SENATE LABOR AND COMMERCE COMMITTEE February 17, 1998 1:35 P.M. MEMBERS PRESENT Senator Loren Leman, Chairman Senator Jerry Mackie, Vice Chairman Senator Tim Kelly Senator Mike Miller Senator Lyman Hoffman MEMBERS ABSENT All members present COMMITTEE CALENDAR SENATE BILL NO. 198 "An Act relating to partnerships; amending Rules 25(c), 79, and 82, Alaska Rules of Civil Procedure; and providing for an effective date." - SCHEDULED BUT NOT HEARD HOUSE BILL NO. 116 "An Act relating to workers' compensation self-insurance." - HEARD AND HELD PREVIOUS SENATE COMMITTEE ACTION SB 198 - See Labor and Commerce minutes dated 2/10/98. HB 116 - No previous action to consider. WITNESS REGISTER Ms. Annette Kreitzer, Staff Senate Labor and Commerce Committee State Capitol Bldg. Juneau, AK 99811-1182 POSITION STATEMENT: Commented on HB 116. Representative Pete Kott State Capitol Bldg. Juneau, AK 99811-1182 POSITION STATEMENT: Sponsor of HB 116. Ms. Sarah McNair-Grove, Insurance Analyst Division of Insurance P.O. Box 110805 Juneau, AK 99811-0805 POSITION STATEMENT: Opposed HB 116. Ms. Robin Ward Alaska Homebuilders Association P.O. Box 91443 Anchorage, AK 99503 POSITION STATEMENT: Supported HB 116. Mr. Steven Wisdom Alaska Homebuilders Association P.O. Box 4184 Homer, AK 99403 POSITION STATEMENT: Supported HB 116. Mr. Paul Grossi, Director Workers Compensation Department of Labor P.O. Box 25512 Juneau, AK 99802-5512 POSITION STATEMENT: Opposed HB 116. Mr. Richard Block Alaska National Insurance Co. 360 W. Benson Blvd. #300 Anchorage, AK 99503 POSITION STATEMENT: Opposed HB 116. ACTION NARRATIVE TAPE 98-6, SIDE A Number 001 SB 198 - UNIFORM PARTNERSHIP ACT CHAIRMAN LEMAN called the Senate Labor and Commerce Committee meeting to order at 1:35 p.m. and announced they would hold the hearing on SB 198 at later date. HB116 HB 116 - WORKERS COMPENSATION SELF-INSURANCE GROUP CHAIRMAN LEMAN announced HB 116 to be up for consideration and that there was a proposed committee substitute as a result of four concerns the committee had last year. SENATOR KELLY moved to adopt the committee substitute to CSHB 116 and asked for unanimous consent. There were no objections and it was so ordered. MS. ANNETTE KREITZER, Staff, Senate Labor and Commerce Committee, explained the changes in the adopted committee substitute. She said the addition from this committee is on pages 12 and 13, Section 21.47.200 which the Homebuilders Association submitted. Number 123 REPRESENTATIVE KOTT, sponsor of HB 116, testified that 14 other states have passed similar legislation successfully. It contains numerous substantive and procedural requirements designed to ensure that workers compensation self insurance groups remain fiscally sound and are able to fulfill Alaska's workers compensation requirements. The Director of Insurance has an enormous amount of leverage over the operation of these self insurance groups. There are some concerns that there isn't enough cash up front to pay workers compensation claims and he is extremely comfortable with the way the bill deals with this. First of all, the aggregate net worth of the employers (who must be 10 or more in number) must be $1 million. There is also a cash security bond, or another instrument acceptable to the division, in the amount of $450,000. There is another layer of provisions in the aggregate excess insurance that can and would be acquired under the guidance of the Division of Insurance who will set the parameters for that. The first year's premium is a minimum of half a million dollars. Thereafter each premium of the group is $750,000. The first year's premium has been divided into two categories, 70 percent for the reserve pool and 30 percent for the administrative pool. Fifty percent of the premium is paid up-front. Of that $175,000 will be put into the premium side and the other 30 percent would be put into the administrative costs. He said there are always monthly premiums being paid by the members of the group. The excess insurance (reinsurance) or stop loss policy is set at $5,000. He said one would need 40 claims the first month to go through the $5,000 and it wouldn't matter if the claims are $50,000 or $1,000,000. Subsequent years, the group would have to again get the excess insurance and the premium would be adjusted accordingly. There is also a self insurance guarantee fund of five percent which amounts to $25,000. If for some reason there were a large number of claims, the process would be that the surplus would be used from the fiscal year rather than the current year. Then you would turn to the administrative funds, then the first year's premium, then go to the guarantee fund. You would then assess the membership. There are several opportunities to ensure that the worker is held harmless and that any form of compensation that is owed to them is paid. REPRESENTATIVE KOTT said he thought this would go a long way toward lowering costs for employers which would provide additional opportunity to either infuse themselves with some capital investments or hiring new employees. MS. SARAH MCNAIR-GROVE, Insurance Analyst, said that many of the things that were addressed as changes have gone a long way to address the Division's concerns, but its main concern that hasn't been addressed