Initial Statement of Reasons
Title 8, Chapter 8, Subchapter 2
Articles 3 - 3.1

Article 3

Specific Purpose

The proposed amendments to these regulations will make them consistent with the new Labor Code statutes that permit an alternative composite deposit posted by the Self Insurers' Security Fund rather than individually by each self insured employer to secure workers' compensation liabilities. In addition, due to the potential exposure of all self insurers to greater amounts of unsecured liability, new sections will establish provisions for revocation of certificates to self insure for failure to post security deposit for a specified period of time.

Necessity

Previously there was one system of posting deposit to secure workers' compensation liabilities by self-insurers. These were addressed in Article 3, Security Deposit Requirements. With the new alternative deposit statute, Labor Code Section 3701.8, the existing regulations need to be amended to reflect the alternative system's existence and specific regulations need to be adopted to implement the alternative system. These new regulations are in the new proposed Article 3.1.

Section 15210(b) is amended to add a reference to the requirement of Labor Code Section 3701.8 and the new Article 3.1. This amendment is consistent with the Labor Code amendments. The amendment reflects the options to the existing self-insurer and new self-insurers to post security deposit.

Section 15210 (h) previously addressed failure to post or maintain deposit would subject the employer to a civil penalty pursuant to Labor Code Section 3702.9(a) and/or revocation of the Certificate of Consent to Self Insure.

Civil penalty maximum is $5000 for over 30 days or portion thereof that the deposit is not posted or maintained. This civil penalty is a cheap alternative to an employer that has a very large deposit to post. Over 22 self-insurers, for example, have security deposits over $50 million. The civil penalty is not large enough to spur compliance. The alternative of revocation of the Certificate is much more punitive, but under the hearing procedure in Article 11 can be drawn out for several months. In the meantime, not only are the liabilities not reviewed fully, but additional liabilities are being added daily. Ultimately, the other self-insurers are responsible to pay all liabilities if the self insurer is unable to pay the workers' compensation liabilities for any reason. It is therefore, in the best interests of all private self-insurers employers that are unable or unwilling to post and maintain the required security deposit be removed from the program quickly. Given the employer may post minimum or no deposit under the alternative deposit system proposed, it becomes ever more important to insure required deposits are posted as the amount of unsecured liabilities can be significantly greater for each individual self insurers than in the past when each employer posted deposit individually. Therefore, we are proposing a summary revocation process without hearing be added to subsection 15210(g) for failure to post deposit for more than 60 days with a 15 day notice of the cutoff date. This would mean the unsecured period could be at least 75 days. The employer could still appeal to Manager's summary revocation action but would have to show as a condition precedent that request for hearing that company is fully insured for workers' compensation liabilities.

Section 15210.1 Adjustments to Security Deposit

Section 15210.1 discusses adjustments in the amount of security deposit. Now that there will be two simultaneous security deposit systems operating. Section 15210.1(a) needed to be clarified that it was addressing the existing system adopted pursuant to Labor Code Section 3701. This clarification was made along with editorial revision that the section applied to "any" security deposit required under Labor Code Section 3701.

Subsection (b) was also amended to clarify that any annual license of security deposit required by Labor Code Section 3701 was the subject of this subsection rather than any deposit due pursuant to the alternative deposit under Labor Code Section 3701.8. The subsection was also revised to cover any other reason that the Manager might require a deposit increase. There are a number of other reasons the Manager might require a deposit increase under these regulations, such as, after an audit that determines liabilities were understated on the Self Insurers' Annual Report, due to additions to the employer's self insurance program, or due to a change in the rate of deposit to be posted above the minimum 135% level of Labor Code 3701. Subsection (b) was further amended to clarify the deposit calculation to be consistent with section 15210(c)(2) to give credit for specific excess insurance coverage above the self-insured retention of the special excess policy. This is Self Insurance Plan's practices, but section 15210.1(b) did not include this step, so it was added in for clarity and consistency.

Subsection (d) was amended to include an editorial reference in Subsection (d) to add a cross reference to new Labor Code Section 3701.8 to clarify the Manager may require a self insurer to post and maintain additional deposit or a higher rate of deposit than the minimum set forth in Labor Code Sections 3701, 3701.7 and now, Section 3701.8. Subsection (d) is further amended adding in the list of reasons--that is not all encompassing--that a self insurer might be required to post a higher deposit in being required to post deposit in whole or part as a result of the Labor Code Section 3701.8 alternative deposit system. Non-fully participating employers and excluded employers have to post some or all the deposit needed under Labor Code Section 3701. A fully participating employer would have no individual deposit posted, but if it was downgraded subsequently to non-fully participating status by the Manager, or brought in new additions to the self insurance program, the employer would have to post separate deposit under Labor Code Section 3701. Therefore these amendments were added for clarity and consistency.

Subsection (f) is added to clarify that the civil penalties of Labor Code Section 3701.9(a) apply whenever a self insurer fails to post deposit required under either Article 3 (Labor Code 3701 mandated deposits) or Article 3.1 (labor Code Section 3701.8) alternative deposits). In case the civil penalty of up to $5000 for every 30 days or portion thereof is not enough to get the employer to post the deposit, the proposed new Summary Revocation by the Manager after 60 days of the non-compliance is added without hearing. The Manager under this section would have to give a 15-day advance Notice of the Termination date to the self-insurer, so that the employer may obtain workers' compensation insurance coverage under a policy. This is necessary as the new Alternative Deposit system could replace all the employer's deposit and the amount of deposit could be in the hundreds of millions of dollars. The largest security deposit currently posted is over $400 million by one employer. A $5000 civil penalty per month is a small price to pay for a $400 million loaned deposit, essentially secured by all other self insurer's through the Security Fund. Something more than a civil penalty is needed to insure compliance. Summary revocation of their self insurance coupled with proof of insurance coverage if you want to appeal the Manager's action after 75 days of non-compliance (60 days failure to post and 15 days advance notice of Termination Date) would move most all self insurers to action. In addition, it cuts off the self insurance period if they do not take action much quicker than can be done currently.

Subsection (g) is added to require the Manager to advise the Security Fund if a self-insurer is required to post a deposit increase after an audit due to understated liabilities. This is not currently done. However, with the advent of the alternative deposit system, the Security Fund will be assessing self-insured employers on a pro-rate share of the total security deposit required for each employer. If this amount is significantly understated, then the Security Fund's assessment would be under charging that employer. By telling the Security Fund of the understated liabilities, the Fund has the opportunity to

collect a revised assessment based on the correct liabilities. Self Insurance Plan's audit history over the past few years have faced many instances of shortfalls in excess of $1 million. By advising the Security Fund, the Fund can send a supplemental assessment on the shortfall amount found.

Section 15210.2. Deposit Adjustments Upon Revocation of Certificate of Consent to Self-Insure

Subsection (a) and (b) are editorially revised to reference any deposit adjustment pursuant to either of the concurrent deposit systems. The regulation currently addresses only security deposits posted pursuant to Labor Code Section 3701, so a reference to Labor Code Section 3701.8 was added in both subsections for clarity and consistency.

Section 15216 Administration of Insolvent Self Insurers' Claim's

Section 15216 and subsection (c) are amended to editorially change the title of the section from "Insolvent" to "Defaulted" and in subsection (c) to delete the use of the terms "insolvent" and" bankrupt" leaving only the term "defaulting" self insurer. While the regulations permit calling of security deposits due to insolvency (lack of funds) or bankruptcy (reorganization or liquidation) it is defaulting (stoppage of payment of benefits) that triggers action by the State. While insolvency or filing of bankruptcy may result in a simultaneous or subsequent default on payment of benefits, it is the default itself not the insolvency or bankruptcy that causes the Manager to take action on the deposit.

Subsection (d). Editorial correction to cross reference Labor Code Section 3740-3747 is changed to Labor Code Section 3701.5. It is Section 3701.5 by which the Director of Industrial Relations turns over responsibility to the Security Fund to pay benefits. The statutes that created the Fund are the sections currently referenced, Labor Code Sections 3740-3747.

