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Anatomy of the Downfall of a Recalcitrant ManagementState Fund Group Administrators Paid $500 Million

The firing of State Compensation Insurance Fund president Jim Tudor and vice president of group programs Renee Koren last week was another step toward the culmination of years of likely funny business in the insurer's group safety programs.

Jim TudorSCIF has paid nearly a half-billion dollars in fees to its group administrators over the past few years—disbursements it never disclosed to employers placed in the groups.

In many cases, Tammany Hall style, the money was used to purchase political favors from a powerful cadre of Sacramento movers and shakers. And as if the fees were not enough, group administrators were sometimes told which vendors to use so that money could go where it was needed.

The immense amount of money sometimes created a culture of aggressive competition among groups, with some of them even offering cash prizes and vacations to brokers who funneled into them large volumes of business. State Fund pays up to 3 percent of premium to group administrators, which, according to numerous sources, do precious little in exchange.

Workers' Comp Executive last year uncovered the details of how lack of transparency around groups and how their administrators were paid left the door open for financial and political mischief. The Executive's coverage exposed parts of the secretive world of groups and the conflicts of interest between two State Fund board members, who also were group administrators. The stories spurred an investigation by the governor's office that led to the firing of Tudor, who had run the group programs like his personal fiefdom, according to internal sources at the company.

Tammany HallThe firings come after intransigence over the past four years, during which State Fund's management fought tooth and nail to avoid attempts at oversight by state regulators, even going so far as to legally challenge the insurance commissioner's authority to enforce risk-based capital laws. Report after report was done, and Tudor managed to manipulate the outcomes of all but the last. See our related commentary by publisher J Dale Debber, click here.

State Fund officials, including Tudor, reacted with indignation when then-Insurance Commissioner Harry Low five years ago wanted State Fund to reduce its sky-high commissions of 15-18 percent at a time when other carriers were going bankrupt.

State Fund management, some say, intentionally created cash flow problems for smaller carriers. It captured market share while sinking its competition.

And last year, when then-Senator Jackie Speier tried to push through legislation that would have given the state more oversight, State Fund rolled out its big lobbying guns to kill the measure. But the Executive reported on high-paid lobbyists' plans, and Senator Speier publicly called it what it was.

And then there was the way dividends were distributed to groups. In the old days, the industry was used to seeing trade journals such as Underwriters' Report print "grip and grin" photos of dividend checks being presented to groups that had displayed exemplary loss records.

But in the few years since Tudor assumed control of group activities, State Fund rarely announced how much it was paying in group dividends. This left favored group administrators to deposit checks in their own accounts and distribute these funds to employers as they saw fit, according to SCIF employees who have worked its group programs. That left a lot of wiggle room and the potential for administrators not to pay everything, with employers being none the wiser.

Last week, Koren and Tudor were escorted out of the home office in San Francisco under guard, and employees were admonished to avoid all contact with them about State Fund operations.

 

Tudor's Background

Tudor, as have all State Fund presidents and vice presidents, worked his way up through the civil service system in the organization.

Sources inside State Fund say that Tudor made sure he had people loyal to him in all areas of the organization, even the motor pool. This resulted in few people being willing to speak freely about concerns they had in the company. A climate of fear also was ensured with at least one firing.

A former manager of State Fund information technology, whose name we are withholding, worked her way up through the organization. She had been with State Fund's information technology department for about a year. She discussed with her close staff a report from an outside contractor – the Gartner Group – that was highly critical of State Fund's IT, and specifically critical about State Fund's system that runs its payroll, accounting and billing, insurance support, and collections services.

According to sources, she knew she was treading on sensitive ground and so tried to relate the bad news in the report as lightly as possible, the idea being to work with her staff to correct the issues.

Tudor heard about the discussion, and wanting to keep the Gartner report top secret, fired her. She was later that day escorted from the building and told not to come back.

This sent a chilling message to the rest of State Fund about how to deal with Tudor.