is the liquidity of the assets. There is a $1 million net worth requirement, but there is no requirement that any of this be actually available in cash to pay out to a loss, if there is one. There is a bond, but the way the draft is written, the bond will only be available after the group becomes insolvent. So it will be there after there are problems, but not before. She concluded that a lot of concerns have been met and she appreciates that, but the bill hasn't gone far enough in addressing all the concerns they have. SENATOR KELLY asked how they get the initial capitalization to begin operating the organization. MS. GROVE said she wasn't sure of the answer to that, but the security bond is not used for the operations of the group. It is used only to pay losses, if there has been an insolvency. SENATOR KELLY asked if that was for $450,000. MS. GROVE replied yes. SENATOR KELLY asked where the initial operating cash comes from. REPRESENTATIVE KOTT explained that the initial capitalization is on page 10 which says that the group must meet at least 25 percent of the estimated annual premium which is $500,000 minimum for the group. The other part is on page 2, #10 - proof of payment to the group by each member of not less than 25 percent. SENATOR KELLY asked if there is a minimum figure. REPRESENTATIVE KOTT replied that the minimum figure is the aggregate amount of $500,000. SENATOR KELLY said if there were 10 members, everyone would put up $50,000 in cash to get started and asked if that was correct. MS. ROBIN WARD, Alaska Homebuilders Association, answered that the actual initial premium is half of $500,000. The minimum number of employer members is 10, but the combination still has to be $500,000 for the first year. Fifty percent of that is paid up front. Twenty-five percent is prepaid premiums; the other 25 percent is prepaid premiums in the form of a deposit that stays with the account in the reserve account until the employer leaves the pool. She estimates that the first day they start there will be $175,000 as a minimum in cash to begin. SENATOR KELLY asked how many members she has committed to joining the organization when they get going. MS. WARD answered that they have a list of many more than 10, but without the legislation they can't begin their business plan. SENATOR KELLY asked if the 10 had signed a commitment to do it. He asked how dependable were the commitments for the $175,000 which isn't a lot of money. MS. WARD replied that the commitments are very solid, because they can't even get a certificate until that many members are signed up and can prove they have $500,000 in the first annual premiums. She repeated that she has a list of interested people, but they can't draft a business plan without legislation, because they don't know what form it will be in. Number 314 SENATOR MACKIE said one of his concerns was for the actual workers out there who get injured and whether or not there will be sufficient finances available to take care of those claims. He asked if there was any reason the Division might believe under this provision there might not be enough money to initially pay claims. MS. GROVE answered that one of their main concerns is the initial start-up and that the initial amount of the money is only $175,000 and 30 percent of it goes to administrative costs and 70 percent goes to paying losses. If there is a large loss right away, you could go through that 70 percent very quickly. SENATOR MACKIE asked if they didn't also pay premiums on a monthly basis. MS. GROVE answered said that is part of the new proposal, yes. She deferred further comments to the Department of Labor because they are the ones who deal with claims payments. SENATOR MACKIE asked if she could recommend something in particular that would make the Division feel better about the whole thing. MS. GROVE replied that they are not at all opposed to the idea of self-insured groups, but they have proposed to them that of the $1 million net worth, that they set aside 25 percent of it as liquid assets so it's not just net worth in their tool, vehicles, and trucks. However, they have responded, "no." SENATOR KELLY commented that the Homebuilders Association is proposing instead of $250,000 liquid cash, if they can get all these folks to join, to have $175,000 in liquid cash to start. MS. WARD replied that is correct. SENATOR KELLY commented that if these people get together to form an insurance company, they need about $3 million in cash, or they can get together and form a reciprocal insurance company for which they need about $1,750,000 in cash, but what THEY want to do is get together and form a self-insured group and only have $175,000 in cash. He asked if that was pretty close to where they are. MS. WARD answered yes, but that's on the first day. SENATOR HOFFMAN asked if 70 percent of the $250,000 has to be liquid cash and 30 percent of that is for administrative costs or if that $250,000 has to be all liquid. MS. GROVE explained that in order to form this group there has to be a net worth and the proposal says $1 million of net worth, however they want to calculate it. The Division is recommending that in part of that calculation there be some liquidity. The other part is the premiums, the $175,000 