Annual Report. Building on a Foundation of Sustainability. [Launching a decade of safety] [Letter from the President] [2009 Financials]

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1 Annual Report [Launching a decade of safety] [Letter from the President] [2009 Financials] Building on a Foundation of Sustainability Ultimately, we decided to build a new office. But like all decisions we make, it was a deliberative process. First, we hired Dr. Larry Swanson, a noted economist from The University of Montana O Connor Center for the Rocky Mountain West. Dr. Swanson conducted an in-depth, independent study to provide a picture of growth for the state s economy, population, business insurance market and Montana State Fund, specifically. Using his report, MSF estimated that based on the business community s need for our services, Montana State Fund should plan for up to 408 employees. In workers compensation insurance, sustainability is vitally important. Every decision made has an impact on how an insurer, like Montana State Fund, sustains itself and is able to fulfill its longterm mission. Decisions about investments, computer hardware, claims, personnel and operations must bear out decades into the future. Quite simply, sustainability of the company ensures that claims are managed and injured employees are taken care of that Montana State Fund meets our commitment to Montanans. Five years ago, Montana State Fund came face to face with a decision directly related to our ability to sustain a high level of service for policyholders. We had outgrown our current leased building and had another 60 employees were working at locations leased off-site. Public board meetings, training sessions and large business meetings all had to be held in rented rooms around town. The result was the opposite of efficiency and productivity. We needed a better option one that would allow our entire staff to work in a single location, one that could accommodate projected growth over time, one that would improve rather than impede our ability to serve Montanans. We then connected with the Montana State University School of Architecture Community Design Center. This team of students and professors conducted a two-phase feasibility study based on meeting a need for functional, efficient space for 400 employees. The team objectively looked at numerous options keeping the space we leased currently and adding on, leasing other spaces in town, building at the edge of town, building in downtown Helena. After more than a year of study and public meetings, the management team, the Montana State Fund Board of Directors and the Montana Board of Investments determined the smartest, Continued Montana State Fund 2009 Annual Report Page 1 of 11

2 most sustainable option financially and operationally was for Montana State Fund to invest in a new building. Montana State Fund chose to invest a small percentage of the more than $1 billion portfolio we maintain into a new office building. A new building could be configured to maximize efficiency and improve operations. As owner, Montana State Fund would be adding an asset to its books that would appreciate and provide a benefit over time. The building would be located in downtown Helena to keep our 300 employees working, eating lunch and running errands downtown. And the structure would be sustainable in construction and beyond incorporating Montana-made materials, being energy efficient and allowing for growth over time. We ve created a work environment that is team oriented and encourages collaboration. We ll have a workforce that is more productive and satisfied, and will deliver even better customer service. Mark Barry, Vice President, Corporate Support 855 FRONT STREET Now, three years after the decision to build was made, 855 Front Street in the Great Northern Town Center is nearly complete. And it is living up to its goal of being a smart, sustainable investment already. The three-story floor plan is open and emphasizes natural light. It will be LEED certified (Leadership in Energy and Environmental Design) to a gold standard, which means it is about as energy efficient and low maintenance as a building can be. Sensors actually measure available daylight and adjust the office lighting to reduce energy usage. The climate control system is built around an in-basement heat exchanger that is highly efficient year-round. Heat from the data server room is captured and used to keep sidewalks free of ice to reduce falls by employees and visitors in winter. Rainwater is captured from a green roof and used to irrigate landscaping. The building also creates a better environment for serving clients. For the first time in nearly 10 years, Montana State Fund employees will reside in the same location. Spaces are organized by team and function to improve workflow efficiency and collaboration. There are breakout areas and conference rooms, including a dedicated training room for continuing education, employee orientation, safety sessions and agent training. Sound dampening measures dramatically improve privacy for claim examiners, attorneys, policyholders and injured employees. Our decision was a good investment for Montana. The project s completed price is $28 million, about $2 million under the projected budget. The majority of the building s materials are Montana made and were purchased within 500 miles of the construction site. Over the past 18 months, general contractor Dick Anderson Construction has employed 70 to 85 workers per day on site. Beyond the site itself there is an additional impact. According to national statistics, every million dollars of construction creates or maintains 30 jobs which means that during a lull in Montana s economy, this project helped keep more than 840 people working and earning paychecks. A SOUND DECISION FOR THE FUTURE Recent history has shown us, in the bluntest of ways, that economies change and shift. We are in a very different economic space than the one during which we broke ground just two years ago. Yet, decisions, like a new building, are not based solely on the here and now. They are decisions made with the future in mind the future of the company, our policyholders and the workers of our state. This new office will help us be more efficient and productive. It will improve the service we deliver and enable us to attract and retain the best people in our industry. It will enhance our financial position from an investment diversification perspective. And those strengths will, in turn, help sustain our mission for decades to come. I d like for our policyholders to know that we didn t borrow for the building. It s an invested asset that will grow in value over time. Laurence Hubbard, President and CEO Montana State Fund 2009 Annual Report Page 2 of 11