A new subsection (e) is added to address call order of security deposit. Currently there is no call order under Labor Code Section 3701 or in self insurance regulations. Call order has to do with which security deposit-if these is more than one goes first. It is the practice of Self Insurance Plans to call all deposit, convert it to cash and turn the entire cash amount over to the Security Fund. Thus, a letter of credit posted for half of the deposit required along with a surety bond for the other half are both called, converted to cash and given to the Security Fund. A call order would require one or the other in the example of the letter of credit or surety bond to be "called" first and exhausted prior to the other being called for payment.

The Department of proposing a call order for the first time with all deposits of any type posted pursuant to Labor Code Section 3701 to be "first in line". Second in line is any cash portion of the alternative composite deposits posted by the Security Fund under Chapter 3.1 of these regulations and Labor Code Section 3701.8. The third in line would be the remainder of the alternative deposit posted by the Security Fund. This would constitute the proposed call order. In most cases, the deposit posted for any one of these deposits will be inadequate to pay all benefits once the alternative deposit program is implemented. Therefore, the language of subsection (e) also clarifies that the Director at his/her discretion may call any portion of the entire security deposit posted at his/her discretion without waiting for the exhaustion of all funds in the prior level of the call order set forth in this subsection. This later discretion is needed to prevent arguments by deposit providers at a higher call level that all the funds must be exhausted and paid out before the next level deposit may be called. The new subsection (e) sets forth a call order for clarity and permits the director to call any or all deposit as the Director determines is needed to pay benefits.

An editorial revision of subsection number is made to subsection (e) and subsection (f) of the existing Section

15216 to subsections (f) and (g) due to the addition of a new subsection (e) on call order to the text.

Article 3.1

Specific Purpose

The proposed new regulations in Article 3.1 would permit the Director of Industrial Relations to accept an alternative security deposit system pursuant to Labor Code Section 3701.8 whereby private self insured employers workers' compensation liabilities could collectively be secured through the Self Insurers' Security Fund. The new sections will establish the qualifications and procedures for the new alternative security deposit system.

Necessity

Labor Code Section 3700 currently requires every employer in California, except the State itself, to carry workers' compensation by either being (1) insured against liability to pay compensation by an insurer(s) duly authorized to write compensation insurance in this state (Section 3700(a) Labor Code) or (2) securing a Certificate of Consent to Self Insure from the Director the Department of Industrial Relations (Section 3700(b) Labor Code).

Labor Code Section 3701 requires every private self insuring employer to post a security deposit to secure incurred worker's compensation liabilities and requires the security deposit to be cash, securities, surety bonds or irrevocable letters of credit, or any combination the director deems adequate security and in a form approved by the Director.

Existing Article 3 of self insurance regulations address requirements for security deposit s required under Labor Code Section 3701.

New Labor Code Section 3701.8 permits the Security Fund to post an alternative, but not mandatory, security deposit for private self insurers, to replace some of all of the deposit posted by qualified self insurers to secure their aggregate incurred workers' compensation liabilities through the Self Insurers Security Fund. To the extent the Security Fund's alternative deposit would replace some or all of the security deposit required by Labor Code Section 3701, the two deposit system run concurrently. To the extent the alternative deposit excludes certain self insurers, the Labor Code Section 3701 mandates remain in place. The new regulation in Article 3.1, therefore, addresses the alternative deposit to be posted by the Security Fund.

Labor Code Section 3702.10 authorizes the Director of Industrial Relations to adopt, amend and repeal regulations necessary to carry out the purposes of the Labor Code Section 3701 and 3701.8.

The amendment of these self insurance regulations and adoption of Article 3.1 are necessary to implement and make specific the provisions of Labor Code Sections 3701, 3701.8 and 3702.10.

Article 3.1

Labor Code Section 3701.8 was added by legislation, (Chapter 866, Statutes 2002), that would permit the Director to accept an alternative security deposit system whereby all private self insured employers designated for full participation could collectively secure aggregate self insured workers' compensation liabilities through the Self Insurers' Security Fund. This alternative composite deposit by the Security Fund would be in lieu of each participating private self-insured employer posting their own security deposit for their worker's compensation self insurance liabilities individually. A new Article 3.1 addresses the alternative deposit system.

Section 15220 Deposit Amount Required

Each private self insured employer annually prepares a Self Insurer's Annual Report that provides an estimate of future liability of each self insurers' workers' compensation claims. This report is provided to the Director of Industrial Relations through the Office of Self Insurance Plans. If the Security Fund is to post an alternative composite deposit, it will need information on each employer's liabilities and the deposit amount required. New Section 15220 will require the Manager of Self Insurance Plans to provide the deposit required for each individual self insurer to the Security Fund in order for the Fund to provide an alternative composite deposit if the Fund chooses to do so.

A new subsection (a) is added which requires the Manager to annually prepare a listing of the security deposit amounts

required by Labor Code 3701 for each private self insured employer. The listing will contain the total amount of security deposit required based on the year end Self Insurer’s Annual Report as well as any deposit adjustments made by the Manager due to audits, additions of new subsidiaries or affiliates, deposit rate adjustments, or any other adjustments necessary. The listing is confidential under Section 15405.

This section is necessary as a straight calculation off the Self Insurer's Annual Report does not always reflect other adjustments in security deposit. When new subsidiaries or affiliates are added, a deposit adjustment, for example, is required in most instances under Section 15210(d). The Annual Report does not reflect these adjustments. The same is true for understated liabilities found in audits. The figures provided on the List of Open Indemnity Cases is audited against the figure. When the liability is understated, the audit report will note the indemnity or medical liability that was found to be unrecognized. Calculation errors are also frequently made on the Annual Report-- even when the liabilities are correctly stated. Each year the Manager processes the Annual Reports and prepares a demand letter that is sent back to the employer indicating the deposit increase due or decrease authorized in security deposit. The information, therefore, is available and needs to only be converted into a listing to be provided to the Security Fund.

A new subsection (b) addresses the problem of how to handle the self insured employer that is late filing its Annual Report. Each year there are approximately 50 more or less employers that are late filing the report by over 30 days. If the listing to the Security Fund is to be complete, some amount will need to be made by each employer. The Manager will not have a current figure from those employers that fail for whatever reason to file a complete and timely Annual Report. Subsection (b) will require any private self insurer that fails to file their Annual Report by April 1-- 30 days after its March 1 due date pursuant to Labor Code Section 3701.9 and 3701-- shall be deemed to have twice the liabilities indicated in the prior year's Annual Report for purposes of preparing the listing of required security deposits. Each such self insurer will be flagged in the listing that has an entry based on this section to permit easy correction later on when the Annual Report is received.

A new subsection (c) requires the Manager to provide the listing to the Director and upon request, to the Security Fund Board of Trustees. Since the alternative composite deposit is not mandatory on the Security Fund, there is no reason to automatically provide deposit information unless the Security Fund is considering this. Subsection (c) also provides this listing of required security deposits provided by the Manager to the Security Fund remains confidential in the possession of the Security Fund pursuant to Section 15405. This is necessary as the information is financial and is held confidential by the Department. With the new statute this information is being shared with the Security Fund but only to permit the Security Fund to post an alternative composite deposit.

A new subsection (d) will permit the Manager to provide the listing of required security deposits to the Security Fund in a series of partially completed lists as the Annual Reports are processed. This is necessary to provide information on the required amount of deposits as quickly as possible, rather than waiting until all reports are fully processed. For example, Self Insurance Plans could process the first 100 largest self insurers and provide this partial listing, followed by a second listing of the net 100 largest self insurers etc. until the list is completed. At some point in the listing, the remaining self insurers that have not been processed will have a negligible impact on the total amount of deposit to be posted. Currently approximately $4.5 billion is posted individually. The top 300 self insurers probably 90% of the total, while the remaining 400 more or less self insurers represent about 10% of the total deposit, as the latter group have smaller deposits.

Section 15220.1 Financial Summary

Each year every private self insurer provides it annual financial report to the Manager pursuant to Section 15203.2. Most annual financial reports are available within 4 months after the close of the company's business year. Some business years correspond to the calendar year but many do not. Thus financial reports dribble in to the Manager all year. Self Insurance Plans financial review is focused on net worth and net income, as required by Section 15203.2.

