State-sponsored workers' compensation insurers are supposed to protect small and midsize employers from being bruised in the marketplace of private insurers. But recent scandals suggest that some state funds have been playing fast and loose to the detriment of their constituents.
Within the past two years, the CEOs of state funds in California, Maryland, Ohio and Rhode Island have been fired or forced to resign due to personal or corporate misdeeds. Each insurer has faced the humiliation of criminal investigations and revelations of executive debacles.
But hold off on any broad-brush condemnation. State funds, of which there are 27 in all, are entirely independent of one another. No two are alike in styles of governance. Some perform outstandingly. But the seriousness and visibility of these scandals are bad news for the credibility of the entire state fund community.
These scandals underscore the risk states may fail to run workers' comp insurers because they have a track record of weak boards, alarming misjudgment and slack internal controls.
CALIFORNIA: THE FALL OF THE MIGHTY
The State Compensation Insurance Fund is the largest workers' comp insurer in the United States. In 2004, at the height of the California workers' comp cost spiral and before the reforms, it sold $7.9 billion in insurance.
How it controls itself is a question that even Steven Poizner, the state commissioner of insurance, has been trying since early this year to find out.
One of his examiners has been at the fund "for some time," according to Jennifer Kerns, an aide to Poizner, in an interview earlier this year. She says that "the problem is that the fund has been a quasi-private, quasi-public entity."
The fund has fought off insurance regulation, arguing its status as a public agency. At the same time, it has resisted public meeting rules on the grounds that it is a private company.
In recent years, it terminated its relationship with the ratings firm of A.M. Best after the fund's rating declined. It fired its outside auditors in a dispute over a $1 billion reserve increase auditors believed was needed. It then sued the California Division of Insurance to prevent it from enforcing risk-based capital rules. It has brushed off numerous requests for interviews by the media.
Things began to fall apart after September 2006, when the board of directors promoted acting CEO, James Tudor, a 35-year veteran of SCIF, to permanent status. He followed a line of internally recruited CEOs.
Shortly thereafter, Gov. Arnold Schwarzenegger's office, concerned about conflicts of interest, pressured two board members to resign. They were Kent Dagg, executive director of Shasta Builders' Exchange, and Frank Del Re, president of Western Insurance Administrators.
Dagg and Del Re brokered group discount programs funded by SCIF. Del Re had been on the board since 2003; Dagg, since 2004, as a Schwarzenegger appointee.
Dagg and Del Re were, in effect, overseeing fund managers responsible for setting commissions to brokerages controlled by them, and for negotiating premiums for risk groups brought to the fund by their institutions.
Stanley Zax, CEO of Zenith Insurance, a leading writer of workers' comp in California, calls this arrangement "absurd."
They were two of the five voting directors on the board. Jeanne Cain, an executive at the California Chamber of Commerce, was and remains chairwoman. The two others are Vincent Mudd, a San Diego businessman, and James Santangelo, a Teamsters union official. Two voting seats vacated by the brokers remain unfilled.
The resignations of Dagg and Del Re took place in late October and early November 2006. It took Cain until Nov. 16 to announce their resignations.
When she finally did, she told the Los Angeles Times that "the potential of a conflict of interest is a problem. I recommend that we don't have these kinds of appointees."
In September, SCIF ended its relationship with Western Insurance Administrators, SCIF's largest program manager, which previously administered eight safety groups, according to spokeswoman Jennifer Vargen.
But the departure of Dagg and Del Re was only the start of SCIF's troubles.
By March 2007, the governor's office, the Division of Insurance and a legislative committee had launched separate investigations of SCIF. On March 26, the board--without the departed Del Re and Dagg--fired Tudor and another senior executive, Renee Koren, who had been in charge of the agency's group discount programs.
What precisely prompted the firings and the investigations by the governor's office and insurance regulators has not been made public.
But an individual close to one of the investigations said that information has surfaced about alleged misuse of funds set aside for safety incentive programs.
Poizner expected his investigation to take six months--wishful thinking. In July, after five months of sleuthing, the Insurance Department created a task force with the California Highway Patrol and the San Francisco District Attorney's Office to investigate potentially criminal misconduct by "former employees."
Poizner went further. He demanded massive top-level reform.
In a March press release announcing his investigation, he said his concerns and those of the governor, with whom he had met in planning the audit, centered on conflicts of interests and favoritism among board members and senior executives.
