Insurance Linked Securities

Below the clouds is a runway ... we hope.

"Although California is always one bad court ruling or piece of legislation away from disaster, we think the current environment is quite healthy."

That's what Jerry Azevedo, a spokesman for the Workers' Compensation Action Network, said to WorkCompCentral in response to the latest California Department of Insurance market share report.

238 workers' compensation carriers combined to write $11.43 billion in premium in 2014, up 10.97%, compared to $10.3 billion in 2013, and is the fourth consecutive double-digit increase.

Written premium has increased a cumulative 65.5% since 2009.

Premium growth lately is more a reflection of increasing payrolls rather than rates, as those have held rather steady in the last few years.

But another, more insidious, reason for premium growth lately is the pathetic returns that Chief Financial Officers are able to lock in using traditionally safe investments because of the historically moribund interest rate environment.

Investors can't make much if they have only a one or two percent spread to work with buying Treasury Bonds, so they are looking to alternative investment vehicles.

History doesn't look kindly to that kind of activity - the last time "interesting" financial assistance came into the California (and subsequently national) market was in the mid-1990s when the Unicover/Craigwood reinsurance scheme was being pitched to minimize carrier risk ... and dozens of carriers folded.

Now we have a new investment vehicle that is picking up steam, and I think it portends future trouble if not kept in check: ILS.

In aviation, ILS is Instrument Landing System - a way for aircraft to find the runway under a layer of clouds and fog.

In insurance ILS is Insurance Linked Securities.

The most common ILS, and what brought this alternative to note, are CAT bonds.

Catastrophe bonds are risk-linked securities that transfer a specified set of risks from a sponsor to investors. They were created and first used in the mid-1990s in the aftermath of Hurricane Andrew and the Northridge earthquake.

Wikipedia has a good explanation:

"An insurance company issues bonds through an investment bank, which are then sold to investors. These bonds are inherently risky ... and usually have maturities less than 3 years. If no catastrophe occurred, the insurance company would pay a coupon to the investors, who made a healthy return. On the contrary, if a catastrophe did occur, then the principal would be forgiven and the insurance company would use this money to pay their claim-holders. Investors include hedge funds, catastrophe-oriented funds, and asset managers. "

But the creativity of Wall Street is ceaseless, and at least one insurance investment observer indicates alarm at the "convergence" of the insurance and capital markets.

Michael Moody, MBA, ARM, in ‘Rough Notes’ magazine (April 2015 issue – page 54) writes about "Capital Market Convergence" and describes the rise of ILSs.

The money behind the capital structure of the insurance industry is increasingly being collateralized and sold off to investors with the single intent of increasing yield on capital invested: "With interest rates continuing at historically low levels, most institutional investors are looking for better yields. Currently, many of the ILS products are producing results that are 5% to 6% higher than traditional investments."

Here's the issue - there will be many investment people who know nothing about the insurance product providing the capital. Financial instruments such as Credit Default Swaps (CDS) and Collateral Debt Obligations (CDO), and other fancy named financial "treaties" created by Wall Street will move capital out of the insurance industry to the detriment of the insured public, and this includes workers' compensation.

Moody understatedly writes:

"Agents and brokers who have accounts that utilize significant amounts of reinsurance need to be aware of the advancements that are being made in the ILS market. The old days of competing on price are disappearing. Capital market professionals believe it is only a matter of time before reinsurance and ILS will be used in the same manner that reinsurance is purchased in layers today. It will not be uncommon to find excess limit programs that are made up of a combination of reinsurance and ILS. The genie is out of the bottle, and the capital markets appear to be willing to embrace the convergence with the insurance/reinsurance concept. As a result, agents and brokers who are interested in a long-term view of the insurance industry would be well advised to monitor this situation closely as it will remain extremely fluid for some time."

Certainly departments of insurance will protect us, right? After all it is their job to regulate the insurance market and ensure a safe, healthy, and vibrant industry.

Well, that didn't happen when Unicover/Craigwood came around, and there's no reason to believe that any regulating agency is going to be proactive; traditionally regulators are reactive. By the time they are alerted and take action, it's too late - carriers disappear, guarantee associations are swamped, and state funds take up the slack (as in 2000 when The State Fund covered 50% of the California market).

Blaming one bad court decision or lousy piece of legislation is looking at the finger pointing at the moon; the truth is California, and the nation's work comp market, is one bad ILS away from disaster. Carriers won't be looking for the runway under the clouds - rather they'll be looking for insolvency relief.

