Scott Scherer, General Counsel, Governor’s Office

Douglas Dirks, Chief Executive Officer, Employers Insurance Company of Nevada

Lenard Ormsby, General Counsel, Employers Insurance Company of Nevada

Ann Nelson, Associate General Counsel, Employers Insurance Company of Nevada

Roger Bremner, Administrator, Division of Industrial Relations, Department of Business and Industry

Alice A. Molasky-Arman, Commissioner, Division of Insurance, Department of Business and Industry

Danny L. Thompson, Lobbyist, Nevada State AFL-CIO

Robert J. Gagnier, Lobbyist, State of Nevada Employees Association/AFSCME

Paul Brown, Assistant General Counsel, American International Group Incorporated

SENATE BILL 37: Makes various changes regarding industrial insurance. (BDR 53-382)

What I would like to do this morning is take you through about four different discussions, not exactly a high-level overview, but a context of going through the bill section by section. I would like to begin with an overview of what the reinsurance transaction is, how it would occur, and what the pieces of that transaction are. Sometime prior to July 1, 1999, we would enter into a lost portfolio transfer with several reinsures. Under that transaction, we would transfer some amount of money; at this point I am guessing it will be between $775 million-$800 million, in cash, transferred to a reinsurer. Simultaneous to that transfer, the reinsurers will assume liability. They will assume liabilities up to $2 billion for all of our claims that have occurred prior to July 1,1995.

The $800 million in cash that we transfer to them will be reinvested in risk-free securities, with an asset-liability match in a trust fund, and the amounts deposited in that trust can only be used for paying the claims liability that they have accepted under this transfer. Those assets will be discounted and the transfer of the liability will be discounted on our financial statement at a rate not to exceed 6-percent. First, the rate that will ultimately be used to discount those liabilities will be based on whatever the yield is, and the assets invested in the trust. We have chosen that approach because it gives us great security. In the event that the reinsurer or reinsurers financially fail, down the road, the assets are held in a trust. They cannot be commingled with the reinsurer’s other assets. We think that gives us great security for those assets. Secondly, by placing it in a trust discounted in lieu of going out and purchasing, as security for that asset pool, letters of credit, we believe we can reduce the costs of this transaction by several tens of millions of dollars. Again, we save money and we have what we believe is a very high level of security for those assets that will be used to pay out liabilities on claims for potentially the next 60-80 years.

The reinsurers will all be A-rated reinsurers; A & M Best Rates Insurance Companies, these will all be A-rated, the top-rated reinsurers in the country. Again, it will be syndicated. We will not be placing this risk with one insurer; it will be placed amongst several, based on a sharing agreement that will be reached as we finalize the agreement. On July 1, 1999, the reinsurers will be responsible financially for the payment of those claims. As it is currently structured, we will continue to manage the claims on behalf of the reinsurers and they will pay us back, at this point in the negotiations, 7 percent of the cost of the claims paid as a fee to us for managing the claims for them. This achieves a couple of results. First, we can retain more jobs because we will continue to manage the claims even though we will no longer have financial responsibility for them. Second, in the reinsurer’s opinion, we are best positioned to manage these claims because we are managing them now. We know the claims, we know the injured workers, we know the medical providers that are taking care of these injured workers; so the reinsurers that have met with us are of the opinion that we are best positioned to continue managing these claims for them.

In the event that our pricing proves higher than it should have been, let’s [let us] assume we pay $775 million for this transaction and the payout pattern turns out to be more favorable than any of us thought. The reinsurance agreement will have a profit-sharing component to it, where we will share in the profit. That also does a couple of things. First, we’ve [we have] got a profit incentive and that always helps. Second, it makes certain that as we manage those claims on behalf of the reinsurer, we manage them effectively and efficiently because if we do, we share in the profit from doing that. And so the profit-sharing agreement inures to the benefit of both our companies in a go-forward basis and the reinsurers by making certain that we do not exceed the limits. We believe today that the ultimate liability, and this a kind of a consensus of all the actuaries from all of the reinsurers, the ultimate liability for the pre-July 1, 1995, claims is approximately $1.45 billion. Currently in our books, we are booking that at about $1.6 billion. We are buying reinsurance protection up to $2 billion. So we are buying $550 million more reinsurance that we currently think the claims will ultimately develop to.

