A popular workers compensation insurance program offered by Berkshire Hathaway subsidiaries Applied Underwriters Captive Risk Assurance Company (Applied Underwriters) and California Insurance Company may be in trouble. On January 21, 2016, the California Insurance Commissioner adopted an administrative decision finding that a critical piece of the program had not been submitted for approval and was therefore void. Any company now insured under this program should carefully monitor developments and consider alternative options for workers compensation insurance.
The Applied Underwriters EquityComp program is unusual. It consists of a normal “guaranteed cost” policy (the premium is not sensitive to loss history) issued by California Insurance Company. The insured in addition signs a “reinsurance participation agreement” (RPA) with Applied Underwriters, billed as a “profit-sharing” plan. The RPA actually controls what the insured pays under the program and results in workers compensation insurance that is loss-sensitive.
Shasta Linen Supply complained to the Insurance Commissioner that Applied Underwriters shouldn’t be allowed to enforce the RPA because it had never been approved for use in California. The Commissioner agreed. Both sides asked for reconsideration of that decision and it’s now been withdrawn because of the appeal. But the Commissioner is expected to issue a final decision sometime this summer, probably confirming that the RPA is “void.”
In the meantime, in a San Francisco Superior Court lawsuit brought by Luxor Cabs, the court also ruled that the RPA is void and unenforceable. That decision is now on appeal. In the wake of the Commissioner’s ruling, Shasta Linen filed a class action lawsuit against Applied Underwriters in the Eastern District of California alleging fraud and unfair business practices. Three other lawsuits against Applied Underwriters have been filed in the last few months in California federal courts, and there may be more in various California state courts. The program is under attack in other states as well.
Several features of the program and the way it is sold appear to have prompted the complaints by Shasta, Luxor and others. Shasta and others have alleged that the program is sold with a description of how the program works, including projected minimum and maximum premiums over a three-year period (it is sold as a three year program). But they allege they were not given the RPA until they had already agreed to the program.
The RPA itself is virtually incomprehensible, which should raise red flags for any company. But the monthly invoices received from Applied Underwriters begin to illuminate how the program works in practice.
Insureds are billed monthly for “capital deposits” and “base fees.” Deposit and fee requirements are front-loaded to some extent, and will jump once the first claims are asserted, though they may level out later. The deposits and fees are intended to cover claims payments and claims handling costs, with the prospect that some part of the capital deposit will be returned eventually once all claims are closed.
And therein lies one of the chief complaints. Any claims still open at the end of the program can result in a spike in demand for capital deposits during the “run-off” period (until all claims presented are closed). In addition, the RPA stipulates that Applied Underwriters can hold onto the company’s deposits for up to seven years before returning any excess. (The RPA is opaque about what amounts will be returned, though presumably it is the capital deposits still being held once all claims are closed and seven years have elapsed since the program’s end.)
A second complaint arises from the RPA’s cancellation provisions. If the company seeks to cancel mid-program, it faces not only a demand for run-off reserves, but also an “Early Cancellation” fee equal to 20% of the “anticipated premium.” Both the cancellation fee and the hefty run-off capital deposit requirements may serve to handcuff companies to the program. Moreover, the RPA contains onerous provisions requiring that any disputes be arbitrated in the British Virgin Islands under Nebraska law. (The Luxor Cabs court ruled this provision unenforceable for the same reason that the Commissioner found the RPA void.)
On the other hand, some companies have done well under the program, paying significantly lower workers compensation costs even taking into account the long-held capital deposits. This is attributed in part to what is perceived to be an efficient claims handling operation run by Applied Underwriters.
We recommend that companies insured under the EquityComp program, at minimum, review their experience and monitor the recent challenges to the program. If the Commissioner’s decision is confirmed, Applied Underwriters is probably going to have to cease selling the program and work out an orderly process to transition insureds out of existing policies. Applied Underwriters will likely try to put in place a new program approved by the Commissioner to which it could try to shift existing policyholders. Other insurers may offer enticing premiums to capture market share from Applied Underwriters. Insureds will in any case want to be prepared to transition in an orderly way to a new workers compensation insurance program, whether with Applied Underwriters or another insurer.