SCIF's internal audit unit, Poizner said, had to report to the board of directors.
The board had to set up an audit committee to, in his words, "ensure the integrity of the fund's financial statements, internal controls, the fund's compliance with legal and regulatory requirements, and the findings of internal and external audits."
Poizner demanded that SCIF create the offices of chief financial officer and chief investment officer, positions that SCIF earlier this year admitted had been divvied up among "outside consultants and internal staff."
Poizner also decreed that SCIF "adopt a clear conflict-of-interest policy and code of ethics for board members and management staff to avoid the types of conflicts of interest which have occurred at SCIF in recent years."
Late this summer, after the dismissal of its CEO, the board hired a new one--Janet Frank, the executive vice president of North American field operations for Chicago-based insurance carrier CNA. Frank was expected to assume the position in early October.
In August, SCIF issued a status report of its own investigation, which it claimed had begun well before all the uproar. It hired a temporary CFO; established an audit committee; and said that it is at work on a code of ethics. The board also demoted top legal counsel Charles Savage.
The insurer also said that it made "fundamental changes" to the administrative fee program, which doles out millions of dollars, ostensibly to support safety activities for groups of small employers with similar risks--employer groups represented by the brokerage firms run by Dagg and Del Re.
These programs are at the center of a class-action suit filed in late May on behalf of Burbank, Calif.-based Acro Contractors, a policyholder of SCIF.
The suit alleges that SCIF executives conspired with Dagg and Del Re to pour $25 million worth of safety program assistance into these brokers' pockets. Plaintiffs are seeking $75 million in damages.
MAKING THE R.I. VIP LIST
But rest assured that workers' compensation shenanigans aren't limited to the big states on the Left Coast.
More than 3,000 miles to the east, in one of the smallest states in the Union, workers' comp funds also serve as revolving doors for the politically connected.
The Rhode Island state legislature and governor created Beacon Mutual Insurance Co. of Rhode Island in 1991 as part of a strategy to reverse the state's then disastrously high workers' compensation costs.
For years the sun shone on the company, and it dominated the insurance market in Rhode Island. It was noted for the innovative quality of its safety programs.
But as it grew its policyholder surplus to a level 30 times its initial funding, Beacon Mutual continued to maintain a mom-and-pop-shop leadership culture that proved its undoing.
In 2005, CEO Joseph Solomon sought to expand its writing authority to other states, emulating the state funds of Maine and Utah.
The proposal prompted a nasty spat between the legislature and Gov. Donald Carcieri, who opposed expanding the fund's reach.
Then, late in the year, a whistle-blower called a board-created hot line three times with allegations about self-dealing and a secret VIP list of favorites.
According to the whistle-blower, Beacon executives colluded with board members to set artificially low premiums for clients, some of whom were controlled by board members themselves.
Brokers were allegedly awarded special favors and, according to the caller, the comp insurer was cutting premiums for one of its largest accounts--a healthcare provider--on whose board Solomon sat.
The existence of the calls became public, prompting a scorching rebuke from the governor, who sought to unseat board members appointed by past governors.
Shaken, the board commissioned an investigation by former New York City Mayor Rudolph Giuliani's consulting firm.
Its report, submitted in April 2006, concluded that governance policies were "weak or nonexistent."
That VIP list cited by the whistle-blower turned up a handful of policyholder names. Solomon initially denied its existence. And when it was discovered that David Clark, vice president of underwriting, scrambled to delete copies of the list from Beacon Mutual's computers, prosecutors had grounds to charge him with criminal conspiracy. Solomon was fired; so was Clark, whose trial has yet to begin.
In August, Rhode Island insurance regulators issued a laundry list of improprieties, lapses of judgment and legal infractions against the fund: a $34,000 golfing junket to Scotland, safety groups of policyholders being run without insurance department approval, no functioning CFO position.
The report said that instances of serious abuse of authority were relatively few, but due to lax controls the potential for misconduct was systemic, particularly in the setting of premiums. The board and management were, if not particularly venal, clearly in over their heads.
Governor Carcieri, who controls four seats on the nine-member board, has brought in a former banker to serve as CEO, and a new head of underwriting was hired. Beacon Mutual is paying a $2.5 million fine and $7 million in refunds to policyholders to compensate for years of underpricing of premiums and excessive broker commissions.