We again believe that adds a level of protection to this transaction because if for some reason there is medical inflation in the future, or if there is some unanticipated change in the payout level, that additional coverage will protect the reinsurers. And now we are paying for that coverage, we are paying for $2 billion of coverage. If, in fact, it turns out to be a $4 billion, we will get that extra payment back through the profit-sharing agreement. The risk the reinsurers are taking off from the state’s books and are taking off from our books is a possibility that the claims-payment pattern will accelerate, that claims will become due at a more rapid rate, or that there will be medical inflation in excess of what is anticipated in the pricing of this transaction. They do not assume any market risk. They will invest the assets in U.S. treasuries or other risk-free investments and they will match the assets and liabilities out of the yield curves so that if there is a dramatic swing in the market, it should not impact this transaction. They are removing, to the fullest extent possible, market risks. That is our brief overview of the reinsurance transaction; again its primary function is to remove liabilities from the state’s books, ensure solvency of the company going forward, and doing it in a cost-efficient manner.

Next I would like to move very briefly to the tax implications of this transaction. As you read through this amendment, it probably looks contorted when you look at this, and you must think there had to have an easier way to do this. We certainly thought that, and then we called the Internal Revenue Service [IRS]. And as you would expect when you call the IRS, if there is a more difficult way to do it, they’ve [they have] probably got it. That is not a criticism necessarily of the IRS, they are our friends, but they have their rules that they have to satisfy, too. I have to say, in fairness to the IRS, they have been extremely helpful in accelerating this process, understanding that you are working under a 120-day legislative deadline, and they have been extremely helpful to us. But they have to apply their rules, and to make certain that this transaction is done in a way that does not cause tax liabilities to the state or to the policyholders. We had to follow a fairly difficult course to put together a proposal that would make sure there were not tax liabilities. That is why you see what we refer to as the two-step; where we initially create a public entity and then subsequently create a full-private mutual. That is being done solely to satisfy the requirements of the IRS code so that we can do this in a tax-efficient manner. We do not have room to maneuver here. The IRS did not come to us and say, "there are four different ways you can do this, choose the one you like best." We have found one way to do this and it somewhat limits our ability to change the structure within which we do this. If you are comfortable with the policy goal of ultimately creating a private mutual insurance company owned by its policyholders, we have laid out what we believe, and the service tells us, and the only way we can do that without incurring substantial tax liabilities. So when it comes to the structure of the deal, of the creation of the mutual, there is not a lot of room to move, because if we alter those provisions we run the risk of creating serious tax complications and taxable events.

They will put that in writing. We are at the point now where we have requested a private-letter ruling. We expect within the next several weeks, we will get a reaction from the IRS. We have been having conversations with them through our counsel in Washington [D.C.] for the last several months. We expect a firm written response from the IRS probably mid-to-late summer, which is why this proposal provides that the Governor, upon receipt of that private letter ruling, can by proclamation create the private company. If we get a response back that says, "No, I am sorry, it was close, but it did not quite work, and you owe us $100 million in tax;" at that point, you will have given, through this legislation, the Governor the authority to say, "I do not think we want to do this. That does not make sense to me". So, because we will not have the private-letter ruling prior to the end of this legislative session, we have provided, in the bill, the Governor the authority to say whether or not he wants to complete this transaction based on the IRS’s response, through the written private-letter ruling.

There are a number of timelines in this bill that I would like to go through; and, again, a lot of these timelines are driven because of the two-step approach we have to take to satisfy the IRS code requirements. Let me give these to you very quickly, and, again, at a very high level. At passage and approval, a number of things would occur. First, the employees at EICON would become eligible for reemployment rights. Second, the Governor, prior to July 1, 1999, but subsequent to passage and approval, would appoint the Chief Executive Officer of Employers Mutual Insurance Company of Nevada. Third, prior to July 1, 1999, the Governor would appoint a board of directors. Subsequent to passage of approval and prior to July 1, 1999, we will enter into the reinsurance transaction. I cannot give you a specific date on that, but it is anticipated that would occur prior to July 1, 1999. At July 1, 1999, EICON, the former State Industrial Insurance System, would become a public mutual insurance company. It would be a tax-exempt entity under section 501(c)(27) of the IRS [Internal Revenue Code] code. It is not yet, at this point, a private insurance company. It is a public entity, but not a part of the executive branch of government. Its employees would continue to participate in the Public Employees Retirement System; they would continue to participate in the state’s health and welfare program, and would be eligible for all the current leave package that is available to state employees. But they would be in the unclassified service of the state and it would be a public entity, not a part of the Executive Branch of government. That board of directors would be responsible for adopting a budget; setting the investment guidelines for the company. Subsequent to July 1, 1999, and at this point, we have a board of directors appointed by the Governor; we expect to receive from the IRS a private-letter ruling to the effect that the transaction that we have entered into through this legislation would not result in significant tax consequences. Upon the receipt of that private-letter ruling with the completion of the reinsurance transaction, this legislation would, through your power, delegate to the Governor the authority to proclaim that the public mutual would become a private mutual insurance company, owned by its policyholders, effective January 1, 2000.

