Source: Smart's California Workers' Comp Bulletin

Industry analyst applauds CDI directives to State Fund

Property/casualty insurance industry analyst V.J. Dowling applauded a directive issued last week by Insurance Commissioner John Garamendi to the State Compensation Insurance Fund ordering the state-chartered workers’ compensation insurer to make specific revisions to its business plan. Noting that he had “worked diligently with State Fund management since taking office in January,” Garamendi announced he had directed the plan to call for reduced premium income, increased surplus and profitability, and a strengthening of management and operating efficiencies. Once implemented, Garamendi said the plan should boost the fast-growing State Fund’s surplus by more than $1 billion and help achieve a reduction in the amount of premium written.

“ I would argue that Garamendi is being responsible,” Dowling told the National Insurance Leadership Symposium in San Francisco. The annual event is sponsored by the Council of Insurance Agents + Brokers, the American Insurance Association and the Reinsurance Association of America in association with Russell Miller. “He rang the bell and has taken action.” State Fund spokesman Jim Zelinski said Garamendi’s order is the result of “an ongoing dialog with the commissioner’s office,” adding that the business plan is “a work in progress.” Zelinski emphasized State Fund’s view that its reserves are adequate to meet its obligations to injured workers and policyholders.

Hearing set: Garamendi’s directives came just two weeks before the Assembly Insurance Committee is scheduled to conduct an oversight hearing on State Fund and the Department of Insurance. The hearing is set for Wednesday, March 19 at 9 a.m. in Capitol Room 437. If the hearing actually takes place, it will be the first to go forward among at least a half-dozen legislative hearings on the State Fund that have been scheduled over the past 18 months but later cancelled.

Broker blasts plan: Not all system stakeholders are pleased with Garamendi’s plan for the State Fund. Bill White, president of Canoga Park-based Alliance Insurance Agency, takes issue with a provision that State Fund make a “dramatic” reduction in new writings, accepting submissions by brokers and agents only when coverage is not available elsewhere. The plan also calls for broker commission rates to be cut and business submitted by brokers reviewed. Garamendi also wants brokers who consistently write unprofitable books of business to be decertified. “He wants to bolster State Fund’s coffers by a billion dollars and do it on the backs of brokers,” complains White, who says the plan will force small comp brokers out of business. “It’s an absolute horror,” White told Smart’s. “Most of us over the years have placed a huge amount of business in the State Fund. For some of the shops, the income loss will really be substantial.”

White’s book of business is 56 percent workers’ comp, specializing in difficult-to-place risks and employers with high experience modifications. White predicts Garamendi’s directives will “thoroughly disrupt the placement” of workers’ comp cover in California, do nothing to increase capacity in the marketplace and foster adverse selection that will harm rather than help the State Fund. “Ultimately if he’s successful, only the bad business will stay with the State Fund and the good business will migrate out.”

White contends Garamendi has singled out brokers in favor of other stakeholder groups that supported his commissioner campaign last year, specifically pointing to applicants’ attorneys, chiropractors and outpatient surgery centers. “A true leader would have had the courage to levy the burden on all parts of the industry rather than singling out those not really in a position to take definitive action. Why doesn’t he tackle the lawyers? Clearly, he doesn’t have the gumption to reduce their contingency fees, which are set by statute.”

In a keynote address at the National Insurance Leadership Symposium in San Francisco earlier this week, AIG Chairman M.R. “Hank” Greenberg warned states not to tax private workers’ compensation insurers to cover losses generated by state-chartered workers’ comp carriers. Greenberg estimates 31 state funds are currently operating under impaired financial solvency, which could prompt public policymakers to look to private insurers to bail them out. Greenberg contends such a policy would unfairly burden private insurers. “If they try to levy on the industry for their [state funds’] misbehavior, we’ll be in court,” Greenberg vowed. Some industry observers believe that the prospect that private carriers could be required to subsidize losses of the State Compensation Insurance Fund has made insurers reticent to enter California’s workers’ comp insurance marketplace.

A.M. Best downgraded the financial strength rating of Liberty Mutual Insurance Companies to A (Excellent) from A+ (Superior) and cut the financial strength of the Kemper Insurance Companies to B (Fair) from B+ (Very Good). The rating house said Liberty’s downgrade and negative outlook reflect Liberty Mutual’s deteriorated capitalization and weak operating returns in recent years, despite significant improvement in 2002. Statutory surplus has declined considerably over the last few years, A.M. Best noted, largely driven by unrealized losses from the bearish equity markets, adverse loss reserve development related to rising medical inflation, increased asbestos claim trends and the impact of the World Trade Center catastrophe.

