Message from the President

I would like to express my sincere thanks to the more than 160,000 policyholders who chose State Fund for their workers’ compensation needs this year.

When I joined State Fund in 2010 I came with a passionate belief in State Fund’s mission because I believe we have an important role to play in California’s workers’ compensation market. I’m a newcomer to State Fund but have been involved in property and casualty insurance for more than 30 years. The business of insurance is substantive and complex and through the years I have witnessed the enormous value it provides to the economy at large. Done well, our business enables and stimulates the business of our communities, state, and country.

Much of the news of late has focused on how we all must reinvent ourselves in order to weather the economic storm impacting us all. From large corporations, to mom and pop businesses, to the business of running a household, we all have had to rethink the way we manage our finances.

California’s economy is showing signs of recovery, which is welcome news - but forecasters warn us the recovery won’t happen overnight. If there is a lesson to be learned from all this, I believe it’s that the status quo is no longer acceptable.

Stubborn economic cycles are not new to State Fund. We have successfully managed problematic market cycles throughout our 98-year history of serving business and their injured workers throughout the state. And again this year, we have taken a hard look at the way we do business and committed ourselves to be more efficient and effective to better serve the needs of California’s employers.

To make this happen, State Fund is undergoing a transformation to reposition our operations so that we can more effectively manage the cost of workers’ compensation insurance for all Californians. In late 2010 we announced plans to reduce our real estate footprint, streamline operations, and consolidate into areas of the state where it is more economical to do business. These changes will require a meaningful level of sacrifice by everyone at State Fund, but by 2013 will reduce annual operating costs by nearly $200 million. We will emerge from this restructure process stronger, more efficient, and better able to deliver value to our policyholders. The greatest thing we can do for California is reduce the cost of worker's compensation so employers can build businesses and hire more Californians.

The market will demand more of us and will want more of our services to the extent we provide value to the market. In 2010 we launched several initiatives to do just that, and to make doing business with us easier. We created an online small business resource center where employers can request a quote, get help with an Injury and Illness Prevention Program, educate themselves about workers’ compensation insurance, and find useful resources for starting a new business. The pace of change and services we offer will only accelerate in the coming years.

Our financial position is strong as we embark on these changes. I’m pleased to report that in 2010 State Fund continued to record strong financial results. We wrote approximately $1.1 billion dollars in premium and recorded net income of $171 million for 2010, up from $143 million for the prior year and further strengthening our ability to meet our future financial commitments. We also strengthened our balance sheet and capital base through solid investment returns. At 2010 year-end, 99.9-percent of our investment portfolio was rated NAIC I, the highest rating that the National Association of Insurance Commissioners gives to investments. State Fund took modest rate increases in 2010 allowing us to maintain a 75-percent loss ratio, consistent with the prior year. This translated to $850 million of incurred losses in 2010 versus $940 million the prior year. We also lowered underwriting expenses to $409 million, down from $457 million in 2009.>

While we are pleased with these results, our loss adjustment expense ratio (defined as loss adjustment expenses divided by premiums earned) and, as a result, our combined ratio (defined as the sum of loss ratio, loss adjustment expense ratio, and underwriting expense ratio) are at 46 percent and 157 percent, respectively. These ratios are well above industry benchmarks and are due in part to a large inventory of open claims dating from 2001 to 2004 when we shouldered an unusually high market share following the workers’ comp crisis when many carriers went insolvent or left the California market. These ratios will come down over the next few years as we bring many of the older claims to resolution, improve business processes and reduce our overall expenses.

State Fund was created in 1914 by California’s State Legislature and charged with two roles: 1) to compete fairly with other insurers; and 2) with modest exceptions, accept all risks. When people ask me what State Fund is, I sometimes say, “We’re the Yes company” – meaning our job is to say yes to virtually any California business. Our job is to provide a fairly-priced choice, not only to those employers who have few choices in the marketplace, but also to those that have many. We have served California for nearly a century and are positioned to continue to do so because of our financial strength and careful underwriting and investment practices. After our consolidation we will still be the Yes company, only more efficient and even stronger financially.

Sincerely,

Tom Rowe