 

The Groups

State Fund offers group insurance through about 270 safety groups and trade associations. Some of these groups are run by former State Fund employees, such as Frank Del Re, president of Western Insurance Administrators Inc. of Long Beach. Del Re was recently a member of State Fund's board until he was asked to resign along with another group administrator, Kent Dagg, of the Shasta Builders Exchange, due to apparent conflicts of interest.

Employers qualify for inclusion in a safety group at State Fund by some combination of class code, loss experience and geography. State Fund has or had rating and quoting software that automatically determines group eligibility and, if eligibility is established, quotes the risk as group business. Groups get a 6 percent discount on their premiums and the group administrator is supposed to provide regular safety services to ensure the employers maintain good loss histories.

Brokers interviewed for this story said they aren't sure what functions administrators perform to earn their fees. Even many of the workplace safety pamphlets that administrators give their members are produced and printed by State Fund. Safety meetings often are conducted by State Fund personnel.

Policies in the respective groups are written though special State Fund underwriting operations known internally as LAG, BAG and SAG—acronyms for Los Angeles Groups, Bay Area Groups and Sacramento Area Groups. They perform all of the same underwriting and issuing functions as any other SCIF underwriting unit, including determining risk acceptability and overriding requirements when need be.

Group policies are treated essentially the same as any non-group policies, with insureds billed in the same way, and there is no difference in the broker relationship.

State Fund won't discuss the fees it pays safety group administrators, but a fee schedule from 2003 obtained by the Executive shows a graduated scale capping out at 3 percent of premium depending on the size of the group. Brokers say that employers that belong to safety groups have no clue about the groups, many of which also collect annual membership dues from insureds. State Fund sometimes paid those fees.

With such big money involved, one former State Fund group employee, who asked for anonymity to protect his job, says there was poaching going on regularly between groups. He knows this because once in a while they would receive a complaint about one group administrator attempting to raid another group for members.

Rich Norlie, a Northern California broker, tells the Executive of some safety groups wining and dining brokers who funnel them large volumes of business. One group, the Solano-Napa Builders Exchange, holds an annual luncheon at which it gives out cash prizes and trips. At last year's function, it awarded ten $500 cash prizes to individual brokers, he said. It also sprang for free cruises to brokers who place $1 million or more in premium in the group, and trips to Pebble Beach for those who place $500,000 in business with the group.

 

Parsing Out Dividends

When State Fund used to pay dividends, before the Department ordered it to cease the practice due to its then-precarious financial position, it would pool group members' experience for the purpose of determining and paying dividends.

Group members were not always told how much their group received in dividends in the aggregate. There are allegations that some administrators in the past doled out dividends and that administrators retained a percentage of those dividends.

State Fund had paid dividends every year to its policyholders since its inception in 1913, but that all changed in 2002 when the Insurance Department raised concerns about the practice in light of the insurer's waning surplus. In 2001 it paid $99 million in dividends, with most of those funds going to groups.

After all other carriers in the California marketplace had ceased paying dividends in the late 1990s, State Fund zealously and inexplicably paid them even to the point of losing money.

State Fund posted its third straight year in the red in 2000 when it lost $88 million after paying out $82 million in dividends. Before dividends, State Fund reported a $6 million profit on net written premiums of $1.2 billion. In 1999 State Fund lost $112 million after paying $93 million in dividends and posting net loss before dividends of $22 million. Before dividends in 1998, State Fund earned $9.7 million, but after dividends it lost $77 million.

Dissolving Transparency

Last year it became clear the lengths to which State Fund's management would go to avoid scrutiny by the state legislature, regulators, or its parent Department. That's when then-Senator Speier floated what she termed a good-government bill, SB 1452, which would subject SCIF to the same audit standards as other state and publicly created entities. The bill was originated by the Office of the State Auditor because it felt it needed to obtain affirmative legislative relief to do its job. Under state law, State Fund is part of the Division of Industrial Relations, which is subject to State Auditor oversight.