If we get a letter back from the service that is drastically bad, we will continue as a public mutual insurance company, meaning we will have a board of directors appointed by the Governor; we will be an agency of the state, but not a part of the Executive Branch. We will be tax-exempt. At that point, you would probably come back in the 2001 [Legislative] Session and reevaluate it. But if the service gives us a negative response or a response different from what we expect and from what we require, we would continue as a 501(c)(27) entity. At January 1, 2000, the Governor, through the proclamation and through this legislation, would transfer the interest in the public mutual to the policyholders of the new private mutual insurance company. At that point, the policyholders, the businesses of Nevada, would become the mutual owners of this insurance company. Those policyholders, pursuant to bylaws, would elect their own board of directors. And that board of directors would be responsible, as any other private company’s board of directors, for selecting the management of the company and overseeing the management of the company. And so that is the timeline again, a lot of that is driven by the need to do the reinsurance transaction at the right time and the need to follow the IRS’s requirements through the private-letter ruling.

Finally, I would like to conclude with where I probably should have started, which is why are we doing this anyway. When I look back at workers’ compensation, and I have been in Nevada 7 years today, I have almost been with the company for 6 years; when I look at the history of workers’ compensation and the state’s role in it as a monopoly, and as a semi-monopoly, and now moving into a competitive environment, I think what we are left with is a company that was never designed to be anything, but rather evolved into what it is today. When we, in 1995, authorized through A.B. 552 [Assembly Bill (A.B.) 552 of the Sixty-eighth Session], the opening of the market to competition, we really did not change the structure of the company.

ASSEMBLY BILL 552 OF THE SIXTY-EIGHTH SESSION: Makes various changes to provisions governing industrial insurance. (BDR 53-1991)

I guess we must have assumed that the structure would be appropriate as a monopoly and just as it would be as a competitive company. I do not think that is the case. I think if we were going to start all over today and say we are going to have a state involved in the workers’ compensation environment, we would not design what we have got. And in fact, if you look at the newer state funds, none of them look like us. They are created as mutual insurance companies; they are not created as arms of the state, extensions of the state. Because if the best way to run an insurance company were applying state rules to it, I would expect that all the private insurance companies would have state rules. But none of them have state rules, and that leaves me to believe that running an insurance company like any other state agency cannot be the best way to do this. So I think this bill gives us an opportunity to look at it, and say, "What is the best way to do this?" The Governor has done that; the Governor has designed what he thinks is best and his design is let’s [let us] create a mutual insurance company owned by its policyholders. And in that way, we can have the greatest likelihood of success for this company; for those who work for this company. I think the evolution in the marketplace suggests a need for a fundamental change in the way we are structured. I want this company to succeed. I want it to succeed for a number of reasons. I want it to succeed for our policyholders. We have never received a dime of state money.

Our success, to date, has been because of the hard work of our policyholders and the financial backing through the premium paid of our policyholders. It is time to fundamentally change this and recognize that they are the owners of this company, because they are the ones that funded it, and they are the ones who are ultimately responsible for it. Also, I think it is critical to point out that as we are established, there is nothing that would prevent a recurrence of what happened in the late 80s [1980s] and early 90s [1990s], and I do not think any of us want to go back to that, where we’ve [we have] got an unfunded liability in excess of $2 billion. And I think this bill gives us the opportunity to say we are never going back there again, because we came pretty close to total collapse back in 1992, and we are darn lucky it did not happen, and I can’t [cannot] imagine any reason why we would want to take the chance that it would happen again.