The Long Arm of Failure

How far do failed New York self-insurance trust issues go?

Answer: All the way across the nation to the West Coast.

In a lawsuit recently filed, California-based Waste Connections Inc. says it was duped because New York based Hudson Valley Waste Holding Inc. failed to disclose nearly $5 million in assessments by New York regulators for liabilities stemming from the Team Transportation Workers' Comp Trust, that failed in 2010.

Waste paid $300 million for Hudson Valley in 2011.

In 2005, the New York Workers' Compensation Board calculated that the trust equity ratio was 78.6% and deemed it to be underfunded as of Dec. 31, 2004. While the group's equity ratio improved to the point that the board stopped classifying it as underfunded as of Dec. 31, 2007, by July 29, 2010, it was once again declared underfunded.

In October 2010, the trustees held a meeting in which they voted to close the trust effective Jan. 1, 2011.

An audit was conducted by the board after it took control of the trust in 2012 and the analysis found the trust had a deficit of $32.5 million, plus interest.

The amount owed by the Hudson Valley companies consequently became $4.9 million. As of July 1, 2014, interest totaling $49,000 had accrued, and continues to accrue until the deficit is fully paid, according to Waste's complaint.

A Workers' Compensation Board report sent to lawmakers in June says the Team Trust has 120 open claims. The trust had 193 open claims when the board took it over in 2012.

Hudson Valley has not filed a response to the complaint, but an attorney for the company in a 2012 letter to Waste Collections filed as an exhibit to Waste's complaint denies any wrongdoing or intentional misrepresentation/concealment.

Waste Collections filed its lawsuit about one week after the New York Workers' Compensation Board extended the deadline for members of the Team Trust to sign a memorandum of understanding agreeing to pay just 75% of their assessment and to do so over an 18-month period.

The transportation industry group was one of the many New York trusts that failed starting in the mid-2000s. Of the 62 trusts that were operating at the end of 2005, only three remained operational by the end of 2012, leaving an estimated 10,000 employers responsible for nearly $1 billion in claims.

The untold story is the many injured workers who got the brunt of this irresponsible financial management.

Trusting Mistrust

The sub-theme of my talk to the California Society of Industrial Medicine & Surgery on Saturday is, "You can't trust a system built on mistrust."

A couple of stories in this morning's WorkCompCentral News provide substantial evidence (you knew I had to work that in!) of that concept.

A grand jury indictment was unsealed yesterday alleging a huge financial kickback scheme involving compound drugs, doctors and pharmacists, some of whom are "regular" names in California workers' compensation and within the Greater Los Angeles area (recall that recent studies reflect dramatically higher costs in that geographic zone compared to the rest of the state).

Kareem Ahmed, the president and chief executive officer of Landmark Medical Management, is charged in the indictment with paying doctors more than $25 million in kickbacks to prescribe and dispense to California injured workers three compound creams he had formulated to use the most profitable ingredients.

The indictment alleges that Ahmed, acting in concert with pharmacist Mike Shah, Landmark Marketing Manager Evette Charbonnet and former Landmark Vice President Bruce Curnick, to identify and recruit physicians who treated injured workers to prescribe and dispense these three medications.

The way the kickbacks were concealed was for Landmark to purchase accounts receivables from physicians; the purchase of receivables was allegedly contingent upon the physician prescribing the “remaining month supply” to the patient from a pharmacy that had a contract with Ahmed.

Ahmed through his attorney has denied any wrongdoing.

Posting bond and also named in the indictment are:

• Dr. Daniel Capen, who faces nine counts and posted a $1 million bond on Wednesday. He received $2.5 million from Ahmed between 2010 and 2013, according to the indictment.
• Dr. Eduardo Anguizola, who faces nine counts and posted an $800,000 bond Thursday. He allegedly received $2 million from Ahmed.
• Michael Barri, a chiropractor and owner of Tri-Star Industrial Medical Group Inc., who allegedly received $1 million from Ahmed. He faced nine counts and posted a $400,000 bond Wednesday.
• Dr. Randy Rosen, who allegedly received $600,000 from Ahmed, faces nine counts. He posted a $300,000 bond Wednesday.
• Curt Hauge, who is accused of receiving $8 million from Ahmed for referring business to Landmark subsidiaries, faces five counts. He posted a $100,000 bond Thursday.
• Bruce Curnick, a former vice president of Landmark who is accused of a single count of conspiracy. He posted a $100,000 bond on Wednesday.

