BILL ANALYSIS Ó Senate Appropriations Committee Fiscal Summary Senator Christine Kehoe, Chair SB 1513 (Negrete McLeod) - State Compensation Insurance Fund: investments Amended: April 16, 2012 Policy Vote: Insurance 8-0 Urgency: No Mandate: No Hearing Date: May 14, 2012 Consultant: Bob Franzoia This bill may meet the criteria for referral to the Suspense File. Bill Summary: SB 1513 would authorize the board of directors of the State Compensation Insurance Fund (SCIF) to invest or reinvest, an aggregated maximum of 20 percent of the moneys that are in excess of the admitted assets over the liabilities and required reserves, in specified investments. Fiscal Impact: Increased investment risk > Background: A financial review of SCIF, as well as other insurers, included assessing such aspects of their investment portfolio as liquidity, diversification and quality. This bill would have permitted SCIF to expand its investment portfolio in riskier products without any limitations. While the expansion would help with diversification, there were significant concerns with the resulting additional risks. The current version of the bill reflects efforts to limit this risk to an acceptable level by providing a 20 percent cap on specified investments. The 20 percent limit was calculated as follows: * Total liabilities were deducted from total assets. (SCIF is required to support all of its policy-related liabilities with currently authorized investments). * Deduction for various assets and accounts (real estate, surplus enhancements for reinsurance, additional capital SCIF will need to set aside for higher risk investments) that need to be supported by the surplus. * Deduction of a 10 percent cushion for market fluctuation of assets supporting the liabilities. * Deduction of an additional cushion for operational risk. SB 1513 (Negrete McLeod) Page 1 * The remaining balance equated to approximately 20 percent of surplus. Proposed Law: State Fund Prohibited Excess Funds Investments this bill would allow: (1) Insurance Code 1191 (a North American company's stock). (2) Insurance Code 1192.4 (10 percent maximum of capital and surplus in Canadian corporate stock). (3) Insurance Code 1192.6 (mortgage, mortgage-backed bond, mortgage participation, pass-through, conventional pass-though, trust or participation certificate secured with real property or pool of real property). (4) Insurance Code 1192.10 (securities with undivided interest in, right to receive payments from or payable primarily from distributions on pools of financial assets other than those permitted by Insurance Code 1192.6, as specified). (5) Insurance Code 1194.7 (federal home loan bank stock). (6) Insurance Code 1198 (maximum investment limit on corporate capital stock of 10 percent of insurer's admitted assets exceeding liabilities & reserves). Staff Comments: Existing law authorizes SCIF to invest primarily in bonds. While this minimizes risk, it can also limit investment earnings. By way of comparison, the State Teachers' Retirement System has similar investments with the exception of Insurance Code 1194.7 (federal home loan bank stock). STRS invests in Insurance Code 1192.4 (Canadian corporate stock) but without a ten percent limit. Clearly, the biggest risk is investment in Insurance Code 1191 (North American company stock). Both PERS and STRS have had losses in this investment. Recommended Amendments: In order to provide legislative oversight of the expanded investment options, staff recommends the bill be amended to require SCIF to report on these investments in its 2018 annual report. For example, - Have the new investments reduced the volatility in market price of the investment portfolio. In other words, when bonds prices fall (interest rates go up), did the market value of the SCIF equities increase or fall less than the fixed income portfolio. SB 1513 (Negrete McLeod) Page 2 - Over longer periods of time (3 years, 5 years, and 10 years) did the equity portfolio outperform the bond portfolio on a total return basis (income plus appreciation)? - Have the SCIF investment managers outperformed the S&P 500 index? Have the SCIF investment managers outperformed strategy specific benchmarks, for example, the Russell 1000 for a dividend growth strategy.