3 New Building: Making a Responsible Decision for Customers and the Planet Workflow Efficiency Th space was The wa designed to facilitate collaboration, while protecting policyholder and worker privacy. Ownership Advantage With Wi th its ene energy saving features, MSF estimates that we will realize a 50% savings on utility costs per square foot. Planet Friendly Sensors adjust lighting according to available natural light and the heating and cooling system is among the most energy efficient available. Philip Woodland, Support Services Team Leader, has managed the building project, day-to-day, for the past 18 months, helping to keep it on schedule and under budget. Montana State Fund 2009 Annual Report Page 3 of 11

4 Your Questions. Our Answers. Over the past five years, we ve fielded questions about the new building and its impact on costs and services. Here are answers to five of the most common questions. 1. Will this affect my rates? The greatest impact on rates isn t operations, it s covering the cost of future claims. For example, at the height of constructing the new building, we still delivered a $4 million dividend to our safest customers in FY09. The funds to build were allocated from invested assets. Our feasibility study shows that through superior team efficiencies, long-term maintenance costs and the appreciation of the building itself, the new facility will actually allow Montana State Fund more control over operating expenses in the long run. 2. Isn t this a lot to spend during a bad economic time? The decision to build, site selection, architectural design and even construction itself were all made or begun prior to the recent recession. But even knowing what we know now, the decision remains responsible. The building process has created jobs and put money into the Montana economy, a positive thing for the state. Owning a LEED-certified, highly efficient facility prepares us to compete and provide extraordinary value to customers, even in times of economic downturn. 3. Where did the money come from? The new facility is a $28 million capital asset that remains on our balance sheet. The funds were allocated from our invested assets of approximately $1.2 billion with the approval of the state Board of Investments. The new facility equates to approximately 2 percent of these invested assets and helps to diversify our investment portfolio. No tax money was used to build the new headquarters. 4. What will happen with the current building? Our current building is owned by the state of Montana, and will be occupied by another state government agency shortly after Montana State Fund moves. So, the state will get 52,700 sq feet that will no longer need to be leased saving taxpayers money. 5. Will the move itself impact service? Well before the official move-in date, the Information Technology Department will set up work stations and the information and data flow will be up and running before we occupy the building. The final move will happen over the three-day Memorial weekend to limit any impact on customer service. The only change you should notice in terms of customer service is that our local phone number will change to In short, we anticipate very little service impact from the move. We re Moving New contact information beginning June 1, Front Street Helena, MT, Fax TDD-TTY Customer Service Montana State Fund 2009 Annual Report Page 4 of 11

