The new hot potato confounding public officials is the State Compensation Insurance Fund, the historic quasi-public entity established to meet California's constitutional mandate to make mandatory workers' compensation insurance competitive and available.

There are basically three camps now engaged in skirmishing - the first is under the command of Insurance Commissioner John Garamendi, who has for some time suggested that SCIF's reserves are strained to the tune of $1 billion and that it needs to be conserved or at least under his direct control. This amount does not include an acknowledgment by State Fund that it is also surplus-impaired due to the rapid growth necessitated by the failure of so many other carriers. This, at least in part, is due to the application of Risk-Based Capital (RBC) statutes, a solvency tool enacted in California and many other states that allows early intervention to protect a company from going out of business. The National Association of Insurance Commissioners in its model laws does not require monoline carriers such as State Funds to come under the aegis of RBC. The California Commissioner has not been a model of financial consistency on the State Fund, apparently agreeing with the Legislature that impaired reserves and surplus are no barrier to lowering rates.

The second camp is the Governor and the Legislature. They are frustrated that State Fund has not reduced its rates by an amount they think is appropriate, given the "tough" decisions made over the past two years reforming the workers' compensation system. The Legislature, and the Democrat majority in particular, has been particularly vocal in its disappointment, apparently equating an insurer's surplus with the "surplus" in the state budget - in other words, something that looks good on paper but is not essential to paying the bills. Given the State's potentially dire financial condition, it is easy to understand why the finer points of reserving and insurance accounting methods elude many policymakers in Sacramento. One key question is whether the Governor will allow control of the State Fund to fall to the Commissioner.

Finally, there is the State Fund itself. Embroiled in controversy and under very public assault from the Commissioner and others, its response was to sue the Commissioner and seek a declaration that RBC does not apply to it, even though the Legislature thought it did after AB 1985 (Calderon) was enacted a few years ago. SCIF has a good point, however, from the standpoint of not allowing the Commissioner to seize or even exert much control over it. A "fairly competitive" state compensation insurance fund is guaranteed in the Constitution to make insurance for the mandatory workers' compensation obligations available to all California businesses. Furthermore, SCIF is a division of the Department of Industrial Relations and its board is appointed by the Governor. Each of these facts makes it a bit complicated when the Commissioner is seeking to shut it down even if the shutdown is not through a direct takeover and might take the form of just quietly managing it into a gigantic crisis or insolvency. As long as this litigation drags on, however, there will be a cloud of uncertainty over this marketplace that benefits no one. This is a fundamental conflict that must be solved in Sacramento by the Governor and the Legislature, rather than a courtroom in San Francisco by a judge.

We believe that RBC laws should not apply to the State Fund but should be used as a guideline. This would allow the State Fund to act in an emergency as it has over the past five or so years without the necessity of ceasing to write business. The lawsuit should continue (to protect the State Fund from a politicized Commissioner) until the legislature acts.

Changes in the SCIF Board of Directors, and ultimately in SCIF's management, are widely acknowledged as being inevitable. Indeed, by the time this is read, State Fund is likely to have three new Board members appointed by the Governor, a voting majority. Thus begins a journey down a slippery slope of politicizing the operations of State Fund, a process wisely avoided, by and large, by virtually every Governor since the creation of the State Fund. Changes in the composition of the Fund board have been made twice over the past two decades with no discernible change in the Fund's operations. That, however, is likely to change if the Fund becomes a tool to deliver expectations of reform before experience justifies such expectations.

Taken one step farther, it is easy to imagine the legislature seizing the State Fund's $12 billion in surplus (most of it in cash or cash equivalents held in the Controller's office) to balance the state's creaky budget next year. In trade for this, the legislature might argue that State Fund should pay its obligations out of cash flow and end up with the State guarantying claims payments should there be a shortfall.

This is where the RBC debate takes on a more important consequence. It is more than a dispute between the Commissioner and an insurer. Legislative leaders and labor representatives have publicly stated that one of the reasons they want to change the financial accountability standards for State Fund is so that it can reduce rates. In other words, RBC is standing in the way of legislators impairing the Fund's surplus to deliver immediate rate reductions in an election year. That inspires confidence, doesn't it?

A significant reduction in State Fund's rates will have the immediate effect of slowing down the otherwise slow return of private surplus to the marketplace. In other words, many private carriers complain about State Fund's low rates, lowering them further will exacerbate a bad situation.

If change is to make certain the State Fund stays solvent and than it meets its obligations to its policyholders and injured workers more efficiently that it does today, then change will be positive both for the State Fund and the insurance marketplace as a whole. If, however, the Governor and the Legislature lack the discipline to keep their hands off the daily operations of the State Fund and succumb to the siren's song of raiding its surplus to paper over their own fiscal mismanagement, then all stakeholders in the system will suffer greatly. The new leadership of the State Fund, if there is to be new leadership, must be professional, responsible, articulate and, above all, contemplative. If it is anything less than that, this experiment will fail.

More than 90 years ago, Governor Hiram Johnson stated that there was a need for a state fund but that the state should ".invade the sphere of private enterprise only to the extent that is needful in order to obtain justice for its people." The current Governor would be well served to heed that advice.