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Berkshire Hathaway’s EquityComp Program Problems

EquityComp LogoA California employer is fighting a two state battle with Applied Underwriters and California Insurance Company, both units of the Berkshire Hathaway empire.  It’s over a $290,000 final bill which is based on allegedly trumped up loss development factors – LDFs which changed substantially when the employer didn’t renew.  The employer contends they were applied because it didn’t renew the program. The problems include variable monthly premiums apparently unrelated to either payroll exposure or claims reserving – using a formula Applied refuses to disclose.  In addition, the reserves charged to the employer within the program are not consistent with the actual reserved and paid losses.

The employer is asking the California Department of Insurance to step in and exercise its regulatory authority to protect workers’ comp policyholders from illegal side agreements and unfiled rate plans. 

The case pits Shasta Linen Supply against Applied Underwriters and California Insurance Company. The legal question in dispute is whether or not the reinsurance participation agreement (RPA) that Shasta Linen signed to take part in Berkshire’s EquityComp Program is an unfiled workers’ comp rate plan and therefore illegal. Also in question is the validity of the arbitration clauses in the RPA that Shasta is fighting before the Department and before the Nebraska Supreme Court.

An administrative law judge at the Department has already held a week of evidentiary hearings in the case and is planning to take additional testimony later this month or in May. The ALJ’s decision will then be sent to Commissioner Jones for consideration. From there an appeal into the courts could ensure.

Beyond the strict legal issues, observers say a broader and more basic question is also in play.  Is Insurance Commissioner Dave Jones effectively overseeing the actions of carriers and protecting California policyholders?  The ultimate decision by Commissioner Jones in this case will go a long way to answering that question.

 

Agree To Disagree

Shasta argues that the RPA with Berkshire’s British Virgin Islands based reinsurance arm – Applied Underwriters Captive Risk Assurance company (AUCRA) – actually determined what Shasta paid on a monthly basis for its workers’ comp coverage as opposed to the guaranteed cost program it received from California Insurance Company.  Therefore it argues the RPA should have been filed with the Department.  It isn’t.

Defense attorney Spencer Kook declined to comment on the case but in case documents Berkshire maintains that the workers’ comp policy that Shasta had was with California Insurance Company and that policy was on an approved form with approved rates. The RPA just provided the “formula and methodology for how the profit sharing/risk sharing retention component of the EquityComp program worked,” according to case documents.  “Since the RPA is a reinsurance contract, it does not have to be filed and approved by the CDI and unlike the guaranteed cost policy issued by CIC, does in fact contain a robust broad arbitration agreement.”

The question then is does a reinsurance contract which adjusts premium costs or specifies rates an employer must pay, and which is executed directly with an employer require a rate filing, or have Berkshire attorneys found a way around the rate filing requirements?

 

Undisclosed Rating Plan

“My client Shasta Linen entered into a program that was supposed to be for 3 years of workers’ comp coverage – supposedly written under a guaranteed cost approach on an annual basis, but the proposal also required entry into an EquityComp agreement,” attorney Craig Farmer tells Workers’ Comp Executive. Farmer is representing Shasta in the dispute before the Department of Insurance. “The EquityComp agreement really in our opinion was the agreement that specified the rates to be paid by Shasta Linen.”

Unlike a strict guarantee cost program where the bill would vary only with fluctuations in payroll, Shasta’s monthly bills varied widely. “The numbers were extremely variable in terms of how much was charged per month throughout the three years,” says Farmer.

Exactly how the monthly bills were calculated was never disclosed. This is a problem with the program that has draft authority of an employers bank account.

“One of the biggest complaints that policyholders have is that they cannot understand how the monthly charges are calculated,” says attorney Art Levine who studied the program and served as an expert witness for Shasta in the dispute. “They vary greatly even if the claims values don’t necessarily change from month to month.”

