Attorneys representing Applied Underwriters’ California Insurance Company and the California Department of Insurance faced steady pushback by a panel of justices as the First District Court of Appeal heard arguments in the carrier’s attempt to overturn a rehabilitation plan that, among other things, would usher CIC out of the state.
There are very interesting interchanges between the lawyers and the Justices.
CIC framed the case as an example of regulatory overreach and statutory interpretation, while the state raised issues about the carrier’s integrity and its flagrant attempts to avoid California regulation.
Applied filed the appeal nearly a year ago. It was after the San Mateo Superior Court approved the state’s proposed rehabilitation plan in the five-year-old conservation of CIC. Judge Susan Greenberg signed the order in April 2024, approving the plan to resolve the outstanding policyholder litigation over the EquityComp workers’ comp program’s reinsurance participation agreement (RPA) and to auction off CIC’s California operations to clear the way for it to surrender its California certificate of insurance so it can merge with its New Mexico-domiciled alter ego.
Applied brought in attorney David Barrett from Boies, Schiller, Flexner LLP in New York to argue its case on appeal, while Michael Strumwasser of Strumwasser & Woocher represented the Department.
“This case is unique,” Barrett maintained in his opening comments. “It represents the first time, as far as we can tell, in the almost century-long history of statutory conservancy proceedings in insurance cases in California, where the conservation itself and the terms – which I would call verging on confiscatory – of the rehabilitation plan are based solely on an alleged regulatory violation.”
Given his turn to respond, Strumwasser maintained that Applied is advancing for the first time “a pretty shocking theory” of their case, which is that Insurance Code section 1011(c) is essentially preempted by the latter enacted section 1215 and its subsections.
“If he is right, then the preemption isn’t just 1011(c). If you read 1011, there are ten subdivisions and by my count, half of them don’t require any solvency concern,” he argued. “So, if his theory were correct, you would have taken out [subdivision] c, and you would’ve taken out a bunch of others, and essentially rewritten the statute. And, of course, that didn’t happen. For the same reason that there is no history, legislative history of this bill, that indicates a desire to narrow the scope of 1011(c).”
Pushback
A notable exchange occurred between Associate Justice Jon Streeter and Applied’s counsel. Streeter asked Barrett for his take on the statutory purpose of the conservation rules.
“I think it’s very straightforward, Your Honor. The fundamental purpose of conservation is to protect rights of the insureds, in this case the workers and the policyholders, to be paid when they have injuries,” noted Barrett. He maintained that the function of insurance is to pay the victims who have suffered injury and, in the case of workers comp, to protect the employers from any other lawsuits relating to those injuries.
“And in order to make sure that that goal is honored, isn’t it important to ensure that the entities that are in charge of that have integrity and are following the rules that are set for them? And when there is a clear violation of a rule or rules, isn’t the [Insurance] Commissioner empowered to impose certain remedies,” Justice Streeter asked.
Barrett replied that the Commissioner did have the right but pushed back against the use of conservation when lesser actions, such as an injunction, orders to show cause or removal of a license, could be employed.
“He’s got a menu,” noted Streeter. “Why should it be for us in black robes to be limiting the menu that the Insurance Commissioner can choose from, and in doing so, to set the policy that that official was elected to adopt.”
“Tone It Down A Bit”
Streeter also pushed back against Barrett’s rhetoric to describe provisions in the Rehabilitation Plan. “The two key provisions of the rehabilitation plan are as follows: One is the settlement of the so-called RPA litigation, and the other basically requires the company to divest its entire California business. Those are both huge interferences with liberty,” Barrett argued.
“Divest its entire business?” Streeter injected while the attorney was still talking. “That’s a pretty bold statement for a condition that, to be sure, requires a very significant change in how business is done with reinsurance. But confiscation?…You can tone it down a bit. We understand your point without getting to those rhetorical heights.”
The provision at issue is the rehabilitation plan’s call for an auction to allow an admitted, unaffiliated insurer to acquire CIC’s in-force policies and to reinsure the remaining liabilities from the expired California policies. If an unaffiliated buyer cannot be found, the assets can be sold to an affiliated carrier, but an independent third-party administrator must handle the claims.
Barrett recharacterized it as “a forced taking of the company’s property.” He also argued that the policyholder litigation never threatened the company’s financial solvency. Barrett maintained that the conservation was never needed because CIC voluntarily agreed not to proceed with the planned merger with the New Mexico affiliate. “[CIC] tried to negotiate with the Commissioner for a month. [Then] without telling them ex parte and making some very serious allegations, the Commissioner got the conservation order,” he argued.
“Let me just push back a little bit on that factually. My recollection is that in the course of the application relating to the Berkshire Hathaway transaction before, the Commissioner said we are not in a position to approve this by the time frame that you are asking, which was the September date,” responded Presiding Justice, Tracie Brown. “Didn’t the Commissioner express concern with respect to the RPA litigation? So, it’s not like that was completely coming out of nowhere when it was part of the rehabilitation plan.”
Where’s the Limit?
Associate Justice Streeter also had pointed questions for the Department, given its argument for broad authority under section 1011 to conserve a company for regulatory violations.
“There are a lot of ways in which the regulations that this commissioner oversees could be violated, but it seems to me that the notion that there ought to be some potential financial consequences attached to any triggered conservancy makes some sense,” he noted. “If a technical violation of regulations could lead to the draconian consequence that you get with conservancy, where’s the limit?”
Strumwasser maintained that the mere fact that this was the first conservation for a non-solvency issue is evidence that the statute isn’t being abused. Furthermore, he argued that independent judges are involved in the conservation process to provide checks and balances to prevent an Insurance Commissioner’s overreach.
“If the Commissioner walks into a courtroom and says, ‘Turns out they’ve got some bad wiring in the men’s room and it’s a hazard that violates the code.’ The first thing the judge is going to say is, are you kidding me? You’re going to take away a company for that?,” he told the justices. “You have to assume that it’s going to be sensible judges and sensible executives.”
Justice Streeter asked where the potential for financial harm to the policyholders or the financial risk for the injured workers receiving benefits was.
“Your Honor, I think the insidious genius of the RPA has been lost here. They aren’t underpaying injured workers, they’re overpaying them and sticking the bill, sticking the employer with the bill. That was the scheme,” he said.
Strumwasser also pushed back on Applied’s argument that there had to be a threat to the company’s financial solvency to justify the conservation. He pointed out that section 1011 also allows for conservation if an executive is embezzling company funds. “[Section] 1011 doesn’t say he took so much money that the company is now insolvent. You just want to interdict that at the outset,” he maintained.
“That’s lack of integrity,” noted Justice Streeter.
“That’s lack of integrity, that’s exactly right,” responded Strumwasser. “And that’s what we’re talking about here.”
Presiding Justice Brown thanked the parties for their briefs and oral arguments. “It’s a very interesting insurance case and these are not words I say all that often I’ll be honest with you, but this gave us a lot to think about and we appreciate it,” she noted. “So the matter will be submitted at this point and we will issue a decision in due course.”