Alternative composite deposits are envisioned in this new Article 3.1 are likely to be much more credit-sensitive and in order for the Security Fund to have credit-worthiness information on each employer, it can obtain much of it from business credit rating agencies, such as Dunn & Bradstreet, Moody's or Standard & Poors. Publicly traded companies have public financial reports and published credit ratings.

In the private self insured community, there are a number of large privately held companies, closely held (such as by family members) companies that do not have published credit ratings. Some of these self insurers are of significant size and have self insurers workers' compensation liabilities that require a security deposit in excess of $2 million. Some of these entities are also very sensitive about access to their company's financial information.

In order for a financial rating to be performed by a credit rating agency, certain standard items contained in Balance Sheet and Income Statements are needed.

There exists, therefore, a problem on how to obtain the necessary credit rating information in order to provide credit sensitive financial security deposits under the alternative deposit statutes by the Security Fund. To address this problem, Section 15220.1 is proposed.

Section 15220.1 (a) permits the Manager to require any private self insurer that does not have a public financial statement or which has no published credit rating to prepare and provide the Manager with a summary of designated general and key financial information from the employer's current financial statement. To further limit the number of self insurers that might have to provide this financial information, subsection (a) further defines the employer to have a required security deposit equal to or greater than $2 million or from any private self insured employer that does not need the financial standards in Section 15203.2 applicable to that employer. Subsection (a) then provides that the financial summary information collected by the Manager pursuant to this subsection shall be made available to the Security Fund upon request.

It is estimated that there currently would be less than 30 private self insurers that would meet the requirements to have to provide the financial summary. Each of these employers, however, are big enough that a credit rating agency issuing a credit determination on commercial paper, for example, to be to be used by the Security Fund as an alternative deposit instrument would want a credit rating determination for all larger risks in the credit pool.

The availability of the Financial Summary information would permit the Security Fund to determine an equivalent credit rating determination for the employer that does not have one.

A new subsection (b) lists the general information and key financial items that would be required. General information is the name of the master certificate holder and the date of the last annual financial statement. The name of the master certificate holder is necessary to identify the self insurer whose financial information has been summarized. While the parent company is often the master certificate holder, there are numerous master certificate holders that are subsidiaries of another company that does not have employees self insured in California. The date of the last annual financial report is necessary as the most current report may be from the previous year, depending upon each company's business year.

Key financial information includes the usual asset and liability figures contained in audited financial statements.

-Cash and Marketable Securities
-Inventory
-Total Current Assets
        Total Assets
-Total Current Liabilities
-Total Long Term Debt
        Total Liabilities
-Retained Earnings
-Net Sales
-Cost of Goods Sold
-Selling, General & Administrative Expenses
-Operating Profit/(Loss)
-Earnings Before Interest and Taxes
-Total Interest Expense
-Net Income/(Loss)

A new subsection (c) standardizes the format and makes it easy for the self insurer to provide to the Manager, the above financial summary requirements, subsection (c) requires the Manager to incorporate the financial information into a form--Form A4-7 (9/02), Financial Summary.

A new subsection (d) requires the Manager to advise the Security Fund of such instances and will be good cause for the Manager to downgrade the non-compliance employer from fully participating to non-fully participating status in any alternative deposit from the Security Fund. This would result in the non-compliant employer have to post up the half of the required security deposit pursuant to Labor Code Section 3701 with no more than half of the required deposit covered by the Security Fund. This section is needed because there is always a possibility that one or more self insurers requested to prepare the Financial Summary Form A4-7 (9/02) by the Manager will refuse to do so. This will leave the Security Fund in the position of having to assign some on-investment grade credit rating to the non-compliance self insurer for creating rating purposes of an alternative composite deposit instrument.

A new subsection (e) permits the Security Fund to assign any non-investment grade credit rating it deems appropriate in its business judgement to the non-compliant employer for alternative deposit purposes. Depending upon the non-invested grade assigned, it could also mean the deposit assessment charge to this employer would be higher than it might have been if the credit rating determination was able to be made.

Section 15220.2 Alternative Composite Deposits

Labor Code Section 3701.8 does not lay out in detail the process by which the Security Fund would propose to cover all or part of the self insurer's security deposits, process or a timeline for review and approval of the

proposal. Section 15220.2 is proposed to lay out this process between the Department and the Security Fund.

A new subsection (a) restates the breath of alternative composite deposits that exist under the new Labor Code Section 3701.8 and Labor Code Section 3701 for clarity. The Security Fund may propose to the Manager to serve aggregate security deposit required, in whole or part, for all participating private self insurers utilizing any one or combination of security instruments listed in those two Labor Codes. This is needed so that the self insurers are aware of what security instruments may be used in securing their aggregate security deposit.

A new subsection (b) requires each time the Security Fund make an alternative proposal to the Manager, the office proposal must be in writing. This subsection is needed to inform the private self insurer that the Board of Trustees shall replace individual security deposits posted by the self insured if the Board deems appropriate.

Subsection (c) sets forth the minimum contents of each Security Fund's formal proposal to the Manager and shall include the following:

  1. A complete description of the proposed composite deposits include what portions are cash and non-cash; any retentions, deductibles, or co-payments contemplated by each layer if any; and any insurance or reinsurance being utilized.

(2) A list of all proposed self insured employers to be covered, their percentage of coverage; their applicable credit rating or equivalent credit rating; and the credit rating agency used to determine the credit rating.

(3) Specification of a call order, if any, of the instruments proposed as alternative deposit.

(4) A proposed effective date of the proposed alternative deposit that is at least 60 days beyond the date of the official written proposal to the Manager.

It is necessary that the Security Fund describe exactly what they are posting, how the pieces fit together, who is proposed to be covered, a call order if any deposit must be

utilized before the next one can be utilized, and an effective date. Labor Code Section 3701.8 gives a few limitations on what can be utilized, so the proposed alternative could be simple or complex. Since the Fund is making the proposal, it seems reasonable that they provide the Manager enough information to evaluate it. The subsection gives the Manager 60 days, in effect, to accept or reject the proposal after receiving it.

A new subsection (d) is added to require the Manager to advise the Director of any alternative composite deposit received and the details of the proposal. The subsection is needed to establish a procedure for the process of the alternative composite deposit.

A new subsection (e) requires the Manager to review the Security Fund proposal and the Manager may approve or reject it in whole or part. The Manager's decision must be communicated to the Security Fund. Once accepted, the Security Fund has 30 days to post the alternative deposit with the Director or within some time period that was specified in the proposal.

A new subsection (f) addresses the release of any existing security deposit posted individually by self insurers pursuant to Labor Code Section 3701. The Manager must hold the existing individual deposits until the alternative deposit is posted before releasing any individual deposits. This is necessary to prevent giving back deposit before its replacement is received. Some self insurers will initially get all of their deposit returned, some others will get up to half returned and some will get none of their individual deposit returned.

A new subsection (g) addresses handling of additions, extensions, replacements, substitutions or other changes in a existing or proposed alternative deposit. It requires the change to be handled in the same manner as the original proposal as set forth in this section. This is necessary

as there could be changes as a result of a rejection of all or part of the proposed by the Manager, or changes or

substitution of a like bond, for example, because the original proposed bond was sold out, there could be changes due to cancellation of bonds, expiration of letters of credit, unexpected redemption of bonds posted etc. So a means to change proposals or existing alternative deposits are likely to occur from time to time.

A new subsection (h) permits the Security Fund to offer its own financial guarantee in various manner provided the guarantee is backs by segregated cash or securities posted with the Director. It is anticipated that the Security Fund will over time build up a considerable amount of excess cash that would permit such a guarantee to be offered. Subsection (h) merely clarifies that such a guarantee may be offered and accepted.

A note is added after subsection (h) to inform the reader that Labor Code Section 3701.8(e) permits the Director to manage its own funds, including cash portions posted with the Director in trust for the Security Fund; or the Director in his discretion may manage the cash portion himself through the Surplus Money Investment Fund managed by the State Treasurer.