5 Letter from the President This has been a challenging year challenging for all of us in several ways. At the top of everyone s list is the economy and how the downturn has adversely affected each of us. Most of you have had to make adjustments to your operational plans just to stay in business. In fiscal year 2009 we have experienced the effects as well. Our premium income declined from $231M in fiscal year 2008 to an estimated $204M this year. Those numbers are a direct reflection of what is happening to our policyholders: reduced payroll, fewer employees and, in too many cases, employers going out of business altogether. Fortunately, Montana business did not experience as deep a recessionary impact as many other states during 2008/2009 and Montana unemployment rates were on the whole, lower. At Montana State Fund we helped our customers manage through the recession by maintaining rate stability and excellent customer service. As of this letter we are seeing some stabilization; and, in analyzing business forecasts for the near future, there are signs of a very gradual strengthening of Montana s economy. That is good news for all of us. Like you, Montana State Fund has taken steps to control costs. We ve left positions open that were vacated through turnover. At the same time, we ve re-purposed others in order to make our operation more efficient and to maintain our customer service. Simultaneously, we stayed the course to ensure that customer service did not suffer while we looked at ways to be more efficient. We also modified our fiscal year 2010 strategic plan to right size the number and costs of projects and to improve efficiency. We implemented new data tools called Insurance Intelligence that enable more efficient delivery of data and information. With it, we can track trends, claims and policies, allowing us to receive better detail and make better informed decisions from that information. We have already seen how our new system better assists us in our customer service and product delivery. We are also working closely with the Montana Legislature, the Labor-Management Advisory Council and the WorkSafeMT effort to help get Montana s workers compensation insurance premium rates under control. There are several cost drivers that, if effectively addressed, can make a substantial difference in costs for workers compensation. Improved workplace safety and Return to Work/Stay at Work programs are part of that endeavor, as are our medical costs and claim durations. Montana State Fund is an active participant in these discussions because we know the negative impact of high premiums on Montana businesses and jobs. Finally, as of this letter we are preparing to move into our new building, which you can read more about in this publication. We are very excited to be in one space that holds all of us rather than in three separate buildings. This new office will be LEED certified to be environmentally sustainable and energy efficient, and offers a more productive and safe environment for our employees. Montana State Fund has proven its stability and value to Montana businesses and workers throughout economic ups and downs and our commitment to the economic health and prosperity of Montanans. It is a pleasure to serve you. Laurence A. Hubbard, President/CEO Montana State Fund 2009 Annual Report Page 5 of 11

6 Letter from the Chair It is an honor to share with you the accomplishments of Montana State Fund for fiscal year 2009 (July 1, 2008 June 30, 2009). While this is the third year for me to present these results, I am continually impressed with the high level of service MSF s 280 employees provide Montana s employers and employees on a daily basis. I am equally impressed with the tireless dedication of my fellow board members. As you are well aware, our nation and Montana have been coping with a turbulent economy. Unemployment, home foreclosures and businesses closing their doors have left many feeling frightened about the future. At MSF, we too felt the effects of the recession in FY09. However, through these tough times, we were able to remain financially strong and provide our customers a stable workers compensation product. In addition, FY09 found us investing our energy into improving our safety education and outreach programs, and setting up IT systems to effectively manage claims. Montana was built by an eclectic mix of rugged individualists. Strong-willed miners, loggers, farmers, ranchers and construction workers toiled in an unforgiving environment to make Montana what it is today. Since 1915, Montana State Fund has been assisting the needs of our employers and workers every step of the way. I am confident that this spirit of commitment will remain for decades to come. I appreciate your support. Joe Dwyer, Chairman EXECUTIVE TEAM Left to right: Peter Strauss, Vice President, Insurance Operations Support; Al Parisian, Chief Information Officer; Laurence Hubbard, President/CEO; Rick Duane, Vice President, Human Resources; Nancy Butler, General Counsel; Mark Barry, Vice President, Corporate Support; Dick Root, Vice President, Insurance Operations BOARD OF DIRECTORS Jane DeBruycker Dutton Joe Dwyer, Chairman Billings Thomas Heisler Great Falls Laurence Hubbard Ex-Officio, Helena Ken Johnson Missoula James Swanson Glendive Boyd Taylor Butte Wallace Yovetich Billings Montana State Fund 2009 Annual Report Page 6 of 11