Other defendants charged with accepting payments from Ahmed in connection to the alleged scheme include Dr. Rahil Khan who is alleged to have received $1 million; chiropractor Robert J. Villapania, owner of Regional Associates Medical Group, who allegedly received $1 million; and Dr. Arsalan Pourteymour and chiropractor David Evans, who are accused of accepting more than $650,000 through Performance Medical Group.

Dr. Craig M. Chanin, is accused of accepting payments in exchange for referring patients but the indictment does not say how much he is alleged to have been paid.

The details, comments by Ahmed's attorney, and allegations of involuntary manslaughter against a half dozen of the defendants are in this morning's story by WorkCompCentral reporters Greg Jones and Sherri Okamoto. You can trust me that they did a fantastic job of uncovering and reporting this story.

Along the same trust theme, the Workers' Compensation Research Institute released the first of four multi-state studies that point to a factor that we all knew impacted return to work success but has never been measured: trust....

WCRI’s Predictors of Worker Outcomes is Phase 1 of a four-phase, 20-state study looking at the factors that influence injured worker outcomes. The first phase of the studies examined data from Indiana, Massachusetts, Michigan, Minnesota, North Carolina, Pennsylvania, Virginia and Wisconsin, and broke out each into its own state-specific study, which also featured the data collected across all states.

Though the reports caution against making conclusions because of the small sample size, they are nevertheless groundbreaking in that they are the first that I know of to delve into the impact of the employment relationship psychology post injury on injured worker recovery success.

For example, workers who were strongly in fear of being fired after their injury were found to return to work a median of four weeks later than those who weren’t concerned about being terminated.

Of the 3,200 sampled workers, interviewed in 2013, and who were injured in 2010 with more than seven days of lost time, 21% who were not working at the time of the interview predominantly due to their injury “strongly” agreed that they were concerned about being fired. 

For that subset of workers, the median time from their injury to their initial return-to-work lasting at least 30 days was 13 weeks.

The 10% who were not concerned about being fired took a median of nine weeks to return to work lasting at least 30 days.

WCRI's study also found that workplace trust factored into recovered earnings.

Sixteen percent of workers who were strongly concerned about being fired reported large earnings losses at the time of the interview predominantly because of their injury, compared to just 3% who weren’t concerned about being fired. Those worried about being fired also had lower average health-and-functioning recovery scores, and were more likely to report problems with access to health care.

There are numerous other factors of course that contribute to the return to work survey results, such as co-morbidities, and WCRI is lining up other states for more study and reporting.

Former president of the Workers’ Injury Law & Advocacy Group, Andy Reinhardt, a claimant attorney in Richmond, Virginia, told WorkCompCentral yesterday, when queried about the study findings, "It’s not a normal employment relationship.”

Indeed.

The WCRI studies can be purchased here. Trust me, this is good stuff...

Trite Financial Cliches Still True

I write sometimes about what would happen if there were no workers' compensation.

Of course I postulate in facetiousness - obviously such an occurrence would certainly teach employers who doubt the value of workers' compensation programs and insurance that it's better than the exposure to tort liability.

But then again, sometimes I'm not so facetious. Sometimes I think that employers do need a lesson every once in a while.

Some New York employers are getting some lessons.

There was a self insurance trust group called the Healthcare Industry Trust of New York. That trust shut down in 2008. That trust was marketed and managed by Compensation Risk Managers which had seven other trusts - all eight have now shut down.

CRM also had a part in five California trusts which have also shut down. WorkCompCentral covered the stories extensively.

Employers who join self-insurance trusts pay premiums, which are pooled, to cover the costs of claims against them. They receive dividends if claims remain under control, but if the group's liabilities exceed its assets, the members have to make up the difference, paying proportional assessments based on their initial premiums. All the members of a group are jointly and severally liable for the group's liabilities.

The Healthcare Industry Trust left its members with a $176.5 million shortfall.

Members are now trying to recoup that expense by suing the brokers that pitched the trust to its members, alleging that the brokers knew that the trusts were in trouble when they marketed it to the employers but that they sold the memberships anyhow.

According to the complaint filed last Monday, the defendants committed multiple related acts of mail fraud by using the U.S. Postal Service to transmit fraudulent and misleading materials to the plaintiffs and other New York employers. These alleged actions serve as the basis for plaintiff's Racketeer Influenced and Corrupt Organizations Act claim.