Section 15220.3 Participation in Alternative Composite Deposits

While Labor Code Section 3701.8 permits any or all qualified self insured workers' compensation liabilities or current or former self insurers to be secured by the alternative composite deposits. The proposed section 15220 will limit the applicability of alternative composite deposits to a more limited field of coverage by a number of specific exclusions. The remaining participants are then further divided into three categories: fully participating, non-fully participating and excluded. Each category has different eligibility for coverage under the alternative composite deposits.

A new subsection (a) permits all current or former private self insured employers granted a Certificate of Consent to Self Insure under Labor Code Section 3700(b) to participate in an alternative composite deposit program except for the following groupings that are excluded from participation:

(1) Any new private self insured employer during their first 3 full years of self insurance as defined in the section.

Security deposits during the first 3 years of self insurance in Section 15210 is based on prior 3 years of incurred liability of that employer in California. This deposit is adjusted after 3 full years of self insurance to the deposit systems for an existing self insured employer based on estimated future liability of claims. The initial deposit system used for existing self insurers after 3 years can not be applied as the new self insurer has not prior self insured claims, no Annual Report to base or calculate deposit upon. The new self insured employer can be small or large, but the only information we know for sure is the incurred prior losses under their insurance policy. At the end of year 1and year 2 we would have new claims, immature ("green") claims, and have little liability to correctly estimate a proper security deposit. By the end of year 3, we assume we have the equivalent of one year's worth of more developed claims liability. The application process is financially sensitive to new employers with acceptable but poor financials, or employers with parents that do no want to assume and guarantee their subsidiary's workers' compensation liabilities. The deposit rate can be adjusted under Section 15210. The Department proposes to retain this initial deposit system for new self insurers. Notwithstanding the above, an exception is proposed to t his regulation to blend in the past practices with the much more credit sensitive alternative deposit statute.

Exception 1

Would permit an investment grade credit rated new self insurer to enter into the next alternative composite deposit cycle proposed to the Manager by the Security Fund.

Investment grade credit rated companies are rated "Baa" or above. These are the most financially strong companies and they offer the least risk of financial default on workers' compensation liabilities. There appears to be no reason to require such a highly credit rated company to individually post deposit under Labor Code Section 3701, when it presents little or no financial risk to the Security Fund and, if included in the next alternative composite deposit would secure its liabilities through the deposit assessment. Since employees can apply for self insurance and be approved to enter at any time during the calendar year, in most cases an initial security deposit to cover the employer to the next alternative composite deposit cycle would be needed in any event. Since the alternative composite deposits are not mandatory upon the Security Fund, it is discretionary by the Security Fund how frequent the alternative composite deposits are offered, if at all. Given this situation, the new self insurer must post initial deposit under some basis and if the Security Fund chooses to include a new self insurer in the next cycle of alternative composite deposits, the regulations will permit this to occur.

Exception 2

Any former private self insured that has a revoked self insured certificate who no longer files an Annual Report, because all claims are closed.

This is necessary because former self insurers are numerous and date back to 1917. As a result, many former self insurers have no remaining workers' compensation liabilities or they are currently fully secured under deposit posted that may be more or less than the current minimum deposits required. These employers no longer submit annual reports. Most have not had any claim liabilities for decades. Some employers have gone out of business or been liquidated over the years. Therefore, these old certificate files are proposed to be excluded from alternative composite deposit coverage.

Exception 3

Any former private self insured that has a revoked self insured certificate and is required to post only a minimum deposit pursuant to Labor Code Section 3701.

Like Exception 2, this is necessary because former private self insurers go back to 1917, all left posting the required amount of security deposit needed at that time. The groups however has some remaining claim liabilities, so some are still filing Self Insurers' Annual Reports for a handful of claims--generally future medical benefits potentially due. Some others do not file Annual Reports but have remaining claim liability, such as asbestos claims. Some of these former self insurers still exist and others have gone out of business or have been liquidated over the years. Therefore, we propose to exclude this group of former self insurers from alternative composite deposit coverage.

Exception 4

Any current or former private self insured who has sold all or any portion of their workers' compensation liabilities under a special excess workers' compensation insurance policy to an admitted carrier; and the self insured is required to continue to post security deposits to secure sold off liabilities.

Labor Code Section 3702.8 permits any self insurer to sell off any or all of their workers' compensation liabilities to an admitted carrier using a special excess workers' compensation policy, essentially transferring the legal responsibility to pay the formerly self insured liabilities from the self insured employer to the admitted carrier. However, Labor Code Section 3702.8(d)(1) also requires the employer to continue to post security deposit for 36 months to secure payment of compensation by the special excess carrier, in effect, to protect the California Insurance Guarantee Association (CIGA) from carrier insolvency for

the initial three year period. Acceptance by the Director of a special excess under Labor Code Section 3701.8

automatically relieves the Self Insurers' Security Fund of liability for the sold off claims. This ultimate liability transfers to CIGA, the guarantor of carriers. This unique

requirements to post deposit specifically to insure carrier performance under a special excess workers' compensation policy needs its own security deposit posted under Labor Code 3701 for this purpose.

Exception 5

Any private group self insurers during its first 5 years of existence or operation.

Initial Statement of Reasons

Labor Code 3700 permits private group self insurance since 1995, but to date there is only one private group--auto dealers-- that have applied or qualified. This group is 1 year in existence. Unlike a large, financially strong employer that self insurers its own, a private group self insurer is a group of small employers that collectively handle workers' compensation together with joint and several liability for all losses. While such groups could become very large, it is a slow process. The auto dealer group started with less than 10 members initially and over the course of one year they now have about 50 members. The group will likely continue to grow to eventually have perhaps 300-400 members of the some 2000 potential members in the state. Group underwriting standards and self insurance regulations on homogeneity by Standard Industrial Classification Code will limit potential size. Having little past experience to reply upon with private group self insurers, the Department is taking a cautious approach to permit inclusion of a private group self insurer in the alternative composite deposits after they can demonstrate 5 years of existence and experience. We see no reason to permanently exclude private groups, and feel a 5 year history of operation should be a good intuition of the private group's potential for continuous success.

Exception 6

Any private self insured that transfers any or all of its workers' compensation liabilities to a fully insured

employer, as a result of a merger, reorganization, sale or spin off of a division or subsidiary.

Generally self insurers are large employers and they frequently buy, sell, reorganize, spin off, merge, reincorporate and un-incorporate parts of their business. Historically, the employer would retain workers' compensation liabilities related to its shedded businesses, giving the new operation no prior workers' compensation liabilities. This is less prevalent today, and, it is not uncommon to transfer all prior workers' compensation liabilities along with assets of the business or to sell off the workers' compensation liabilities to a carrier. The new "owner" of the workers' compensation liabilities may be a self insurer or may immediately apply to become one. In other instances the new owner has agreed to take the workers' compensation liabilities, but the new owner is not a self insurer nor desires to become one.

The alternative composite deposit system could be covering the liabilities that are transferred without the self insurer posting any security deposit (i.e. the self insurer falls into the fully participating category). The new owner is not self insured and does not wish to be. Therefore, a separate deposit for the liabilities will need to be posted under Labor Code 3701 to secure the transferred liabilities by the new owner. Thus this transfer of self insured liabilities to a non-self insurer must be excluded from the alternative composite deposit because the new owner is not a qualified self insurer with a Certificate of Consent to Self Insure.

Exception 7

Any current or former private self insured that has defaulted in payment of their workers’ compensation liabilities and liabilities have been turned over to the Self Insurers’ Security Fund, pursuant to Labor Code Section 3701.5.

When a self insured employer defaults--stops paying workers' compensation benefits on all claims-- regardless of the reason, the liabilities and the existing security deposit posted under Labor Code 3701 or 3701.8 will be

turned over to the Self Insurers' Security Fund by the Director pursuant to Labor Code Section 3701.5. If there

is a failure to post or a shortfall in the security deposit posted as compared to the claim liabilities to be paid out--this liability is unsecured and the Security Fund assesses the private self insured community to collect the remaining funds needed.

