Reform Retro!

Since our Department of Labor and Industries has given away more than one billion dollars on a Retro program with no real benefit, and given how much harm would be inflicted on businesses and workers in our State should our State insurance program fail, it is worth taking a look at the assets and liabilities of our State Workers Compensation Program. The results are disturbing.

 

First we need to explain a little more about our Workers Compensation Program. It actually consists of 5 Separate Funds. Three of these funds are called the Industrial Insurance Fund which is also called the Basic Plan. The three funds in the Basic Plan are the Accident Fund, the Medical Aid Fund and the Pension Reserve Fund. The two remaining funds are called the Supplemental Pension Fund and the Second Injury Fund.

 

The original revenue for the Accident Fund comes from premiums paid by employers. The revenue for the Medical Aid fund comes from premiums paid 50-50 by employers and employees. Because the fund premiums are about equal, it is accurate to say that employees pay 25% of the total cost of workers comp insurance. Both the accident and medical aid funds also receive income from interest in investments made with premiums. The intention of these investments is to pay for the long term obligations associated with the premiums.

 

The remaining three funds (Pension Reserve, Supplemental Pension and Second Injury) are paid with transfer payments from the Accident fund and the Medical Aid Fund. Each of the five funds has its own income and liabilities as well as its own ending balance. The total of the first three funds determines the Basic Plan balance (the Basic Plan is also called the Industrial Insurance Fund). The total of all five funds is called the Workers Compensation Program.

 

The difference between the Industrial Insurance fund assets and the long term Basic Plan liabilities is referred to as the Contingency Fund Reserve. It was $2.1 billion dollars in 2007. However, the Basic Plan Fund Reserve lost $500 million dollars in 2008.  $100 million of this loss was due to about $100 million in Retro Subsidies in 2008 which was given out even though total Basic Plan claims exceeded Basic Plan Premiums by $700 million dollars.

So the Fund Reserve fell from $2 billion on June 30, 2007 to $1.5 billion as of June 30, 2008.

 

However, in August 2009, L & I released a statement explaining that “Between June 30, 2008, and March 31, 2009, the contingency reserve decreased $1.067 billion. “

Thus in merely 9 months, the reserve dropped to less than ½ billion dollars.

$600 million of the loss was due to bad stock market speculation. Another $260 million was due to higher than anticipated claims.  And the remaining $140 million was due to retro refunds (which are hidden in the claims data because they are treated as if they were claims). Continuation of this higher rate of claims (due mainly to the aging of our work force) means that it is likely that our Workers Comp Reserve Fund will be at ZERO by the end of 2010.

 

However, as is explained below, the Workers Compensation Program already has gone broke. This is because one of the remaining two accounts (the Supplemental Pension Fund) has long term liabilities of $12 billion dollars which exceeds the entire remaining assets of the rest of the Workers Comp program. Thus, our workers compensation program when viewed as all 5 accounts is $12 billion dollars in the hole.

 

The hope is that revenue will come in before the long term obligations are due. But this debt rose by $2 billion just in 2008 and at least $1 more billion in 2009. So things are getting worse instead of better.

 

The following chart is from Page 16 of the Washington State Worker’s Compensation Program Comprehensive Annual Financial Report for the period ending June 30, 2008. (Note that the June 30, 2009 report will not be out until December 2009).

 

Workers Compensation Program Funds July 1, 2007 to June 30, 2008

Year 2008	Accident Fund	Medical Fund	Pension Fund	Total Basic Plan	Suppleme Pension Fund	Second Injury Fund	Total
Total Assets	5.5 B	5.0 B	3.3 B	13.8 B	0.2 B	64 M	14.1 B
Total Liabilities	4.7 B	4.2 B	3.3 B	12.2 B	12 B	3 M	24.3 B
Fund Reserve	0.8 B	0.8 B	0	1.6 B	-11.8 B	61 M	-10.1 B
Premiums net of refunds	820 M	344 M (310 H)	15 M	1,179 M	336 M	48 M	1,564 M
Claims (Dev)	739 M	672	512 M	1,923 M	1.8 Billion	2M	3.7 Billion
Administrative Costs	141M	140M	---	281 M	---	---	281 M
Claims+ Adm	880 M	812M	512 M	2,204 M	---	---	2.2 B
Operating Income (Loss)	(60 M)	(468)	(497 M)	(1,025 M)	(1.5 Billion)	47 M	(2.5 Billion)
Investment Earnings	259M	55M	147 M	461 M	5M	--	467 M
Income (Loss) before transfer	204 M	(412 M)	(349 M)	(558 M)	(1.5 B)	47 M	(2 billion)
Transfer to Pension Fund	(271M)	(2 M)	+326M	----	-<----	(54M)	----
Net gain (loss)	(66M)	(414 M)	(23 M)	(504 M)	(1,463M)	(6 M)	(1,974 M)
Begin Balance	859 M	1,206M	7 M	2,072M	(10,326M)	69 M	(8,186 M)
End Balance	792 M	791 M	(16 M)	1,567 M	(11,789M)	62 M	(10,160M)