7 Will 2010 launch a decade of workplace safety? Montana has long suffered from a poor workplace safety record, a problem that hurts Montana workers and their families, as well as Montana businesses. While there are many factors that go into setting workers compensation rates, the single largest about 80 percent of the rate collected goes to pay out claims. A single, serious accident to a worker in his 20s can cost millions in claims to cover health care and lost wages. As businesses, it is in our best interests then to become safer. Qualified, disciplined safety programs are cheap insurance. At Montana State Fund, we re working to help our customers improve safety in their workplaces. We promoted the importance of safety through our Work Hard. Be Safe. campaign, an effort that drove nearly 10,000 Montanans to safemt.com. In 2009, we built on our highly successful WorkSafe Champions program and certified new safety leaders in communities around Montana. We supported legislative efforts that led to developing our Small Business Group Program, which will reward companies for putting safety programs in place and staying injury free. And we continue to help policyholders by conducting safety audits, providing training and offering materials that help keep workers safe. As we look ahead to the next decade, we encourage you to look at safety in your business. Together we can be safer, keep rates in check and improve life for all Montana workers. We can make the next decade a decade of worker safety. WORKING IN HELENA JUST GOT SAFER. CONGRATULATIONS WORKSAFE CHAMPIONS. Please join us in applauding the commitment of these companies and their employees who took the lead in making Montana a safer place to work and live. By participating in Montana State Fund s 12-month WorkSafe Champions certification program, they are building a culture of safety across our state. Find out how your company can be a WorkSafe Champion, by visiting safemt.com. SAFETY CHAMPIONS POSTER AND WORK HARD. BE SAFE. NEWSPAPER AD Blue Cross Blue Shield of Montana Randi Heigh Browning, Kaleczyc, Berry & Hoven PC Michelle Radosevich Montana DEQ Bonnie Rouse Diamond Construction Peter Van Nice Helena Industries Terry Nuss Kleen King, Helena Scott Grove Montana Lottery Commission Dawn Hicks Real Food Store Jen Rasmusson Rocky Mountain Development Council Candi Standall Shodair Hospital Gary Willis Student Assistance Foundation Todd Jones THE BEST PIECE OF SAFETY GEAR I HAVE IS BETWEEN MY EARS. MPION Rand Mich Bon Pet Ter Sc Da Je l C Montana has the fourth highest rate of workplace fatalities in the country. Our days lost to injury or illness are about 50% higher than the national average. The best way to change these frightening statistics starts with you. Start by thinking about working safe. Ask yourself if you have the right equipment and personnel to get the job done. Make sure your company has a safety program. If it doesn t, let us help you implement one. To learn how to work as safe as you do hard, visit safemt.com HIGHLIGHTS Our safety services team hosted 1,038 Montana employers at 78 safety trainings that were held throughout the state. Safety Management Consultants visited 2,324 policyholders last year. That is a 17 percent increase from FY08. Fifty-eight Montana workers graduated from our WorkSafe Champions program. The 12-month safety education curriculum was created to impart a culture of safety in the workplace. We distributed a $4 million dividend to deserving policyholders with superior safety records. Our Speakers Bureau presented 21 workers compensation topics in nine Montana towns. Our ACE (Assisting Charitable Endeavors) program paid $32,170 to 14 worthy projects in FY09. ACE makes matching funds available to qualifying Montana nonprofit organizations that contribute to safety and community well-being in our state. The efforts of the Special Investigations Unit to uncover fraudulent claims has saved nearly $43 million since the program s inception in More than 100 medical providers and workers compensation professionals from across Montana attended our eighth annual medical education conference Low Back Pain: Diagnosis & Treatment. Our scholarship program assists children and spouses of workers who were fatally injured in a work-related accident. $12,000 in scholarships was awarded to six individuals in While nothing can replace the untimely loss of a loved one, our scholarship program provides an additional benefit for those who are most affected by significant loss. We received four awards for our safety websites and advertising campaigns from the American Association of State Compensation Insurance Funds. We broke ground for our new environmentally friendly office headquarters in August Montana State Fund 2009 Annual Report Page 7 of 11