This exception is needed to make it clear that even if there was an alternative composite deposit in place when the next default would occur, any unfunded liability of a defaulting self insurer is not somehow automatically secured by the alternative composite deposit. If this were the case, then the Security Fund would have no ability to recover deposit shortfalls from the estate of the self insurer or the defaulting self insurer, as the Fund has under Labor Code Section 3701.5(e). Deposit shortfalls could result from increased deposits required by an understated liabilities of an audit; new additions to self insurance, changes in credit worthiness that would require deposit to be posted under Labor Code Section 3701 etc. In any of these situations, if the self insurers failed to post the deposit required and then defaulted, the Security Fund would remain responsible to pay all the shortfall, but could still seek recovery for security deposit required but not posted. For clarity and consistency between the statutes and regulations, this exception is needed.

Exception 8

Any current or former private self insured employer that has failed to post the full amount of any security deposit required by the Manager pursuant to Labor Code Section 3701 for more than 60 consecutive days.

Under the current Labor Code 3701 security deposit statutes and existing self insurance regulations, self insurers are generally required to post an adjustment to their security deposit each year in May. For many it is an increase in deposit. Similarly, every 3 years SIP audits self insurers for estimates of future liability reported on the Annual Reports. Revocation audits are conducted when an employer leaves self insurance. Many of the audits result in self

insurers being required to post additional deposit. New subsidiaries and affiliates require higher deposits to be posted in most instances as well. Changes in financial standing and lack of parental guarantees, among other reasons, can result in an increase in security deposit rate from the minimum 135% to 200%. Regardless of the reason for the deposit increase, there are self insured employers that fail to post the security deposit. In every instance the employer is sent an increase in deposit letter and given a period of time to post the deposit increase. A reminder letter is sent out usually with a 14 day grace period to file without civil penalty. After the grace period expires, the civil penalty is invoked back to the original due date with the maximum rate permitted by Labor Code Section 3701.9(a) of $5000 for every 30 days or portion thereof that the employer fails to post deposit.

In the new concurrent alternative composite deposit, up to 50% to all of the required security deposit for qualifying self insurers would be covered by the Security Fund. But we will always have a few employers that refuse to post the balance of security deposit required. If the employer's credit rating qualifies to be fully participating, all deposit is covered by the alternative deposit for that employer at a point in time--for example May 1, 2003. It does not cover subsequent increases or deposit to be posted under Labor Code 3701. This raises a policy issue; Should a non-conforming self insurer who fails to post deposit otherwise required to be eligible for any coverage under alternative deposits? And how long should it be before the employer becomes ineligible? And how long should it be before the employer becomes ineligible? Exception 8 addresses this problem by excluding any self insured employer that fails to post deposit for more than 60 days. Self insurance is a voluntary program and posting the required deposit is a requirement that must be observed. Since cash is always an option to post as deposit, 60 consecutive days without posting a required deposit after notice from the Manager to post seems reasonable to exclude the employer from the benefit of any alternative composite deposit posted by the Security Fund.

Exception 9

Any private self insured employer that does not meet the minimum credit rating criteria as indicated in subsection (b) and (c) of this section.

The alternative composite deposit regulations are much more credit sensitive than current regulations. This is necessary as the composite deposit cost structure is basically the credit worthiness of the entire group of private self insurers. Subsection (b) and (c) of this section sets forth credit worthiness requirements to be fully participating, non-fully participating or excluded so since subsection (a) lists specific exclusions, a reference to the credit worthiness requirements in subsection (b) and (c) are necessary to be listed here in subsection (a).

Exception 10

Any current or former private legally self insured employer that is a member of a public sector healthcare joint powers authority.

There is one public sector joint powers authority (JPA) that has extended membership to three private sector employers without obtaining a Certificate of Consent to Self Insure pursuant to Labor Code Section 3700. The JPA claims there was authority under Government Code Section 6527 for their actions. The matter was in dispute before the Director of Industrial Relations. In the initial decision of the Director, it was determined statutory clarification was needed to remove the authority. Legislation (Chapter 750 2002) was passed on behalf of the JPA that clarified only that public sector healthcare JPA's could now accept private healthcare members and that the Security Fund was not responsible for their workers' compensation liabilities. However, no other clarification to remove other statutory conflicts that require every private sector self insurer to qualify, to post security, etc., was not addressed. Presumably additional statutory clarification will be subsequently made. In the meantime,

3 private sector employers are members of a healthcare JPA and have not been granted self insurance, nor have they

qualified or posted security deposit. It is necessary, therefore, to exclude any private sector healthcare employers that may be participating in this healthcare JPA, since the newly passed statute excluded them from Security Fund coverage.

(b) Fully Participating

A new subsection (b) will establish the requirements for fully participating employers. In order to be eligible for fully participating status in any alternative composite deposit, each private self insured employer shall possess an acceptable credit rating on the date of the Board of Trustees alternative deposit written proposal to the Manager. An acceptable credit rating of any "A" or any "B" as determined in either Moodys Global Ratings Guide or Standard and Poor's Credit Market Service. This subsection is necessary because it will establish the requirements for full participation in the alternative composite deposit program. Full participation effectively means the employer will pay the deposit assessment and not be required on the basis of their credit rating to post individual security deposit. Their workers' compensation liabilities will be secured under the alternative composite deposit up to the amount of security deposit they are required to post.

Neither the Department nor the Security Fund are in the employer credit rating business. It is necessary, therefore, to utilize the credit rating services of specialists in this field. These specialist are Moody's Investor Service and Standard and Poors Company. Each has a business rating service sold on a subscription basis that rates credit risks of businesses.

There are instances when credit rating companies do not necessarily agree on the same credit rating for an individual company at a given date. Therefore, in case of

split ratings from the 2 rating agencies, the lowest rating will be used.

Section 15220.4 Calculation of Deposit Assessments

Subsection (a) divides the deposit assessment into 4 component parts-- each individually determined but Initial collected together. Each part addresses a different cost portion of the whole assessment. The parts are:

            1. Default Loss Fund Fee.
            2. Excess Liability Protection Fee.
            3. Pre-Existing Deposit Shortfall Fee.
            4. New Self Insurers Fair Share Contribution Fee.

Proposed subsection 15220.4 addresses the first 3 fees of the assessment and proposed Section 15220.5 addresses the fourth part, a surcharge. In order to understand the assessment in total, it is necessary to break it down into component parts.

  1. Default Loss Fund Fee. This is the portion of the deposit assessment that builds a cash fund (net worth) of the Security Fund to pay defaults on covered workers' compensation liabilities of eligible self insured employers. This is necessary as the Security Fund, currently set up, has negative net worth. This is somewhat by statutory design--they get workers' compensation liabilities by defaulting self insurers who have posted individual security deposits that at the moment of default may or may not adequately cover all workers' compensation liabilities. The Security Fund has 50+ estates and incurred liabilities exceeding current assets of approximately $50 million.

In the alternative composite deposit design of the new Labor Code Section 3701.8, the Fund will build net worth over a period of year's essentially by collecting the fees or costs paid out currently for individual security deposits to be posted with the Director, and reclaimed these funds to the Security Fund as an assessment. This is considerably more than the current or expected annual pay out of workers' compensation self insurance default, so each year $35-50 million in net worth (more or less) will accrue. In ten years this could be a massive fund of $500 million or more to pay workers' compensation claims of defaulting self insurers. Put another way, the collective body of private self insurers are self insuring their risk of defaulting self insurers among them. The Default Loss Fund is the vehicle for the payment of these future losses and the Default Loss Fund fee is the annual contribution from each Self Insurers' Security Fund member to build this Default Fund.

