislature is investigating additional funding. However, he warned that the Association must consider pro rationing on an annual basis anytime the Guarantee Fund has inadequate funds to pay claims for the entire year. Senator Bunde understood the concept of pro rata payment of benefits to injured workers. He also perceived another situation in which an employer inadvertently breeches its obligation to provide benefits to injured workers and could be sued for payment by an injured worker who has received pro rata payments. Ms. Hall deferred to Mr. Lisankie. PAUL F. LISANKIE, Director, Division of Workers Compensation, Department of Labor and Workforce Development, informed that the Workers' Compensation Act provides that employers are required to provide insurance. He surmised the issue would become whether an employer who purchased workers' compensation insurance would be recognized as complying with its obligation in good faith. He preferred that a judgment would be made that there was no failure to provide insurance. Senator Bunde noted injured workers currently are prohibited from suing their employers under the provisions of the workers' compensations laws. He asked if in an instance of pro rata payment of benefits as the result of the insurer's insolvency whether lawsuits would be permitted. Mr. Lisankie commented that in the United States many opportunities exist for filing lawsuits. Co-Chair Green asked if funds were "infused" to the Guarantee Fund system, whether the problem would be solved or if an ongoing need for assessment changes would remain. Ms. Hall responded that the system must be changed to ensure this situation does not reoccur in the future. Co-Chair Green asked if the calculations provided in the backup material provide for the repayment of the loans made by other states to Alaska. She wanted to know whether repayment is expected or if the funds were grants or settlements. Ms. Hall replied that the funds received from the State of Pennsylvania were an "early distribution of assets" and repayment is not necessary. She furthered that the funds received from the State of California are intended for repayment. She explained the distribution of assets remaining in the Freemont Indemnity estate, of which Alaska would be entitled to a portion. She clarified that the assets are not "dollar for dollar," otherwise the carrier would not be insolvent. Co-Chair Green asked if the federal government operates a fund comparable to the State Guarantee Fund. She recalled instances of major life insurance carriers becoming insolvent and other carriers "stepped in". Ms. Hall was unaware of such a federal program. She noted the State operates two separate guarantee funds: the fund in question, which is a property casualty fund, and another life health guarantee fund. She stated that each state operates two such funds. She told of a national association, but qualified it does not provide funding. She qualified that the matter has been discussed on national and regional levels. Co-Chair Green clarified the life health assessment would not be included in the proposed solution to the workers' compensation situation. Ms. Hall affirmed. Senator Bunde spoke to prevention of a similar situation in the future noting a provision in this bill would allow the fund to receive a loan from the Alaska Industrial Development and Export Authority (AIDEA). He furthered that the other legislation would realize cost savings beneficial to both injured workers and employers. Co-Chair Wilken requested an updated chart showing the information he earlier described relating to a four percent assessment and assessments to JIAs and self-insured entities, to be used for comparison. Ms. Hall indicated she would provide this. Senator Olson asked if self-insured pertains to self-employed small business owners who are not required to purchase workers' compensation insurance for themselves. Ms. Hall answered no and defined self-insured as "companies who apply to the Department of Labor and Workforce Development for exemption and they have to meet certain financial criteria to do that." Co-Chair Wilken asked for an explanation of the changes contained in the Senate Labor and Commerce committee substitute. Senator Bunde remarked the changes are based on the premise applied to insurance, that the risk payments must be spread over a large group of people. He relayed that during Senate Labor and Commerce Committee hearings, he listed attentively as the director explained the problem with the Guarantee Fund and outlined the need to include other participants in the solution. He learned that if the auto and other accounts were assessed, the costs would be passed to consumers. He relayed intent to "cut out the middle man. We could make life less stressful for those who are trying to do business in Alaska to avoid what I had heard mentioned earlier from Senator Olson that businesses being driven into bankruptcy because they can't afford their insurance payments". Therefore, he decided to spread the expense to all Alaskans, who are potential recipients of the benefits of the Guarantee Fund, through the use of the excess earnings of the permanent fund. He informed that the excess earnings are already used to pay dividends, administrative costs, inflation proofing of the fund, and to pay hold harmless provisions. Co-Chair Wilken noted the committee substitute also removes the assessment of self-insured entities and JIAs. Senator Bunde opined that because these entities are receiving no direct benefit from the Guarantee Fund, they should no be required to contribute. Senator Bunde added that the committee substitute retains the ability to access AIDEA loans in the event of another insolvency crisis. Co-Chair Wilken asked whether this legislation should be held to await action on the other bill reforming the workers' compensation program. Senator Bunde answered this bill, SB 276, should not be held and that a solution should timely. He noted the other legislation proposes significant changes to the current system and may require additional consideration. Co-Chair Green asked if a supplemental appropriation would be required for FY 04. Ms. Hall responded that the original version of SB 276 includes a fiscal note for FY 04 supplemental funding. Senator Bunde referenced the letter of intent adopted by the Senate Labor and Commerce Committee that indicates payments are not required all at once. Co-Chair Wilken announced this bill would receive another hearing after the following week. Senator Bunde asked the witness if the Senate Labor and Commerce committee substitute were so substantially different that it would not solve the problem. Ms. Hall answered it is not so different and that it would solve the problem. Co-Chair Wilken ordered the bill HELD in Committee.