Working with its advisors and DIR, California pioneered the Alternative Security Program (Labor Code Section 3701.8) on July 1, 2003, as the first of its kind for any state Self-Insurance Security/Guarantee Fund in the United States. Only one other state to date, North Carolina, has implemented an ASP. At present, 358 self-insured entities, representing approximately $5.3 billion of Estimated Future Liabilities (EFL) collateral, qualify to participate in the ASP.

Prior to implementation of the ASP, California private self-insured companies were required to post a deposit [cash, surety bond, Letter of Credit (LOC) or securities] with OSIP. Each entity's deposit was based upon its EFL. When the ASP was implemented in July 2003, the program replaced over $4.7 billion of posted collateral. It was estimated, at that time, that members had been paying an aggregate of $65 million or more in surety and LOC fees annually. This expense was "lost" to the insurance or banking markets as each year expired. Additionally, posting an LOC drew down each entity's valuable credit capacity.

The traditional state-by-state approach of requiring self-insured members to post collateral individually was a costly and inefficient method of trying to minimize the risk factors of self-insurance. Banks and surety companies earned significant income from this process, but the Fund gained no additional monies and self-insureds had to tie up collateral that could otherwise be used for business purposes. In addition, it was becoming increasingly difficult for some self-insureds to obtain surety bonds due to tightening capacity and failing surety companies. Additionally, many local and regional banks were tightening lending requirements. Finally, OSIP had the additional administrative burden of verifying and enforcing the posting of multiple annual deposits along with changes as member deposits were adjusted.

Not only was collateral difficult to obtain, but in the event of default it could only be used to pay for that member's claims, effectively creating a silo. Deposits posted by one member could not be used to pay for overall collateral shortfalls arising from other defaulted members. Therefore, the Fund was placed in the position of having to assess all members to make up for individual estate shortfalls even when there was excess collateral from other estates.

With the ASP, the Fund arranges collateral on behalf of all of its participating (eligible) members. In lieu of securing collateral individually with OSIP, each member is assessed its share of an overall program fee. In turn, each year, year, the Fund structures optimal risk transfer and places it in the financial markets using standard ISDA ( International Swaps and Derivatives Association) documentation. The current risk transfer covers a portfolio of $5.3 billion of credit default risk with the Fund retaining the first 7.5% ($337 million). The risk transfer counterparties, which assume various tranches of the credit risk, are global institutions rated AA- or better.

Annual member assessments are used to pay for the following:

1. 1. Pre-existing estate claims and Fund on-going operational expenses
2. 2. Risk Transfer (credit default protection purchased from financial guarantors, reinsurers, and banks).
3. 3. Cash Accumulation/Reserves to cover retained risk is the Fund's Default Loss Fund

The underlying concept of the ASP is that a member default (failure to pay its workers comp claims) is credit risk. Generally, the risk faced by the Fund is considered more remote than standard credit risk since bankruptcy alone may not trigger default on the payment of workers compensation claims. If an entity reorganizes under Chapter 11, the bankruptcy plan almost always provides for continuation of workers compensation payments.

Most defaults occur when a self-insured becomes insolvent and is forced to liquidate. At the time of a workers comp claims default, California law states that the Fund has up to 30 days to being making payments to the estate's injured workers.

In order to fairly assess each participating member's assessment share of the program, two factors are taken into consideration:

1. 1. The member's Estimated Future Liabilities (EFL)
2. 2. The member's credit risk as determined by their credit ratings per Moody's and/or Standard and Poor's. The Fund utilizes 16 levels of credit rating from B-/B3 to AAA/Aaa.

The Fund also maintains a $100 million Line of Credit with major banks that provides liquidity. This credit line helps the Fund bridge any unforeseen short-term cash shortfalls and is a further buffer against immediate, supplemental member assessments. The Fund may repay any loan under this facility over several years.

It's very significant to note that member assessments collected each year have reduced from $66 million in 2003 to approximately $32 million in 2007. The retained funds from assessments that were allocated to cash reserves or investments have built up to over $220 million as of December 31, 2007. These growing funds now provide a meaningful source of investment income. The Fund's objective over time is to become as close to self funding as practicable. With the accumulation of an appropriately conservative investment portfolio and resultant investment earnings, the Fund is well on its way to achieving its goal of protecting the workers compensation obligations of defaulted members with minimal annual assessments to its remaining members.