 

The above chart shows that on June 30, 2008, the Basic Plan Fund Reserve was $1.6 Billion. But the Supplemental Fund was in the RED by 11.8 billion. Thus, the entire program was in the red by $10.2 billion. But even the $10 billion dollar shortfall listed on the above table does not reflect the true size of the long terms financial costs faced by the Workers Compensation Program. This is better described on Page 38 of the Report under Section 7.B

Claims Payable. (in $ Billions)

2008 Claims Payable	Basic Plan	Supplemental Plan	Total
Prior Unpaid loss payable	9.2	10.5	19.7
Incurred New Claims	1.7	0.6
Increase in prior estimate	0.5	1.2
Total new Obligations	2.2	1.8	4.0
Claims Paid Current Year Obligations	0.3	----
Claims Paid for Prior Years Obligations	1.2	0.3
Total Claims Paid	1.5	0.3	1.8
Total Unpaid losses (Claims Payable)	$9.9 Billion	$12.0 Billion	$21.9 Billion

 

Total 2008 claims payable are $21.9 billion ($2 billion more than the year before).

$21.9 billion dollars in outstanding obligations sounds pretty bad. But even this hides the true size of the problem because $21.9 billion in obligation is a “discounted obligation”, which assumes that interest earned will be able to offset the eventual claim such that it can be discounted at rates of 2.5% for the Accident and Medical Fund obligations and 6.5% for the (fixed) Pension Reserve Fund obligations.

 

Claims Payable (Discounted) versus fund reserves 2005-2009

June 30 Annual Statement	Accident Fund	Medical Fund	Pension Fund	Total Basic Plan	Basic Plan Assets	Conting Fund * Reserve	Suppleme Pension Fund	Discounted Claims Total
2005 Claims	3.2B	3.0 B	2.3 B	8.5 B	9.7 B	1.2 B	8.7 B	17.2 B
2006 Claims	3.2 B	3.1 B	2.4 B	8.7 B	10.4 B	1.7 B	9.0 B	17.7 B
2007 Claims	3.4 B	3.2 B	2.6 B	9.2 B	11.3 B	2.1 B	10.5 B	19.7 B
2008 Claims	3.7 B	3.3 B	2.9 B	9.9 B	11.5 B	1.6 B	12.0 B	21.9 B
2009 Claims	4.0 B	3.2 B	3.1 B	10.3 B	10.8 B	0.5 B	13.5 B	24.3 B

* The Contingency Fund Reserve is the difference between the total Workers Comp assets/investments minus the discounted long term “Basic Plan” Claims Payable (including only the three “Basic Plan” fund liabilities).

 

Thus, as of June 30, 2008, Basic Plan assets were $11.5 billion and discounted long term Basic Plan liabilities were $9.9 Billion leaving a Reserve of $1.6 Billion. However, there were also $12.0 Billion in discounted Pension Fund Liabilities for total discounted liabilities of $21.9 Billion. Thus total discounted liabilities exceeded total assets by more than $20 billion dollars in 2008.  Total claims payable are going up at a rate of about $2 billion dollars per year and the Basic Plan Fund Reserve is going down at a rate of $1 billion dollars per year.

 

If this trend continues, the Basic Plan Reserve will be at ZERO by the end of 2010 and we will owe more than $24 billion dollars in discounted liabilities. Subtracting estimated assets of $11.0 billion still leaves the Workers Comp program $13.5 billion in the red.

 

$13.5 billion sounds pretty grim. But the true debt is much worse. The $21.9 June 30, 2008 debt listed in the above Table has been heavily “discounted” under the assumption that future interest and inflation will lower the actual amount. But what if interest and inflation doesn’t happen??? What if we have a long term recession and deflation instead??