 

Runoff Loss Development Factors

Another issue in contention is the program’s application of higher runoff loss development factors on any open claims when the program ends – either by the policyholder opting to leave for a different program or by the carrier deciding not to renew.

In Shasta’s case Farmer says there were two open claims at the end of the program that had been reserved at roughly $50,000 and $75,000 while the program was in effect (see Compline’s X-Mod history for Shasta Linen in the graph below). “But when you applied the loss development factors on a runoff basis in the EquityComp program those numbers ended up moving up about 2 to 3 times their previously reserved values,” says Farmer. The end result was a final bill for roughly $200,000 over and above the billed amounts during the three years of the program.

“They’re seeking $289,000,” says Farmer noting that this includes $70,000 that was billed for the last month of the program. “The $164,000 and the additional $40,000 on top of that seemed to come out of their determination that they’re entitled to apply these runoff loss development factors to the last two open claims.”

Since the end of the active program, the assigned value of the open claims has continued to increase.

“They have been determined to have an adjusted loss cost of $500,000 and $900,000 dollars for these two open claims,” says Farmer, maintaining that the loss runs are for far less than that. The claim that was valued at $500,000 was subsequently closed at $130,000. The second one is still open but has a reserve and a paid amount together of $280,000.

“That’s where the whole process gets really ugly,” says Farmer. “Its just incredible that they could of some how built these numbers up to $900,000 and $500,000.”

Shasta Linen Xmod 

Arbitration Demand

While Shasta is arguing its case to the California Department of Insurance it is also battling an arbitration demand in Nebraska where AUCRA is seeking to collect on the amounts allegedly owed. Shasta’s policy with California Insurance Company did not include an arbitration provision, only the RPA agreement.

 The question of whether the arbitration can proceed is currently before the Nebraska Supreme Court where Applied Underwriters has appealed the issuance of a temporary injunction to stop the AAA arbitration proceeding.

“They’re trying to get Shasta Linen to pay another $290,000 which they would then keep and reinvest to their own benefit until eventually they decide that there are no further exposures to be paid on that last open claim,” says Farmer. “Then if [Applied Underwriters] were to pay nothing further on that last open claim they’ve said that they would owe $260,000 back to Shasta Linen under their program...Maybe. There’s nothing set here that says any of that is really going to happen.”

It is also unclear what is going to happen when the issue gets before Commissioner Jones.  Attorney Levine maintains that the program as currently operated appears designed to circumvent state regulation. “I testified that I thought the program was illegal. That’s the bottom line. I testified that I thought the program needed to be filed,” Levine tells Workers’ Comp Executive.

“I told the judge that at the end of the day if you find this to be legal and it doesn’t have to be filed then insurers in this market – at least for policyholders paying over $100,000 – will be able to do what they want by having a side agreement that says whatever it says and who cares what the policy says. I don’t see how the Department of Insurance can tolerate that,” he says. “The employer’s cost isn’t determined by the policy – it’s determined by this side agreement over which they say [the department has] no jurisdiction. Maybe they don’t have jurisdiction over a reinsurance participation agreement but they sure have jurisdiction over letting their licensee make this possible.” 

 

Editors note: The following response from California Insurance Company arrived too late to be included in the original article.

"You have asked for our comment. Ordinarily we do not comment on ongoing litigation but will do so in this case.
Our EquityComp® product has successfully provided clients with flexible risk retention options effected through a separate reinsurance participation agreement. EquityComp® has been reviewed by the California Department of Insurance multiple times during regularly scheduled examinations.
The current administrative proceeding before the California Department of Insurance is nothing more than a preemptive attempt by a client to avoid paying a contracted amount due and owing.
All necessary filings and approvals have been made with the California Department of Insurance. In the unlikely event the reinsurance participation agreement needs to be adjusted and/or filed, such a finding, by statute, would apply only going forward and would have no bearing on the current client dispute. If required, we will make any necessary adjustment and/or filing promptly."

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