(2) The second portion of the Deposit Assessment Funds the costs of a very different form of protection for the private self insured employers-- aggregate loss protection against multiple, large defaults by self insurers during the year while the Default Loss Fund is small. This is necessary, as the alternative composite deposit removes the individual security deposits posted for most private self insurers. This means the defaults when they do occur will be larger in dollar amount. If a self insurer has actual liabilities of $50 million in workers' compensation claims and the current security deposit is $45 million from the last annual report, in a default the Security Fund would assess its member for the $5 million shortfall. Under the new alternative composite deposit, the Self Insurers' Security Fund would pay out the entire $50 million if the employer was fully participating over a period of years. What if instead of one $50 million self insurer defaulting, there were five (5) $100 million liability employers all of whom were fully participating? Or one that was a $350

million liability employer? To protect against this type of occurrence, the Security Fund will likely protect its members by arranging some type of catastrophic protection

layer, such as, any loss or series of losses exceeding $300 million would be protected. Thus the Security Fund would only pay up to its "self insured retention" -- in this example $300 million. This layer or layers of aggregate protection would be purchased in any a number of ways. The cost of this level of protection --whatever it might be, would be spread across the private self insurers through a pro-rata fee on each self insurer. This portion of costs to secure aggregate protection is the Excess Liability Protection Fee portion of the deposit assessment.

(3) The third portion of the deposit assessment goes to fund the existing funding shortfall the Security Fund already has, which is approximately $50 million. This is necessary as the current Security Fund Insolvency Assessment is capped at a maximum rate of 2% of paid benefits during the previous calendar year. Currently this raises approximately $4.5 million per year. With a current liability shortfall of over $50 million, it would take over 10 years to raise this amount to retire the liability-- and there could be no further defaults. Since 1984, there averages about 2 or 3 defaults per year, so it is unlikely that defaults will cease altogether for the next 10 years. The cash flow generated by the existing Labor Code Section 3745 Insolvency Assessment is inadequate. So the deposit assessment will retire this existing liability with a third portion of the new assessment, which we deemed the Pre-Existing Deposit Shortfall Fee. Over time, this portion of the deposit assessment will be retired, as the pre-existing $51 million shortfall is funded. This portion will drop off, the same as the Labor Code Section 3745 Insolvency Assessment will stop--replaced by the third portion of the deposit assessment.

(4) The fourth portion of the deposit assessment is the New Self Insurers Fair Share Contribution Surcharge Fee.

This is covered by Section 15220.5 of the proposed regulations.

Subsection (b) The Board of Trustees shall determine and collect the deposit assessment owed by each fully participating and non-fully participating private self insured employer. The Board will also collect the assessment due from excluded employer, but the amount of the assessment due will be determined by the Manager, who will advise the Board of the amount to be collected from excluded employers.

This is necessary as some party will need to collect the deposit assessment. Since this is the funding mechanism for the alternative composite deposit, it is reasonable that the Security Fund-- the party proposing the alternative composite deposits-- be the party to collect the assessment.

One of the reasons for breaking down the deposit assessments into fourth parts--

1. Default Loss Fund Fee,
2. Excess Liability Protection Fee,
3. Pre-Existing Deposit Shortfall Fee,
4. New Self Insurer Fair Share Contribution Surcharge was able to make it easiest for the Manager to determine the portion of the deposit assessment that the excluded self insurer must pay. The excluded employer posts its own security deposit, so these employers get only some indirect, practical benefit from the Default Loss Fund and Excess Liability Protection portions of the deposit assessment. This is mainly that future losses will be covered by these two fees probably better than in the past. So their contribution to both of these fee by excluded employers at best, should be minimal. The pre-existing deposit shortfall fee can be applied to any self insurer that has not been revoked for at least 36 months. This is because the existing Labor Code Section 3745 Insolvency Assessment is only applied until 36 months after the employer left self insurance. So many of the excluded self insurers fall into this category--revoked for over 36 months. Once the Labor Code 3745 Insolvency Assessment is replaced, all remaining self insurers and all future self insurers are fair game for the New Pre-Existing Default

Shortfall Fee. An argument could be advanced that former self insurers that have already been revoked prior January 1, 2003, should also be considered only eligible to be charged for existing insolvencies for 36 months after their revocation. While Labor Code Section 3701.8 made no such distinction, it is expected that the Director would receive appeals in all such instances, so as a practical matter the Manager intends to apply the New Pre-Existing Shortfall Fee portion of the deposit assessment on all revoked self insurers that have not gone beyond 36 months from their revocation date. For those former self insurers that are over 36 months out from revocation, there will be no application of this portion of the assessment. Nor will there be any application after 36 months to any self insurer revoked prior to January 1, 2003. For all those current self insurers who might leave self insurance in the future, it is the Manager's intention on this portion of the deposit assessment to be applied as long as the revoked self insurer has open claim liabilities and charged on some basis as any current self insurer. The Manger will not know what the basis is until the Security Fund makes its proposal for an alternative composite deposit and the Board of Trustees determines how its first deposit assessment is applied. The method used to apply the Pre-Existing Deposit Shortfall Fee may change from cycle to cycle for revoked self insurers again depending upon how the Board of Trustees applies this portion of the assessment to the rest of the self insured community. Hopefully the Board of Trustees will settle on a particular methodology in this area, such as a percentage of paid losses or some other calculation, that could then be added to the regulations.

Subsection (c) The Board of Trustees of the Security Fund shall in the exercise of its business judgement determine the pro-rata share amount of each portion of the deposit assessment for each private self insured employer having fully participating or non-fully participating status.

It is necessary to defer to the Board of Trustees to exercise its business judgement to determine how to determine how the deposit assessment will be shared, since the statute, Labor Code Section 3701.8 (b) does not specify any particular methodology to be followed. Subsection (b) only requires reasonable consideration of

(1) the total amount needed to provide the Composite deposit;

(2) the self insurers paid or incurred liability as reflected on the Annual Report;

(3) the financial strength and credit-worthiness of the self insurer; and

(4) other reasonable factors as may be authorized by regulation.

Section 15220.4 (c) references the three statutory considerations as its first consideration. The section then goes on to add item (2) addressing cost considerations of security instruments permitted including the cash holdings that will make up the Default Loss Fund and/or the level of aggregate excess liability protection provided in the proposes alternative composite deposit.

It is necessary to consider cost of the security instruments and to consider the cash that may have built up along with the layers of aggregate protection. The entire package must be considered, not just any single element within it.

Item (3) addresses the amount of security deposit required by the Director for each self insurer to secure its liabilities. This is necessary as it is another way to look at statutory consideration of incurred or paid liabilities in Labor Code Section 3701.8 (b)(2) from the Annual Report. Security deposits affords a means of pro-rate sharing of the costs as well that would include other factors not reflected in liabilities reported alone, such as recent additions to the program, lack of parental guarantee, poor credit worthiness, failure to post deposit, audit results, etc., as the Manager had traditionally done.

Item (4) clarifies how credit worthiness will be considered under the regulation as set forth in the reference to Section 15220.1 or Section 15220.3 of these regulations. Financial strength and credit worthiness is included in the Labor Code Section 3701.8 (b)(3) as one of the items to be considered by the Board of Trustees. Since these regulations go further to spell out this consideration in greater detail, a reference to these regulations is necessary.

Item (5) permits the Board of Trustees to consider an amount, if needed, for pro-rata share of incurred but not reported liabilities aggregated across all private self insurers. This is necessary to permit the Board of Trustees a full range of analytical tools commonly used to estimate incurred liability. Since these are considerations upon which the Board of Trustees can exercise its business judgement in determining the deposit assessment, and it is not uncommon to make these liability estimates factoring in an incurred-but-not-reported loss amount, it has been added to the list.

Item (6) permits the Board to consider an amount to be collected to pay off the existing, unfunded liabilities of the Security Fund from previously defaulted estates. This

is necessary as the existing Labor Code Section 3745 Insolvency Assessment will be replaced by the Pre-Existing Deposit Shortfall Fee, a portion of the deposit assessment. The current approximately $51 million shortfall does not have to be immediately funded in total, but the cash flow needs to retire this shortfall should be considered.

Section 15220.5 New Self Insurer Fair Share Contribution Surcharge

This new section requires the Self Insurers' Security Fund Board of Trustees to track and develop a historical, annual schedule of cash contributions for the first 10 years to build net worth in the Default Loss Fund. Each new self insured employer under this regulation is then surcharged a "fair share" contribution for any years of the initial ten years that the new self insured employer did not contribute to the Default Loss Fund. This 10 year contribution to new worth is called the New Self Insurers Fair Share Contribution Surcharge Fee and shall be assessed in addition to any other payment required of the new self insurer to the Default Loss Fund.