The trust plaintiffs assert that their brokers knew CRM "lacked the expertise and knowledge" to properly administer the Healthcare Industry Trust, but said nothing because of the generous commissions they earned.

According to the complaint, the brokers "acted in concert with CRM to increase the membership of the trust despite a mounting deficit by aggressively marketing trust membership as a relatively safe and conservative alternative to regulated insurance products, while negotiating, pursuing and accepting excessive and hidden commissions that were dramatically higher than those customary in the industry."

Defendants named are the Cool Insuring Agency, Hickey-Finn & Co., Hirsch Wolf & Co., Marshall & Sterling, Oxford Coverage, The Rampart Group, The Reis Group, Shel-Bern Associates, The Spain Agency, The Treiber Group and The Vanner Insurance Agency.

Self-insurance trusts were all the rage in New York during the mid-1990s after rule changes to make the state's workers' compensation market more competitive.

In September 2005, though, the New York State Workers' Compensation Board declared nearly half of the 62 self-insurance groups then in operation as "underfunded on a regulatory basis."

Seven trusts went dissolved between 2006 and 2007, and another 10 failed in the following year. New security requirements imposed in January 2012 took care of most of the rest.

Only three remain in operation today.

Consequently about 10,000 employers were left holding the bag for nearly $1 billion in claims.

The board reported the outstanding liability for the defaulted trusts had been reduced to $346,076,000 as of the end of 2013 by its settlements with employers and its bond program.

The bond program raised $370 million and the proceeds of the bond sales went to the board to arrange a loss-portfolio transfer that assumed the risks of the defaulted trusts.

The board sued CRM for $450 million in December 2009 but settled for $41 million in 2010 because of CRM's tenuous financial position.

The board currently has 11 pending lawsuits against various administrators, accountants and actuaries for mishandling trust assets as well. CRM is named as a defendant in two of them, although Majestic Capital, CRM's parent company, declared insolvency in April 2011.

A suit similar to the current New York broker complaint was dismissed in California.

The 3rd District Court of Appeal upheld summary judgment, explaining that the only obligation a broker owes a client is to procure legitimate coverage. Brokers have no independent duty to inquire into the financial health of the provider from which it secures coverage for a client, the court said.

But the lawyer for the California plaintiffs told WorkCompCentral that his investigation didn't discover a document that laid out the marketing agreement between CRM and the defendant brokers in his case until after discovery had closed. He thinks this document is material to the New York case.

But regardless the ultimate responsibility falls on the employers to make sure their workers are protected, and relying on another's expertise or knowledge does not delegate that responsibility.

The lesson - you can't get something for nothing. Or probably more accurately, you can pay now, or you an pay later, but eventually you will have to pay. Or, perhaps even more acute, penny-wise, pound foolish.

In other words, all of those trite cliches you learned as a child about proper financial management still apply.

A Bankruptcy Court Flirts With Dangerous Precedent

A very interesting legal fight is going on in Maine involving the bankruptcy of a self-insured employer.

The case is In re Irving Tanning Co. et al, No. 10-11757-LHK.

At issue is an attack on bankruptcy subject, Prime Tanning-Hartland's, set aside reserves for future claims.

The bankruptcy trustee wants to liquidate the reserves except for the amount that has been estimated as necessary to fulfill the outstanding claims obligations.

Those opposed to the plan (the Maine superintendent of insurance, the Maine Self-Insurance Guarantee Association, the Missouri Department of Labor and Industrial Relations and the Missouri Private Sector Individual Self-Insurers Guaranty Corp. have filed objections to the reorganization plan; Prime Tanning-Hartland had operations in both Maine and Missouri) say the move is unprecedented and threatens a precedent where self-insured reserve accounts may be fodder for future liquidations.

Apparently, according to the International Association of Industrial Accident Boards and Commissions (IAIABC), there is much more in the reserve account than the face value of the outstanding claims.

The liquidation plan proposes that the bankruptcy court estimate the total amount of Prime's present and future workers' compensation liabilities and then release any amount of security determined to be in excess of this estimate to Prime for payment to its creditors.

Objectors to the plan have some valid concern.

As we know because of our connection to the industry, it is very difficult to estimate the future liability of long tail claims, in particular those with outstanding future medical for catastrophic injuries.

