The announcement by the Mervyns retail chain that its planned reorganization under Chapter 11 is being turned into a liquidation has put the state Office of Self-Insured Plans (OSIP) and the California Self-Insurer’s Security Fund (CSISF) on notice that they will soon be called into action. Mervyns, no longer self-insured, has liabilities upward of $20 million. Only a fraction of those liabilities will be covered by the $720,000 in deposits the company has posted with the state.
Questions are sure to be asked in the Legislature and elsewhere as to why OSIP has not required proper securitization for these liabilities. And if Mervyns is not alone in the debacle, which and how many other self-insureds or former self-insureds are undersecured?
CSISF says it is preparing for what will be one of the largest claims takeovers in the 25-year history of the Security Fund.
Mervyns is no longer a self-insured for workers’ comp employer, but it was self-insured for workers’ comp for more than a decade, which is where the ongoing liabilities emanate from.
“We’re watching and waiting, but as long as they continue to pay benefits, then we won’t declare default,” says Jim Ware, chief of OSIP, noting that every dollar the company continues to pay out on its own only lowers the future liabilities for the Security Fund. “But I know that if you have a company that is going to shut down, then at some point they’re going to stop paying benefits.”
A Mervyns spokesman declined to comment on the company’s plans for its self-insured obligations and referred all calls to its bankruptcy claims administrator, who did not respond. Ware says he has been in regular contact with the company but does not know when it will stop paying claims.
Mervyns has actually been operating under federal Bankruptcy Court protection since July, when it filed the original Chapter 11 petition and moved to reorganize its operations. But that plan was pushed aside last month when the retailer said that reorganization was no longer feasible and moved to liquidate its operations by the end of the year. A Delaware bankruptcy court last week ruled that the liquidation plan could continue under the Chapter 11 filing instead of through Chapter 7, which would have put a court-appointed conservator in charge of the effort and likely forced the company into default.
Ware says it’s not uncommon that a company has continued to pay its self-insured workers’ comp liabilities while going through a bankruptcy proceeding. “When a company goes into bankruptcy, if they want to continue with the self-insurance they’ll file a first-day petition with the court to continue to pay workers’ comp benefits,” Ware told Workers’ Comp Executive. “But when they go into default, we take all the money that we have for a security deposit and turn it over to the Security Fund and also give it their liabilities. Whether [CSISF goes] after them in bankruptcy or not, that would be up to them.”
Similar to the California Insurance Guarantee Association, CSISF is the financial backstop for self-insured employers and self-insured groups that default on their obligation to pay workers’ comp claims. To be self-insured in California, an employer is required to put up a security deposit tied to its estimated future liabilities or, if eligible, participate in the alternative security program (ASP) managed by the Security Fund.
ASP allows self-insured employers with good credit ratings and a strong operating history as a self-insured to participate in the program, so instead of posting a security deposit [either in cash, a surety bond, line of credit or securities] CSISF arranges for the collateral and assesses each member for its share of program fees. More than 350 of CSISF’s 550 members are enrolled in ASP, credited with freeing up $4.7 billion in capital when the program was created in 2003.
The wisdom of this so-called “capital free-up” remains to be seen now that economic conditions are worsening, say critics of the system.
Mervyns was an ASP member until its finances went into a tailspin last year and it was deemed ineligible to participate. The company was booted from ASP in July, and filed for bankruptcy before posting its required security deposit.
“It’s unfortunate that they declared bankruptcy before they could fully fund the required security deposit as an excluded [ASP member], so the amount that they have posted is only $720,000,” says Jeff Pettegrew, executive director of the Security Fund. “So if default is declared, that money will be turned over to the fund, but the fund will be responsible for paying the claims for whatever period of time is needed. And ultimately the value of that will be well above $20 million, I’m sure.”
Pettegrew notes that Mervyns had made an initial payment of $550,000 toward its required security deposit, and posted a $220,000 bond when the Chapter 11 filing was made. “Of course, we’ll petition the bankruptcy court, but security funds really don’t have a privileged position in bankruptcy, so very seldom do we see much more than pennies on the dollar.”
The last program taken over by CSISF, National RV, had posted its $5 million deposit, which should be enough to cover its estimated claims of $3.6 million.
“At this point nearly all of the companies that have been excluded from the alternative security program have been able to post the required collateral, which means they’ve posted 135% of their estimated future liabilities. GM and Ford, for example, were excluded last year and they posted as required,” says Pettegrew. “But Mervyns fell out too quickly.”
Perhaps the only bright spot in the Mervyns situation is that the company had not been self-insured for more than four years now. The company first became self-insured in February 1990 and then moved to a high-deductible policy in the latter half of 2004.
“So the good news is that the claims are runout claims, so every day that they pay a dollar that’s a dollar that we won’t have to pay,” says Pettegrew. “We’ve already identified a team to take over the claims, and I’ve spoken to their carrier. I’ve spoken to our actuaries, bankers, and we’ve got the whole thing all laid out. We’ve done as much as we can to prepare ourselves to take over payments, so now we’re just waiting.”
And so are the other self-insureds who must make up the losses.