A note is added to permit the Board of Trustees to calculate an average annual surcharge amount for this surcharge.

This requirement is necessary as the existing employers that are self insured will build hundreds of millions of dollars of net worth into the Default Loss Fund over the first 10 years of its existence. New self insurers that enter self insurance in future years will directly benefit from these contributions, but will have made little contribution to this net worth. For example, a new self insurer in year 3 would not have contributed anything for year 1 or 2. A new self insurer entering into year 6 would have paid nothing for years 1-5. A new self insurer

entering in year 11 would pay nothing to the net worth guaranteeing payment of their liabilities at all. To even this out, a surcharge on the new self insurer would provide whatever years of contribution are missing to be paid off essentially an equal number of years that were missed. This surcharge balances the books, so all self insurers will have paid an equal pro-rata share toward the net worth. This has the added benefit of building a greater net worth, as well, reducing future assessments for all other self insurers over time.

It is likely at some point--absent significant large defaults, that the default loss fund could reach a range of between $500 million - $1 billion. At that time, it is conceivable that assessments to build net worth in the deposit assessments could be greatly reduced for all self insurers, as the Security Fund could offer is own guarantee backed by this Default Loss Fund and its ability to assess for additional funds to cover any defaults that might occur. This could attract more companies to self insurance that would post no separate deposit and not contribute to the net worth of the Default Loss Fund if some type of "fair share" contribution to the net worth of the Security Fund were not required.

Section 15220.6 Deposit Assessments; Failure to Pay; Assessment Liability

A new Section 15220.6 will require each private self insurer who participates in the alternative composite deposit to pay a deposit assessment and to establish civil penalties for the private self insured employer who fails to post the deposit assessment in the time allotted by the Self Insurers' Security Fund.

A new subsection (a) will establish if the Security Fund proposes an alternative composite deposit will be binding to all private self insured employers eligible for fully participating status or non-fully participating status.

This is necessary as it is optional for the Security Fund to propose the alternative composite deposit, but, if offered, it is binding upon the private individual self insured employer. The individual employer may not decide to not participate. Just as the private self insured employer has no rights in not belonging to the Self Insurers' Security Fund when the fund offers the alternative deposit, all fully qualified and non-fully qualified members are covered to the extent of alternative coverage offered. This will also permit spreading costs equitably among the members of the deposit assessment.

A new subsection (b) will establish the responsibility of determination of the amount of deposit assessments, billing and collections for private self insured employers to be the responsibility of the Self Insurers' Security Fund. This is necessary so it will be clear who has authority to collect and charge out the assessment to the individual self insurer. These fund are then used to provide the deposit instruments to serve workers' compensation

liabilities of the understated self insured employers, as determined by the department.

A new subsection (c) will establish the civil penalties of not less than 10% of the amount of the deposit assessment on the private self insured employer who fails to pay the deposit assessment in the time allotted by the Security Fund Board of Trustees.

Existing civil penalties in Labor Code Section 3702.9(a) for failure to post deposit as required under Labor Code 3701, top out at $5000 for every 30 days or portion thereof. Self Insurance Plan's experience shows this civil penalty is often more attractive because it is less expensive than the cost to the self insurer to post the deposit increase, particularly if it is a large amount. Similarly, the Labor Code 3702.9, civil penalty for failure to pay an assessment, user funding assessment, fraud

investigation assessment or the Security Fund insolvency assessment-- is an amount not to exceed $2500 for every 30 days or portion thereof. This assessment penalty is also not enough in most cases to obtain the divested performance --assessment payment. Labor Code Section 3701.8(d), sets a much higher penalty assessment for failure to pay the Security Fund deposit assessment in the time frame provided of not less than 10% of the deposit assessment itself, plus posting of the security deposit separately under Labor Code Section 3701. The penalty is added to the Security Fund's deposit held by the Director. Thus an employer required to pay a $3 million deposit assessment who fails to do so in the time frame permitted, could pay a penalty of at least $300,000 and would have to post separate individual deposit with the Director. The $300,000 would be much greater than any existing Labor Code Section 3701.9 civil penalty plus the Security Fund would receive the penalty instead of the Department. With this severe penalty, non-payment of the deposit assessments should be practically non-existent.

The severity of the penalty, however, is consistent with the fact that the Security Fund covers half or more of the total amount of security required for the self insured employer, who must only pay their pro-rata share of the deposit assessment.

Subsection (c) in addition to the civil penalty the private self insured employer who fails to pay the deposit assessment in the time allotted requires this employer to post a separate security deposit pursuant to Labor Code Section 3701, within 30 days of the notice by the Manager.

This is necessary because failure to pay the deposit assessment effectively means no deposit would be posted by that employer to secure its workers' compensation

liabilities under the alternative composite deposit. Labor Code Section 3701.8 requires such employer to post its own deposit under Labor Code 3701 to secure its liabilities. While initially, every private self insurer would have to be notified of its failure to perform, assessed the civil penalty, and advised by the Manager to post an individual security deposit pursuant to Labor Code Section 3701 in the amount required. A period of time would be needed in order to comply with posting a separate deposit. The proposed regulation provides all of this and grants the employer 30 days to post after notice by the Manager to secure its workers' compensation liabilities.

A new subsection (d) will provide for failure to pay by the self insurer of the deposit assessments in the time specified by the Security Fund Board of Trustees and/or failure to post and maintain the full amount of required individual security deposit for more than 60 days or both, shall be good cause for the Manager to summarily revoke the private self insured employer's Certificate of Consent to Self Insure without a hearing. This is necessary to cut off the self insurance period. Presumably the self insured employer has made a decision not to pay the deposit assessment securing its workers' compensation liabilities

and then has failed to individually secure the liabilities as required with a separate deposit under Labor Code Section 3701 for at least 60 days. Securing workers' compensation liabilities is a fundamental requirement to be self insured. Normal revocation proceedings could stretch

out the period of self insurance for several months--just adding more unsecured liabilities to the employer's account. Summary revocation without a hearing by the Manager will cut off the period at about 75 days, as 15 days notice of the summary revocation date is needed. This is adequate time for an employer who wants to be self insured to comply with deposit requirements. The employer

may still appeal the Manager' Summary Revocation action, but must as a condition precedent to such an appeal first show that all new liabilities are secured by a workers' compensation insurance policy.

Subsection (e) clarified that the self insured employer may post a separate individual security deposit, but that action does not negate any deposit assessment civil penalty assessed of at least 10% of the deposit due nor does posting of a separate individual deposit release the self insurer of any portion of the deposit assessment otherwise due, such a the amount due for prior defaults. The only means by which these obligations can be released is whole or part is by successful appeal under Section 15220.6.

Section 15220.7 Appeals on Deposit Assessments and Appeals of Deposit Assessment Penalties

The Director is required by Labor Code Section 3701.8 to consider appeals on deposit assessments and appeals on deposit assessments penalties. The Directors regulations on Hearing and Appeal Procedures are contained in Article 11 of the Director's self insurance regulations. For clarify and consistency, Section 15220.6 cross references the reader to Article 11 for appeals on both these subjects.

Section 15220.8 Cash Portion of Alternative Composite Deposits

A new subsection (a) requires the Board of Trustees of the Self Insurers' Security Fund to make a detailed accounting of the monies collected from each deposit assessment to the Director within 90 days of the payment due date of the assessment.

This is necessary as the Self Insurers' Security Fund will be collecting between $50-$100 million in each deposit assessment initially for every alternative composite

deposit. Each self insurer is separately invoiced by the Security Fund so it should be a simple matter to account for its assessment collection within 90 days of the payment due date to the Director, so there would be no way to know if it had all been posted without an accounting of the collection itself.

Subsection (b) requires the Board of Trustees of the Self Insurers' Security Fund to cause an accounting to be prepared to summarize all funds collected in a deposit assessment, the costs of each instrument posted as alternative composite deposit, all commissions and costs due or paid related to the alternative deposit system for that deposit cycle, and any excess funds left over.

