Funds rife with conflicts of interest: from California to Rhode Island, state-sponsored workers' compensation insurers suffer from the brazen misdeeds of managerial appointees. Our columnist offers remedies that are basic, but routinely ignored

Risk & Insurance, Nov, 2007 by Peter Rousmaniere

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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."