Speier was alerted by a Workers' Comp Executive Flash Report that State Fund was paying big bucks to hired lobbyists to defeat the bill. The Flash Report outlined the strategy the lobbyist was using, down to the committee in which the bill was going to be killed. The Flash Report was released the day before the hearing, and Senator Speier, according to staffers, almost blew a gasket. She held a news conference at which she lambasted the company for overstepping its bounds.

"So why are we holding this news conference?" Speier asked rhetorically. "It's because State Fund has been so aggressive. They've hired an outside lobbyist to kill the bill and have paid him at least $178, 000. Either they have too much money to spend, or they have something to hide."

"It would be preposterous in my mind to not have the authority to audit an entity created by the state," she added.

At the time, State Fund lobbyist George Miller of Lang, Hansen, O'Malley & Miller Governmental Relations denied being hired to kill the legislation.

Faced with the facts, the committee passed the bill and it was later signed.

Coming to a Head

Things started to unravel last year when the Executive ran a story pointing out the potential conflict of interest of board members Dagg and Del Re voting on Tudor's call for increasing commissions on group business to 12 percent from 10 percent.

Dagg was head of a large SCIF construction group, Shasta Builder's Exchange, and Frank Del Re was president of Western Insurance Administrators, which runs eight SCIF safety groups.

Tudor at the time of the vote was interim president and angling to make it a permanent position. The measure took effect on Oct. 1, 2006, when many of SCIF's group policies incept. Strangely, the measure was put in place for six months only. The move came at a time when State Fund was bleeding business due to a resurgence of competition in the marketplace. State Fund wrote about $6 billion in premium in 2005, but that's dwindled to about $3 billion on an annualized basis this year, according to SCIF underwriters.

A few weeks after the conflict of interest concerns emerged, the board voted to approve Tudor as president. Reportedly, Dagg and Del Re abstained. Shortly thereafter they stepped down. Attempts to reach Del Re were fruitless.

After De Re and Dagg stepped down, that left the board with chairwoman Jeanne Cain, a lobbyist and senior vice president of the California Chamber of Commerce; Vincent Mudd, a principal in several San Diego businesses and board member of the San Diego Regional Chamber of Commerce; and James A. Santangelo, a prominent member of the Teamsters Union since 1959.

There are also three non-voting members: Jay Hansen, legislative director of the State Building and Construction Trades Council of California; John Rea, director of the Department of Industrial Relations; and Don Moulds, a top aide to State Senate President Pro Tem Don Perata. The state senator last week replaced Bobby Alverado, head of the Northern California Carpenters Trust, with Moulds.

The Fallout

The governor's office had grown so concerned about State Fund's operations that it hired two law firms to investigate. Company sources say lawyers interviewed numerous executives and employees during the past few months. What they found has not yet been made public, but it was apparently damaging enough to force Tudor and Koren to be instantly removed. In an indication of the seriousness of the affair, an internal memo, issued at 5:05 p.m. on the day of the firings, read:

"Effective immediately, Jim Tudor and Renee Koren have resigned from State Fund and are no longer involved in any aspect of State Fund operations. Therefore all communication with them regarding State Fund matters must cease. No employee is permitted to communicate in any way with Mr. Tudor or Ms. Koren regarding any subject involving State Fund."

The next morning Lawrence Mulryan, former director of the California Insurance Guarantee Association, was at Tudor's desk as interim president.

This week the State Senate will hold an investigative hearing into State Fund, and talk was rife of a possible criminal probe being launched by the Attorney General's Office.

Just how deep the probe will go is still unclear, but what has transpired the past week indicates that State Fund is finally on the road to becoming a more transparent organization, which as a quasi-state agency, it should be.

Fallout on the "16th Floor," as the executive offices are commonly referred to, likely will continue, with other executive vice presidents loyal to Tudor probably opting to retire rather than face the inevitable. And for State Fund employees, the climate of fear is starting to wash away, and they are growing less concerned about whom they can talk to now that Tudor is gone.

 

SCIF Story Unfolding

Click here to see how the WCE unfolded the continuing scandal at State Fund. A timeline of the reality of the unfolding scandal con tains some historical references to the factual making of California's own little Watergate.

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