 

On page 38 of the 2008 Workers Comp Comprehensive Financial Report, it notes that the ACTUAL June 30, 2008 estimate of long term liabilities with no discounts was $36.0 billion dollars. Thus, the discount under-states the actual obligation by about $14 billion dollars. Subtracting $11.5 billion in assets from $36 billion in ACTUAL claims leaves a 2008 actual debt of $24.5 billion.

 

But wait, there’s more! As we all know, the period from July 1, 2008 to July 1, 2009 was much worse for stock market investments than the preceding year. In addition, workers compensation claims are known to rise with increases in the unemployment rate. These two problems are likely to reduce interest income by hundreds of millions of dollars and add more than one billion to the long term liability.

 

 

 

 

 

While the next Financial Report is due out in December 2009, it is likely that the discounted Liabilities are now over $25 billion and the actual undiscounted liabilities exceeded $41 billion dollars as of June 30, 2009. Subtracting $11.0 billion in assets leaves the Workers Comp program $30 billion dollars in debt. For comparison purposes, $32 billion is the entire State operating budget for the next two years.

 

Non-discounted ACTUAL claims payable:

June 30, 2007: 32.7 B

June 30, 2008: 36.0 B

June 30, 2009 (estimate) $41 billion dollars

 

Examples of Losses since the June 30 2008 report

 

An addendum to the 2008 report notes that in September 2008, L&I sold investment in Lehman Brothers for a loss of $37.6 million and in AIG for a loss of $3 million for a total loss of $40 million. There were also unrealized bond losses of $214 million due to holdings which have lost value but have not been sold. (see bottom of page 28).

 

Total losses on investment securities were about $200 million in 2008 (see page 27). Page 25 of the 2008 report shows total assets of $11 billion. However, over $5 billion of this is in corporate bonds and only $2 billion is in US Government Securities.

 

At the WCAC meeting on September 21, 2009, L & I issued a preliminary report on the June 30, 2009 Industrial Insurance (State) Fund balances. They generally followed the table on the previous page. However, there were some disturbing aspects of the June 30, 2009 numbers:

First, while total assets fell by $200 million, long terms claims liabilities rose by $700 million.

 

An August 2009 Statement admitted another $600 million in stock market losses, dropping assets below $11 billion.

 

Thus, the Actual liabilities of the Workers Comp program, as of June 30, 2009, are likely to be over $41 billion dollars. And the true Reserve left is likely to be near ZERO. And the estimated assets may be much less than $11 billion

Leaving the entire program $30 billion in the red.

 

The total number of workers covered in 2008 was 2.6 million. If each of these workers paid $400 it would generate one billion dollars. To pay off the entire obligation of $30 billion would cost 30 x $400= $12,000 per worker.

 

As the above chart shows, most of this future obligation is in the Supplemental Pension Fund. This fund is used to pay cost of living adjustments (COLA’s) for injured workers living on a pension. Our legislature could eliminate this obligation the same way they just eliminated a billion dollar cost of living adjustment for our teachers. They could simply fail to follow through on their commitment to injured workers and cut the COLA for injured workers at the last minute. The problem is that these injured workers have no other source of income.

 

 

Being self supporting means having a balanced budget

 

Even though the Workers Compensation Program is supposed to be self supporting, the truth is it is not. For the Workers Comp program to be truly self sufficient, with any credits or “refunds” to be issued to Retro Insurance Agencies, the credit must not exceed the difference between the premiums paid in and the liabilities incurred.

 

The liabilities must include a full accounting of both claims to be paid and administrative costs associated with those claims.

 

Credit = Premiums + Investment Income from Premiums – Claims – Administrative Costs.

 

Using the 2008 Basic Plan as an example:

Money in = Premiums + Investment = $1,179 Million + $461 million =  $1,640 million

Money Out = Claims + Administration = $1,923 Million + $281 million = $2,204 million

Money Out minus money in = $2.2 billion minus $1.6 billion = $0.6 billion

 

Since the costs of the Basic Plan exceeded the income of the Basic Plan by $0.6 billion dollars, there should not have been any “refunds” in 2008. Thus, the Retro Refund program can be thought of as tax payer money going right in to pockets of retro insurance agencies with no benefit to the public.