8 REPORT OF MANAGEMENT The management of Montana State Fund (MSF) is responsible for the financial statements and all other information presented in this Annual Report. MSF maintains a system of internal control designed to provide reasonable assurance that assets are safeguarded against loss and that transactions are executed and recorded in accordance with management s authorization. This system encompasses the organizational structure and corporate governance practices, selection and training of personnel, communication and enforcement of policies and procedures, monitoring, and ongoing internal and external audit programs. Internal controls are continually reviewed and evaluated by management. The financial statements are presented for our fiscal years ending June 30, 2009, and 2008 and include amounts based on the best estimates and judgments of management. These financial results are presented on a statutory basis, which is consistent with insurance industry financial statement presentation. MSF governs, operates and completes its financial reporting as an insurance company domiciled in the state of Montana, and its financial statements are presented on the basis of accounting practices prescribed or permitted by the Montana State Auditor, Commissioner of Securities and Insurance. The statements included in this Annual Report should not be considered complete audited financial statements. The statements presented are representative of audited financial statements as audited by independent public accounting firms Eide Bailly LLC for the year ending June 30, 2009, and Galusha, Higgins & Galusha for the year ending June 30, Unqualified opinions were issued by both firms on MSF s statutory financial statements for the years audited. The complete audited financial statements including the accompanying notes are available upon request. The preparation and independent external audit of statutory financial statements is discretionary on the part of MSF, but one that is seen as important. Evaluating the financial results of MSF in comparison to other insurers aids in assessing and maintaining the financial security and stability of MSF as a workers compensation insurer. In addition, MSF is a component unit of the state of Montana. As required in law, the Legislative Audit Division (LAD) of the state of Montana conducts independent audits of financial statements of MSF presented in accordance with generally accepted accounting principles (GAAP) as prescribed by the Governmental Accounting Standards Board (GASB). For the financial periods ending June 30, 2009, and 2008, MSF received unqualified audit opinions from the LAD. The audited governmental financial statements and the related audit opinions are issued under separate cover. To obtain a copy of the full governmental financial statements, contact the Legislative Audit Division. The presentation of the statutory financial statements in this report differs from the governmental presentation basis (GASB). A financial reconciliation of equity between the audited GASB financial statements and the audited statutory financial statements can be found to the right. A COMPARISON OF STATUTORY ACCOUNTING ENDING EQUITY TO GASB NET ASSETS FOR THE YEAR ENDED JUNE 30, 2009 Statutory equity (NAIC)...$201,031,900 Add: Non-admitted assets...11,129,022 Change in investment value of bonds to fair market value...(455,217) Change in investment value recognized for GAAP...1,277,932 Change in net income between NAIC SAP and GAAP for: Deferred acquisition costs...4,638,094 Reversal of small adjustment and other...1 GASB net assets...$217,621,732 QUICK FACTS AS OF JUNE 30, 2009 Total earned premium...$203,976,354 Number of policies serviced...31,177 Total number of claims processed...11,899 Investment income...$34,299,010 Net income after dividends...$ 8,627,649 Policyholders dividend...$ 3,996,599 Loss and LAE reserves...$813,304,713 Statutory equity...$201,031,900 Reserves to Equity Ratio (after dividend) Premium to Equity Ratio (after dividend) Montana State Fund 2009 Annual Report Page 8 of 11

9 MSF RATE LEVEL Net of Avg. UW Credit/Debit 1.20 MSF rate levels significantly decreased from 1994 to 2000 INDEXED NET PREMIUM RATE due to improved conditions in the workers compensation arena including lower medical inflation, declining claim frequency and statutory benefit changes beginning in MSF net rate levels bottomed out in 2000 but steadily rose through 2006 due to increasing medical costs, and statutory and judicial benefit expansions. Net rate levels have since stabilized and have fallen slightly in the last three years MSF rates are currently about 18.9% below 1994 rates RATE YEAR AVERAGE COST PER WAGE-LOSS CLAIM Adjusted for Statutory Benefits Level Changes Cost per Wage-Loss Claim $60,000 50,000 40,000 30,000 20,000 10, ,253 53,950 54,373 53,851 55,729 51,261 52,350 50,434 47,539 32,329 32,730 28,682 29,200 29,995 30,895 34,648 25,170 27,402 28,924 25,264 25,268 25,173 20,136 21,267 21,455 21,121 21, Total Benefits Medical Benefits Indemnity Benefits 61,488 39,013 22, Current estimates indicate that average claim costs declined by 22% from 2001 to 2004, reflecting operational improvements in MSF claims management. Normally, we expect the cost of claims to rise by the rate of general medical inflation and the rate of wage inflation. Since 2004, claims have been rising at an average annual rate of 5%, driven primarily by medical costs. Indemnity benefits have been relatively flat while medical benefits have been rising 7% per year. Accident Year 300 MSF GROSS EARNED PREMIUM In $Millions 250 MSF premium declined from approximately $182 million Premium in $Millions (gross earned premium) in 1994 to $71 million in Since 1999, gross earned premium has significantly risen as market conditions have changed and rates have increased to cover the increasing cost of claims. MSF premium has fallen since 2007 due to rate reductions and faltering wage and employment conditions in Montana Accident Year Montana State Fund 2009 Annual Report Page 9 of 11

