Missing the Point on Applied Underwriters’ EquityComp Program

CDI Side Agreement Regs Deadline Looms

By: Brad Cain

The California Department of Insurance is entering the home stretch for updating the rules governing workers’ comp side (aka collateral or ancillary) agreements and policy endorsements. The Department is facing a Dec. 19 deadline to wrap up the package or face the prospect of starting over and as of press time officials were unable to say if they would make it to the finish line.

Comments sent to CDI about the latest proposed language – the fifth version circulated since CDI published the initial proposal nearly a year ago – indicate that the Department may still be off the mark and could even have made the situation worse. If any comments are accepted and result in a material change, the Department is obligated to issue another 15-day public comment period. Such a move would put it past the one-year mark, and the regulatory process would have to start over again.

That may be the best outcome for those who have fought the proposal throughout the process. The insurance industry maintained at nearly every step of the way that the Department was misguided and would disrupt the large deductible and retrospectively rated markets. Others say the department has missed the elephant in the room and is failing to close a loophole that is allowing carriers to circumvent the file and approval requirements.

Will The Regulations Matter?

While carriers are complaining about what is covered by the regulations, one industry insider is raising concerns about what is not covered by the rules. In particular, there are questions whether the Department’s efforts will do anything to stem the abuses that employers allege are occurring in the Applied Underwriters EquityComp program.

Employer complaints focus on the provisions of Applied Underwriter’s Reinsurance Participation Agreement (RPA) that they are required to sign to take part in the program. Could Applied be right that the agreement falls outside these rules and does not need to be filed? The question is currently pending before Insurance Commissioner Dave Jones.

“It may well be they are just clarifying existing rules since the Department’s position (as stated in its Zurich American amicus brief) is that all such endorsements/ancillary agreements need to be filed and approved,” says Ron Groden of the current proposed regulations. Groden, formerly a major company CFO, is a consultant with Triunfo Creek Associates. “These regs may simply be a reaction to the Zurich American case. Unfortunately, the Department may still be behind the curve on this issue.”

Groden notes that carriers are currently getting around the file and approval requirements by reinsuring the premiums and losses on a policy. Groden says the following scenario is taking place:

  • Insurance Company X, licensed in California, issues a guaranteed cost or deductible workers’ comp policy to Insured A using filed and approved rates and forms
  • Insurance Company X reinsures the premiums and losses of the policy into a protected cell captive of an affiliated Reinsurance Company Y.
  • Reinsurance Company Y (through the protected cell) enters into unfiled ancillary agreement(s) with Insured A that significantly modify the terms and pricing of the underlying workers’ comp policy.

“Using this approach any type of deductible or loss sensitive plan can be constructed by Reinsurance Company Y using unfiled rates and forms,” he says in comments to the Department. He notes that the proposed regulations may not prevent this practice from continuing.

“The way I read the proposed regs, insurer is the company that issues the workers’ comp policy,” he tells Workers’ Comp Executive. “It is certainly not clear, using my example above that [the affiliated reinsurer] would need to file and have approved the endorsement. Yet, in the end you wind up with the same result.”

Other Carrier Comments

One change in the fifth version of the regulations that did find support among carriers was the addition of several carve-outs for agreements that deal with the method of making payments or funding the deductible requirements. The carve-outs also cover agreements over the amount of collateral to be maintained for claims under the deductible amount, when payments are to be made and how, and those covering the method for selecting an administrator for claims under the deductible amount.

To be exempt from the filing requirement. However, the terms of these agreements must be disclosed and negotiated “contemporaneously with the inception or renewal of the underlying policy.” Any revisions or additions to the terms after the inception or renewal would also have to be mutually agreed to by the parties.

Thomas Morgan, assistant general counsel for The Hartford says the changes show “significant progress towards recognizing that in the ‘large deductible/loss sensitive’ marketplace, insurers are often required to negotiate the terms of their program agreements. This is due to the relative size and negotiating strength of the employers that purchase large deductible/loss sensitive programs.” Morgan maintains that it would be impractical to suggest that insurers could refuse to negotiate over the terms of these agreements because they had to be filed and approved before their use.

However, Morgan maintains that the changes did not go far enough. “Hartford cannot speak for other insurers, but Hartford’s program agreement contains more terms than those set forth in [Section 2500] (f)(3)(A)-(f)(3)(F),” he maintains. “Thus, despite the inclusion of (f)(3) in the rules, virtually every program agreement that Hartford negotiates with an insured will fail to qualify for the carve-outs and will be deemed to be an ‘ancillary agreement.’”

The American Insurance Association also reiterated its opposition to the proposed regulations. “This is the fifth revision of the Department’s original proposal, to which we have filed comments. We have consistently criticized these revisions as flawed, in sweeping into the definition of ‘ancillary agreement’ documents that do not alter the insurance policy,” says AIA’s Bruce Wood. “The few changes in the latest iteration do not alter our overall objections to the proposal.”

Wood also maintains that the Department made the proposed regulations worse with language that could restrict the use of third-party administration only to the amount of a claim within the deductible amount. Such a rule he says would require the transfer of claims once they reach the deductible amount that can be expensive and disruptive to the claims handling process.

Applied Underwriters was once but is no longer an affiliate of Berkshire Hathaway. Applied’s management bought it. Berkshire Hathaway bears no responsibility for any of the events which have transpired involving Applied Underwriters’ or its subsidiaries including California Insurance Company.