Due to reserve charges, the group’s operating returns have been below historical profitability levels, A.M. Best said, adding that it continues to have concerns regarding reserve adequacy, particularly on older workers’ compensation and asbestos claims, and the potential for adverse development to dampen underwriting profitability going forward. Since capitalization remains exposed to potential unrealized investment losses or adverse loss reserve development, A.M. Best assigned a negative rating outlook. Due to the increased diversification of Liberty Mutual’s operations and hard market conditions, A.M. Best said it expects the group’s current business will prove to be more profitable over the next few years. The rating house said with strong rate increases across all lines in 2002, cash flow has also improved considerably across all business units, and policyholder retention remains strong.

Kemper rating remains under review: A.M. Best said the Kemper rating remains under review with negative implications pending analysis of year-end 2002 financials. Additionally, A.M. Best lowered the debt rating of the surplus notes issued by Lumbermens Mutual Casualty Company to ccc+ from bb-. Lumbermens is the lead member of the inter-company pool and group. Separately, the financial strength rating of B+ (Very Good) of Eagle Insurance Group, including Eagle Pacific Insurance Company (Washington) and its affiliate, Pacific Eagle Insurance Company (California), remains under review with developing implications. A.M. Best said the rating action follows the termination of the 80 percent quota share reinsurance arrangement with Lumbermens Mutual Casualty Company effective January 1, 2003, and its pending successful and timely conclusion of capital enhancing efforts and reinstatement of the inter-company reinsurance pooling arrangement between Eagle Pacific and Pacific Eagle.

According to A.M. Best, the adverse rating action is due to Kemper’s weakened capitalization, ongoing operating uncertainties and execution risk associated with management’s announced restructuring initiatives, including the sale of the renewal rights to various lines of business, including its financial lines, bundled and unbundled large-risk national accounts, alternative risk programs, environmental and excess casualty and surety business. The rating also reflects the weakened liquidity and cash flow following the sale of many books of business, A.M. Best said.

Kemper restructures as newly capitalized company: One day after the rating action, Kemper announced it would sell certain lines of its existing businesses to a new company being capitalized by private equity funds managed by Securitas Capital, LLC, a private equity investment firm affiliated with Swiss Re; The Cypress Group L.L.C.; Gilbert Global Equity Partners; and some members of Kemper’s existing management team. Under the proposed transaction, the new company, which would operate under the Kemper name and would acquire the renewal rights to certain lines of the Kemper Insurance Companies. The lines of business included in the transaction are Kemper’s middle market offerings, such as workers’ compensation, package, auto and umbrella in support of these lines.

Kemper said the new company will be led by Robert A. Lindemann, senior vice president of Kemper and president of American Manufacturers’ Mutual Insurance Company, as well as other current Kemper executives. “We’ve said for some time now that while we have strong operating results in our core lines of business, we lack the access to capital we need to maintain our ratings in the critical ‘A’ category,” said Kemper’s Chairman and CEO David B. Mathis. “ We believe the transfer of these businesses to the new entity is in the best interest of our company and policyholders and will provide for minimal business interruption.”

John F. Shettle, Jr., senior managing director of Securitas Capital, said the transaction is expected to close in the second quarter. “Since last fall we have been conducting extensive due diligence around Kemper’s business, and are impressed with the quality of the management team and the prospective operating results,” said Shettle. “We have shared our preliminary plans with A.M. Best and we expect that the new company would qualify for an A- rating or better, which would enable us to grow what is already an attractive book of business.” The transaction is subject to satisfactory completion of due diligence by the parties involved, definitive documentation, regulatory and other approvals and consents as well as other conditions.

Fremont General Corporation (NYSE: FMT) announced it will write off its investment in its discontinued insurance operations. The company recorded a pre-tax charge of $119.6 million, or $77.8 million after tax, against its fourth quarter 2002 earnings. Last July, Fremont General sold off its Fremont Compensation Insurance Co. workers’ comp book on a going-forward basis to Employers Insurance Company of Nevada and placed the existing book of business into runoff. Fremont General said it determined that its discontinued insurance operations had deteriorated financially, based on year-end 2002 actuarial evaluations reflecting adverse loss development. “As a result, the company expects that a recovery of its current investment in its discontinued insurance operations is no longer probable and that a write down of the entire amount is now warranted,” Fremont General stated.

Fremont General said its net investment in its discontinued insurance operations, prior to the write down, was $45.1 million as of December 31, 2002. The write off amount also includes future capital contributions comprised of both mandatory and contingent capital contributions as part of Fremont Compensation Insurance Company’s December 2000 voluntary conservation agreement with the Department of Insurance. Fremont General said the total amount of these future contributions is $79.5 million and are payable at $13.25 million annually for the next six years. The $79.5 million amount represents the company’s maximum liability for capital contributions to its discontinued insurance operations under the conservation agreement, according to Fremont General.