figure that's been mentioned here, is what's divided into the 70 and 30 percent. SENATOR HOFFMAN asked if they were recommending that $250,000 of the $1,000,000 be liquid. MS. GROVE answered yes. SENATOR HOFFMAN asked what they are proposing. MS. GROVE answered that they are proposing $1,000,000 with no liquidity requirements. SENATOR HOFFMAN asked if they wanted more liquidity to protect the employees, if there's injury. MS. GROVE answered that is correct. SENATOR KELLY asked if the Division of Insurance supports the committee substitute. MS. GROVE answered that the current proposal hasn't gone far enough, no. Number 403 SENATOR MACKIE asked if she could look at the group's finances a year from now and start with that, would she be comfortable with it. MS. GROVE answered although she didn't know what the point in time would be, she would be more comfortable if she was convinced there was enough money from the beginning to pay losses that might occur. SENATOR MACKIE said one of his concerns as far as liquidity goes is that there be a guarantee that claims could be paid and he thought they would have to look at some averages, because the last thing they want is for an injured worker to have to sue 50 or 20 different participants to try and get a claim paid. He also wanted to see some specifics from the Division. CHAIRMAN LEMAN asked if there was a definition in law about what constitutes a liquid asset. MS. GROVE said she would find out for them. SENATOR HOFFMAN asked if she didn't support the legislation primarily because it didn't go far enough in protection for claims from employees. MS. GROVE answered that is correct. SENATOR KELLY asked if the Director of Insurance had physically met with this group in the interim to discuss her problems on this issue. MS. GROVE answered that they have tried to meet with them and there have been various telephone calls back and forth, but there was no meeting during the interim. The Director of the Division of Workers Compensation, Marianne Burke, wrote a memo to the Homebuilders Association in April and she got a response to it about two days ago that addressed some of Ms. Burke's concerns, but not others. Number 430 MR. STEVEN WISDOM, Alaska Homebuilders Association, said back in the spring they did have a meeting with Ms. Burke and one of her representatives in Anchorage; there has been communication back and forth, but no physical meeting since. MR. WISDOM said that of the 14 states with self insurance some of them did have substantial losses early on, but every one of them has remained viable and very effective in the marketplace. This type of program helps each of the employers look after each other to make sure they keep a safe workplace which enhances it for the employee. He said that the Department of Labor ran a review of the current membership showing losses last year (although these members wouldn't necessarily be a member of this insurance group), but they were surprised at how low the losses were in the residential building industry. When they started working on this bill several years ago, they were paying an average of $19 per $100 of wages in workmens' compensation costs. Today that has dropped to $11 and it could drop more. He thought this was because this type of industry is coming to Alaska. In all cases across the board in the 14 other states, the loss ratios have continued to go down for the participants because of the way the programs are set up. SENATOR KELLY said he was aware that workers' compensation rates have been going down in the State of Alaska, but it's not just for homebuilders; it's for everybody. He likes to think the legislature could take some credit for that in the workers' compensation reform they passed several years ago. He thought it wasn't necessarily the threat of this legislation going through the system. Number 527 MS. WARD reiterated the layers of protection they are giving the worker. They want to make sure they are providing every layer of protection they can for them. That is why it is so important for them to have the excess aggregate insurance. Even if there is a catastrophic claim in the first day, they would only pay the deductible because reinsurance would pick up the rest. Liquidity of assets is the very bottom, seventh layer of protection. She said that the department wants small business owners to put up $100,000 or $150,000 of assets and take one quarter of that, which is probably their checking account, their cash flow, and pledging it to this fund which can't be touched. She feels that is unrealistic and that there isn't that much risk that they would ever have to assess the group members or take any of their assets. There is an assessment that can be taken from the members if they have to, but the likelihood of that happening is probably one in a million. They haven't found any evidence of that happening in researching the other 14 states. CHAIRMAN LEMAN asked if she had found any requirement for liquidity in the seventh layer in her research of the other states. MS. WARD replied none. SENATOR KELLY said he was wondering if her group is basically paying the same premiums that they are paying now, and they are going to have to put a significant cash deposit up-front to get started, where