10 STATUTORY STATEMENTS OF ADMITTED ASSETS, LIABILITIES AND EQUITY as of June 30, 2009, and ADMITTED ASSETS CASH AND INVESTED ASSETS Bonds $908,459,736 $870,571,824 Equity securities 81,742,906 87,443,325 Real estate Properties to be occupied by the company 12,732,565 2,390,151 Cash and short-term investments 33,585,750 24,925,611 Other investments - collateral securities on loan 175,758, ,710,845 Total cash and invested assets 1,212,279,411 1,129,041,756 OTHER ADMITTED ASSETS Receivables, net 15,010,343 22,737,995 Equipment, net 663,209 1,106,684 Interest receivable 11,216,101 11,413,760 Other assets 44,913,251 32,316,072 Total other admitted assets 71,802,904 67,574,510 Total admitted assets $1,284,082,315 $1,196,616,266 LIABILITIES AND EQUITY LIABILITIES Reserve for unpaid losses $735,247,613 $677,196,077 Reserve for unpaid loss adjustment expenses 78,057,100 75,057,223 Liability for securities on loan 175,758, ,710,845 Unearned premium 10,914,276 9,842,296 Other liabilities 83,072,972 74,245,643 Total liabilities 1,083,050, ,052,084 EQUITY Policyholders equity 201,031, ,564,182 Total liabilities and equity $1,284,082,315 $1,196,616,266 The complete financial statements, including the accompanying notes, are available upon request. Montana State Fund 2009 Annual Report Page 10 of 11

11 STATUTORY STATEMENTS OF REVENUES, EXPENSES AND CHANGES IN EQUITY for the years ended June 30, 2009, and REVENUES AND EXPENSES PREMIUM EARNED $203,976,354 $230,965,306 UNDERWRITING DEDUCTIONS Losses incurred 178,246, ,249,598 Loss expenses incurred 20,961,369 18,687,513 Other underwriting expenses incurred 32,039,251 38,190,130 Contingent commission income (11,541,461) (11,243,919) Total underwriting deductions 219,705, ,883,322 Net underwriting loss (15,729,160) (8,918,016) INVESTMENT INCOME Net investment income earned 47,924,391 44,347,778 Net realized capital losses (13,625,381) (113,451) Total investment income 34,299,010 44,234,327 OTHER EXPENSES Receivable balances charged off (3,381,505) (1,164,866) Other expenses (2,564,097) (2,056,415) Total other expenses (5,945,602) (3,221,281) NET INCOME BEFORE DIVIDENDS 12,624,248 32,095,030 POLICYHOLDER DIVIDENDS (3,996,599) - NET INCOME $8,627,649 $32,095,030 CHANGES IN EQUITY BALANCE, BEGINNING OF YEAR $216,564,182 $199,168,517 Net income 8,627,649 32,095,030 Change in unrealized gains (losses) on investments (22,978,351) (13,102,014) Change in non-admitted assets (1,181,579) (1,597,351) BALANCE, END OF YEAR $201,031,900 $216,564,182 Montana State Fund 2009 Annual Report Page 11 of 11