This accounting is necessary to get to the net excess cash collected in each deposit assessment. Some portions of the deposit assessment are specifically collected, for example, to pay off existing self insured defaults and will be separately accounted for. The largest amount of the deposit assessment will be collected for two purposes: cash to build net worth in the default fund in order to pay future self insured employer defaults and to purchase financial instruments to protect the Self Insurers' Security Fund

(and indirectly all private self insurers) against a string of catastrophic defaults by more than one larger self insurer. As the default fund grow by $30-450 million per

year in size over the years, the cost and amount of catastrophic protection needed will decrease, permitting either reduced deposit assessments or increasing the growth of the default fund in the short run. Since the deposit assessment will bring in tens of millions of dollars and all excess cash must be posted with the Director, an account of all direct and related costs must be made to determine excess cash available.

Subsection (c). Labor Code Section 3701.8(f) requires the Self Insurers' Security Fund to post the cash portion of the composite deposit from deposit assessments to be posted with the Director. Subsection (c) merely requires this for clarity and consistency.

Subsection (d) Labor Code Section 3701.8(c) requires that any surplus funds collected form the deposit assessment be posted with the Director. Subsection (c) reflects this requirement for clarify and consistency.

Subsection (e) requires the Director to hold any cash deposits from the Security Fund in the name of the Director of Industrial Relations in Trust for Self Insurers' Security Fund. This is necessary to reassure the Security Fund that its cash funds are segregated from any other cash deposits held by the Director. This is consistent with existing cash security deposits requirements for Labor Code 3701 and existing cash in trust regulations contained in Section 15214 of these self insurance regulations. The Director holds all cash security deposits in the same manner as "The Director of Industrial Relations in Trust For" the individual self insurers' legal name of each account.

Subsection (f) spells out how the Director will invest the Self Insurers' Security Fund cash if the Director decides to hold and invest the cash. Subsection (f) also spells

out the alternative, the Director may permit the Self Insurers' Security Fund to manage and invest the deposited cash outside of the State Treasury subject to specific conditions. This is necessary as Labor Code Section permits either approach. If the Director holds and invests the cash it will be deposited in the Surplus Money Investment Fund pursuant to existing authorization contained in Labor Code Section 3701.8 for surplus cash or the cash portion of any alternative deposit.

The Security Fund currently manages and invests its own cash from the security deposits of estates of self insured employers that have defaulted on payment of their workers' compensation self insured claims liabilities. Section

15220.8(f) would also permit the Self Insurers' Security Fund the hire its own funds Manager and invest the deposited cash on its own behalf, outside the State Treasury, provided the following conditions are met:

    1. The Self Insurers' Security Fund Board of Trustees had adopted a cash investment policy outlining the types of investments that could be made to preserve and protect the principal.
    2. The Self Insurers' Security Fund makes quarterly reports to be sent out to the Manger by the funds Manager on all the Director's cash deposits management by the Self Insurers' Security Fund; and
    3. None of the Directors trust funds may be co-mingled with Self Insurers' Security Fund cash nor may within any single investment instrument may funds be co-mingled.
    4. Regardless of who manages the cash, the Director's funds must always remain in the Director's name until such time as the Director may order the release of the funds to the Self Insurers' Security Fund or back to the self insurers.

These specifications are necessary as the Director does not typically manage investments of this potential size. Existing statutes permit depositing cash of the Security

Fund into the Surplus Money Investment Fund that manages the funds. If the Security Fund manages the Director's funds on its own behalf, the it will need to have an Investment Manager and an investment policy to preserve and protect it its principal. Quarterly reports to the Director on the investments by the Funds Manager is a reasonable requirement to tack and document the funds under management and that the investment policy is being followed. Separation of the Self Insurers' Security Fund funds from the Director's funds is necessary as each must be kept subject to different party's control. The Self Insurers' Security Fund already manages extensive funds of its own, has its own investment policies and investment Manager. Funds are managed collectively but accounted for estate by estate by the Self Insurers' Security Fund. Co-mingling of funds in the same account or in the same instrument--government bond for example--could permit funds to be ordered out of the Director's name. Therefore, all accounts and instruments would have to be separated between the Director and the Self Insurers' Security Fund if Self Insurers' Security Fund managed the funds for the Director. This is not a difficult thing to accomplish, as the Security Fund already accounts separately for 50+ estates. However, putting these restrictions into the regulation will spell out the minimum expectations of the Director for the Self Insurers' Security Fund to manage these funds.

Subsection (g) specifies that when the Director initially turns over compensation liabilities to the Self Insurers' Security Fund who were covered by the alternative composite deposit, the Director will also release enough cash to fund expected workers' compensation benefits for the remainder of the calendar year. This is necessary as the cash portion of the alternative composite deposit is in the name of the Director. Since defaults could occur anytime during the calendar year, the regulation will require enough cash be released to fund expected workers' compensation benefits for the remainder of the calendar year. In most instances,

this should provide the Self Insurers' Security Fund with enough cash and time to include in their next calendar year's projection the funding to be released for the new default estate along with all others contained in subsection (h). The Manager should be able to estimate workers' compensation benefits to be paid to the balance of the calendar year by using the paid-to-date information from the last Self Insurers' Annual Report on the private self insurers defaulting. For any of a number of reasons, the Manager's initial estimate could be inadequate and further funds will need to be released before the end of the calendar year. To address this situation, subsection (g) requires the Manager in consultation with the Self Insurers' Security Fund to advise the Director that additional funds for the remainder of the calendar year are needed and request the Director to release an additional amount to fund the payment of benefits and expenses for the period.

Subsection (h) requires the Self Insurers' Security Fund to annual notify the Manager and Director in writing of the funds needed to operation for the next calendar year that will be funded from the alternative composite deposit. The Security Fund routinely does cash flow analysis of its current estates to project funding needed for assessment purposes. This subsection takes that information and translates it into a request to the Director to release alternative composite funds to the Security Fund's control, as all surplus and excess cash is held in the Director's name. A request would be needed from the Security Fund each time it wants funds released from its excess or surplus cash of an alternative composite deposit. Doing it once a

year should provide most of the funds needed by the Self Insurers' Security Fund with one request.

Article 11

Specific Purpose

The proposed amendments to these regulations will make them consistent with the new Labor Code statutes that permit an alternative composite deposit posted by the Self Insurers' Security Fund rather than individually by each self insured employer to secure workers' compensation liabilities. The new sections will establish provisions for hearings on appeals for the alternative composite deposit assessment.

Section 15430 is the first section in Article 11 of self insurance regulations that discusses the self insurance matters that the Director may investigate or conduct hearings upon. The hearing procedures themselves follow Section 15430 in Article 11.

New Labor Code Section 3701.8 adds two new subject matters for the Director of hold hearings on-- appeals of deposit assessments and appeals of penalties for failure to pay a deposit assessment--which will be added as listed subject areas in Section 15430 as new subsection (h) and (i).

Necessity

This is necessary to give form and substance to the self insurer and to the Director as to how such proposals are to be made, procedures to be followed, how hearings will be conducted, and decisions rendered. The existing self insurance hearing process is established and can accommodate the new subject areas. All that is needed is to add the subject areas to the list in Section 15430 for the existing hearing and appeal procedures to apply.

TECHNICAL, THEORETICAL, AND/OR EMPIRICAL STUDY, REPORTS OR DOCUMENTS

The Department did not rely upon any technical, theoretical, or empirical studies, reports or documents in proposing the adoption of this regulation.

ALTERNATIVES TO THE REGULATION CONSIDERED BY THE AGENCY AND THE AGENCY'S REASONS FOR REJECTING THOSE ALTERNATIVES

No other reasonable alternatives were presented or considered by the Department.

ALTERNATIVES TO THE PROPOSED REGULATORY ACTION THAT WOULD LESSEN ANY ADVERSE IMPACT ON SMALL BUSINESS

The Department has not identified any reasonable alternatives or that have otherwise been identified and brought to the attention of the agency that would lessen any adverse impact on small businesses.

EVIDENCE SUPPORTING FINDING OF NO SIGNIFICANT ADVERSE ECONOMIC IMPACT ON ANY BUSINESS

SIP is not aware that there will be any significant adverse economic impact on business.