the payoff is. If the workers' compensation system up here isn't broken, and it doesn't appear to be, because there are about 50 companies writing premiums up here and rates are going down, why are they rushing in to fix it? He thought her answer might be that they want to get together and get the profits that the insurance companies are now getting and redistribute them to their group. So in the long run that would mean less, but if that was the case, what were they estimating the insurance companies are getting for a profit margin? He wanted to know how the group was going to save a lot money for their members. MS. WARD said she had done some research and Alaska now is in the top five of the most profitable states to write workers' compensation insurance in. Most of the insurance companies are making an average of 22 - 37 percent profit on their premiums. She said it is a long term investment for her group. They have to build their reserves before they can return any premium refunds to their members. She thought there were more benefits in that they would be doing their own claims management, could investigate fraud more thoroughly and get the worker back faster. She said the large insurance companies are just paying claims and not managing them as well as her group could. Number 509 MR. PAUL GROSSI, Director, Workers Compensation, said he supported the concept of the bill for these groups to be inclined to pay attention to their claims and to build safety programs, but they are concerned about where the money is. He said money from their group has to be there to pay for the excess insurance since they are self-insured. He questioned that there would be enough. He reiterated that the biggest problem is capitalization. The only money the group has to operate with is the 25 percent deposit and the 25 percent of the advanced premium which amounts to 50 percent of the total premium or $250,000. Only 70 percent, or $175,000, of that is available for claims. It appears that premiums can be assessed monthly, but it also says quarterly. So the initial capitalization could be $175,000 for the first three months of the existence of this group. A lot of things can happen during that time. He said that the Homebuilders as a group is probably a good group, but the problem with the bill is that it doesn't say this is just for the Homebuilders. It's for anyone with $1 million in assets and who can meet the other requirements. This is the problem he has. His suspicion is that this group will end up with more than $1 million in assets and more than the $500,000 premium. But he is thinking about the least common denominator here. The $1 million in assets is a requirement, but that doesn't exist inside the group; it belongs to all the individuals. The group is a different entity than all the individuals outside of that. The $1 million in assets is there, but it is only available if the group goes insolvent, so that's not anything they operate or pay claims with. The $450,000 security deposit comes in only if the group is unable to pay claims and is only for the purpose of paying claims. There is also $25,000 in the guarantee fund, but that's only available if the group goes insolvent. So they have only the $175,000 to pay claims for what could be as long as the first three months. He explained that the Department of Labor already certifies large employers to self insure and they require excess insurance. The closest he could find to a group like the Homebuilders was a group that is an oil service company which had 243 employees in 1996. TAPE 98-6, SIDE B They self-insure for $1 million and purchased excess insurance for everything over that. Their premium for that policy was $168,885. This group is going to have to self-insure for much less than that, at least in the first year. He estimated only $175,000 because that's all the cash they have to pay claims. They would then have to devise the specific and aggregate excess insurance to address the rest and didn't see how they could do that operating on a shoestring. Claims can get really expensive, maybe $1 million for one catastrophic claim. A small concern he has is the guarantee fund of $25,000. If this group does go insolvent, that $25,000 is pretty meaningless. It's something, but their liabilities could be way above $450,000. To say this is a guarantee fund like our guarantee association is not accurate. SENATOR KELLY asked if this bill didn't make them part of the guarantee association. MR. GROSSI replied no, that this is entirely different. They are their own entity. SENATOR KELLY said a year ago the legislature set up a guarantee association that all insurance companies are a part of; so if an insurance company goes belly up, all the other insurance companies get assessed and have to make up for the insolvency. MR. GROSSI said that is correct. SENATOR KELLY asked if this was just their own little $25,000 deal. MR. GROSSI answered yes, but there could be more, if there was more than one group involved. SENATOR KELLY asked if no other insurance company in Alaska has to step in and get assessed to help for this group's insolvency. MR. GROSSI replied that is correct. SENATOR KELLY asked if it was just this $25,000. MR. GROSSI said that is