Sometime before 2005, the Ohio Bureau of Workers' Compensation, the exclusive writer of workers' comp insurance in that state, diverted $50 million of its investment portfolio into a rare coin investment fund. A politician closely connected with the governor's office ran the fund.
A criminal investigation began in 2005, and by May the bureau shut down the escapade. CEO James Conrad, who brashly predicted in 2000 that the bureau would be the premier workers' comp insurer in the nation "bar none," was pushed out. In November 2006, a court sentenced Tom Noe, the engineer of the investment program, to 18 years in prison.
Although "Coingate" attracted a lot of media attention, the scale of its financial impact on the bureau's insureds is trivial compared with the cockeyed programs of group discounts that the bureau had been supporting for years.
The group promoters--brokers that pushed for small businesses to have their risks covered by the state fund--made no special effort at prevention or injury response. And they manipulated their groups by expelling members that incurred losses.
By taking these employers off the books of the groups, the promoters avoided any increase in experience modifications. One impact was to increase the premiums of all nongroup members by adding those losses into rate-making.
The bureau also awarded the groups substantial premium discounts. Premium discounts alone have come to several hundreds of millions of dollars in recent years, some of which the promoters captured as their fees.
In June 2006, Terrence Gasper, the bureau's former chief financial officer, pleaded guilty to federal and state criminal charges. A federal judge sentenced him to 64 months in prison last May.
A fourth Ohio scandal is now coming to the surface thanks to the release in early 2007 of hundreds of communications between the bureau and Ohio politicians.
The e-mails reveal that the bureau's executive staff ordered 179 changes to premium rates on behalf of state lawmakers between 2003 and most of 2005.
In sum, four distinct scandals rocked the Ohio Bureau of Workers' Compensation: Coingate, group financial abuses, a crooked CFO and preferential pricing for politically connected employers.
This past summer, Gov. Ted Strickland announced that he was going to appoint a clean slate of 11 new independent board members.
"The establishment of an independent board of directors brings us a step closer to restoring confidence and accountability," the governor said in a press release.
OLD LINE PUBLIC GORGING
Maryland's Injured Worker Insurance Fund, founded in the 1910s, has had two brushes with unethical CEO behavior in the past decade.
In 1996, the president of IWIF, Paul Rose, personally interrupted a competitive bidding process for a managed-care firm to select a vendor who was thought to have one of the worst bids.
The award went to a spanking new company, Statutory Benefits Management Corp. Services from that firm were reported to be terrible.
IWIF later sought to unwind its relationship with the vendor. In 1999, IWIF ended up buying the firm for $6.9 million and paying the former owners $2.6 million for services delivered since 1996. Then it promptly closed down the firm.
In 2000, Rose resigned under pressure. Eight years into the job, his severance package allowed him a choice of a one-time lump-sum payment of $454,751 or a lifetime annuity of $24,094.
Shortly after his departure, Rose and the founder of SBMC went into the restaurant business.
In April 2002 the governor selected a new CEO, Tom Bromwell, former chairman of the state senate finance committee. Three years later, Bromwell and his wife were indicted on charges of contractor kickbacks unrelated to his appointment as CEO of IWIF.
The board kept Bromwell on full pay until the end of 2006, when it let him walk with a $400,000 severance package plus 18 months of health benefits.
"The board expresses its sincere appreciation to Thomas Bromwell for his leadership of IWIF and wishes him a successful outcome of his trial," said IWIF's board chairman Daniel McKew in a statement.
The former CFO of IWIF, Thomas Phelan, is now serving as CEO.
A common thread to the woes of these four state funds is dysfunctional governance at the highest levels.
The "absurd" practice of filling board seats with people who are in business with the fund is part of a larger failure to ensure that boards are independent, informed and empowered.
But a board of qualified professionals is a necessary, but by no means sufficient step, to restore credibility.
The most dangerous ethical hazard for a state fund is to manipulate premiums and discounts to favor certain parties, whether they be board members, brokers or wealthy businessmen-cum-political donors.
This hazard applies to all state funds, much like option backdating dangers apply to all publicly traded companies.
Each of the 27 state funds should hire special auditors to certify that its premium pricing adheres strictly to a single written guide, with clear audit trails for any deviations.
The funds that know they will come out clean as a whistle should be the first to audit themselves.
If these remedies are not corrected, we may well see more state funds come under scrutiny.
a Vermont-based consultant and writer, is the workers' comp columnist for Risk & Insurance®.
November 1, 2007
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