correct. SENATOR KELLY said he didn't realize this was a stand-alone thing. SENATOR MACKIE said he thought he heard there were surety bonds to deal with insolvency. MR. GROSSI responded that there is a $450,000 deposit, which added to the $25,000 would be $475,000, but there could be millions of dollars in liability, too. There is the assessment of the members, too, but the whole thing is that you want to avoid all of that. You want something that is fundamentally sound so you never have to deal with the guarantee fund or the surety bond. SENATOR HOFFMAN said that there are all these layers that someone who is hurt has to go through and the final chapter of it all is having to take these people to court and having to liquidate their assets in order to get reimbursed. MR. GROSSI said that is correct. CHAIRMAN LEMAN asked if he had done any actuarial studies to look at a block of people in this industry and look at the history of claims to see if the amount of monies being suggested in this bill compensate for the claims. Number 540 MR. GROSSI said that is part of the problem. One of the rules of thumb they have noticed over the years is that approximately 10 percent of the work force gets injured in any given year. What's unpredictable is where catastrophic injuries are going to occur and when. They do happen, but there's no way to predict them. The larger the group, the more able they are to deal with that situation. SENATOR KELLY asked if this group were to form and have a particularly tragic accident, and for one reason or another the group does become insolvent, does the person who got hurt have a course of action to the individual members of this group. MR. GROSSI said yes, there is a joint and several liability section. SENATOR KELLY asked if all members of this group have to pay equally or does it go to the deepest pocket. MR. GROSSI answered that it is joint and several, so it would be equal for a period of time, but obviously it would keep going into the pockets of those that have the most money in it. SENATOR KELLY said they spent years trying to get away from that concept in tort reform. MR. GROSSI commented that compensation rates have been going down, but they have been going down since 1988 by about 40 percent overall. SENATOR KELLY asked what he attributed that to. MR. GROSSI answered to a number of things - legislation in 1988 and 1995 contributed quite a bit, but also safety has been stressed more and more claims are being worked and he liked to think his Division is working more efficiently, too. SENATOR KELLY asked if he agreed with the 22 - 37 percent profit margin. MR. GROSSI said he didn't have that information. SENATOR KELLY asked for that information from the Division of Insurance, because the legislature did a major effort back in 1989 - 90 with the State health insurance costs and benefits. At the time, the insurance companies had a four percent margin and he thought they may have gone too far with workers' compensation claims. MR. GROSSI concluded that if there is a group that is functioning correctly and there is a requirement of putting some cash in, they won't lose on it. If his statements are too conservative, they will get that money back. Number 460 MR. RICHARD BLOCK, Alaska National Insurance Co.(ANIC), said he has offered a significant amount of testimony in opposition to this bill in the past. While there are a number of areas he is concerned with, the fundamental concern ANIC has is the one being discussed today. That is the fact that there is no real financial underpinning to the obligations this enterprise would have to injured workers. His objections persist into the committee substitute. The proposed financial protections are still inadequate. The reason "is that workers' compensation is probably the most volatile line of insurance there is." Within the 10 percent of claims there could be a number of catastrophic claims which could be enormous. Even if there are no catastrophic claims, one of the real problems is that workers' compensation is an ongoing obligation to the injured worker. It could go on for one to five years or even for the rest of a person's life. An insurance mechanism that is being set up to provide for the worker for the rest of their life has to be able to have the financial strength to meet this obligation. This proposal falls short of that. Of the small amount of premiums that would be first available, one of the things that hasn't been explained accurately is that the cost of the excess insurance the Homebuilder's Association is proposing to cover catastrophic claims comes out of the loss fund. An aggregate stop loss at $400,000 for a $500,000 annual premium is going to be terribly expensive. If they are proposing a $5,000 per loss retention and a $400,000 annual aggregate stop loss, they are talking about 60 - 80 percent of the premium being used to pay for the excess. Of the $175,000 a good portion is going to be used up rather quickly in excess and aggregate stop loss insurance premiums. MR. BLOCK told how when he was involved in the formation of an insurance company and followed the laws then, which required about $3 million of capital in the company, they went out and got reinsurance and got it from companies that were "household names" in the insurance community and bought them through very able brokers. It turned out that within five or six years, those companies went insolvent, and he ended up having to pay the claims the reinsurer was supposed to pay. The amounts were within the surplus they had been building up over time and it didn't adversely affect their company. Where there is no financial underpinning there is no place to turn other than the premium which isn't very much in this legislation. MR. BLOCK said that excess insurance also doesn't cover everything like penalties that the Workers' Compensation Board assesses for improper claim handling, etc. There are also punitive damages that may come around through the employer liability section that may or may not be covered by the excess coverage. He informed them that there are 36 states that have adopted legislation that would permit group self-insurance. His written testimony has some of their requirements and there are a lot of states that adopt financial requirements that are equal to or less than what is in the bill before the Committee. There are also states that require substantially more. A number of the groups have worked extremely well and have begun to return funds back to the employer participants. It also has to be said that there are groups that failed and have resulted in at least assessments back to the individual employers that participated in those groups. He said he can tell the committee that the difference between the successful states and the unsuccessful ones is the fact that the successful ones were very adamant in requiring adequate financial underpinning, adequate net worth in the participants, that there be cash put into the organization, and in some cases audited financial statements, and numerous other protections, many of which are not in the proposed bill. He thought there is a misunderstanding about how rates are made in this state. Rates are determined by a rating organization, the National Council on Workers' Compensation Insurance, and it files an actuarial calculated proposal to the Division of Insurance who reviews it. That information is based entirely on past loss and past payroll experience. Underneath that there is a range of competition among carriers that affects the actual price a homebuilder pays, but that's a matter of competition. Among the states that have adopted these groups, they have found that the reason they got started was because there was a crisis in those states. If you have total lack of insurance or insurance that's available only to a select few or only at exorbitantly high prices, and the legislature adopts the authority to establish one of these groups, you are going to have almost a captive market. They have found, however, when the market turned around and the more standard markets became available, there was a rapid depopulation and disbanding of these groups. In this state there is aggressive competition and lowered rates already. It's going to be substantially more difficult for such a group as this to get started, if they have high requirements (as he suggests) to protect the financial underpinning. He said there would be distractions that would draw the financially strong people away from the group. This means that because there will likely be a smaller population doing this and likely those that are least able financially to support it, there's going to have to be something there to provide the financial underpinning that isn't being provided by the fact that just about everyone in that industry are getting involved with it. If the legislature doesn't provide this authority, there are alternatives to the standard insurance market already on the books like a reciprocal insurance exchange, a group retrospective rating plan, and group franchising. SENATOR KELLY asked him to explain the alternatives to the committee in the form of a letter because he wasn't sure this group knew there were options out there. He asked Mr. Block if assessments of individual members to made up for the losses he talked about earlier caused any bankruptcies. MR. BLOCK said he knew that assessments had occurred to the individual participants, but he couldn't tell him at the moment if they had been forced into bankruptcy. SENATOR KELLY asked if there was a national organization this proposal could be sent to for an objective analysis. MR. BLOCK said there are such organizations. SENATOR KELLY had two questions for the Division of Insurance to answer; the first is if the purported 22 - 37 percent profit margin is a fact. Then he wanted an opinon from the Division of Insurance on whether E and O insurance should be extended to the board of trustees as it is to the administrator for the organization. CHAIRMAN LEMAN said he wanted to know if the joint and several liability point was an issue. SENATOR MACKIE said he wanted to understand this issue better and wanted an example of the process an injured worker would have to go through to receive a claim versus how it's done currently. SENATOR KELLY said he wanted an independent organization to review the bill and compare it to experience in other states. CHAIRMAN LEMAN said he would hold the bill for the information and adjourned the meeting at 3:05 p.m.