Greg Krohm, a consultant for and former executive director of the IAIABC, pointed out that if the court's estimate under the proposed plan is too low, injured workers will be "left holding the bag." IAIABC's report notes, "adverse surprises are common in workers' compensation," since claims are "exposed to substantial swings in cost due to medical treatments, costs of care, and claimant life expectancies…"

I think worse, however, is that if this court action is allowed to proceed the availability of bonds to secure such reserves will either become uneconomical or unavailable.

Surety bonds are absolutely necessary for smooth insurance financial transactions in the self-insured industry. Bond-makers will not look at the self-insured risk as acceptable if there is the threat that, should an employer file bankruptcy, its surety bonds will be looked upon as the first line of guarantee for injured worker claims.

What's more - this is a federal attack on the sole province of state jurisdiction.

Prime's lead attorney, Robert J. Keach of Bernstein, Shur, Sawyer & Nelson in Maine, dismisses the alarms and told WorkCompCentral that all claims "will be fully adjudicated and liquidated at the state level," and the bankruptcy court is being asked to "set aside enough money in excess of any conceivable amount to pay those claims."

Keach related that Prime was willing to "take the claims at face-value," and have the court base its estimate on the amounts the injured workers and their attorneys have demanded. "One would assume they erred on the high side," he said.

We have all seen civil attorneys flounder in workers' compensation proceedings to the point of malpractice. I have no reason to believe that a bankruptcy court judge or trustee would fare any better.

The court in this case is tinkering with dangerous precedent.

NY Trusts Go to US Supreme Court

An interesting legal battle going on in New York has escalated to the United States Supreme Court and has implications beyond workers' compensation if the court decides to grant a hearing.

Chairmen of 12 former self-insurance trusts managed by New York administrator First Cardinal filed a petition for writ of certiorari asking the Supreme Court to intervene in a three-year battle over assessments levied by the State Workers' Compensation Board (SWCB) to pay off claims left by a string of trust failures dating back to 2006.

The trusts argue that SWCB had no legal authority to assess healthy trusts – those considered fully funded under New York law – for the failure of 17 other trusts declared insolvent and taken over by the board in the past five years.

The so-called "First Cardinal" trusts won summary judgment from the New York Supreme Court, the state's trial court, in May 2010.

The court ruled that assessing healthy trusts for the liabilities of failed ones constituted an improper taking of the rights of trust members to "reasonable, investment-based expectations" under the Fifth Amendment to the U.S. Constitution.

The trial court's ruling was overturned by a New York appeals court on April 21, 2011. The Appellate Division of the Third Judicial Department ruled that the board's assessments were designed to promote the common good and didn't "rise to the level of a taking."

The New York Court of Appeals -- the state's highest court -- declined to hear the case in September. In a two-paragraph slip opinion, the court said it found no constitutional issues that would merit a hearing.

The First Cardinal trusts contend that their combined board assessments swelled from $155,000 in 2007 to $12 million in 2008, after then SWCB Chairman Zachary Weiss invoked a section of New York law allowing him to impose emergency assessments to pay workers' claims.

To avoid further assessments, the twelve trusts voluntarily dissolved, effective Jan. 1, 2009. They contend they were assessed more than $100 million to pay for failed trusts and are facing another $33 million in exit penalties.

A quick search of "workers' compensation" in the Cornell University Law Library web site did not produce too many results, as one might expect, the last being in 2006, HOWARD DELIVERY SERVICE, INC., et al., PETITIONERS v. ZURICH AMERICAN INSURANCE CO.

The Howard case involved a carrier seeking priority status for unpaid premiums in a bankruptcy proceeding of its insured.

The court held that a carriers’ claims for unpaid workers’ compensation premiums owed by an employer fall outside the priority allowed by §507(a)(5) reasoning that such premiums are more appropriately bracketed with liability insurance premiums for, e.g., motor vehicle, fire, or theft insurance, than with contributions made for fringe benefits that complete a pay package, e.g., pension plans and group health, life, and disability insurance:

"In sum, we find it far from clear that an employer’s liability to provide workers’ compensation coverage fits the §507(a)(5) category 'contributions to an employee benefit plan … arising from services rendered.' Weighing against such categorization, workers’ compensation does not compensate employees for work performed, but instead, for on-the-job injuries incurred; workers’ compensation regimes substitute not for wage payments, but for tort liability."

The First Cardinal petitioners argue that New York's group-trust crisis is part of a bigger liability problem facing multi-employer pension systems and health insurance plans across the U.S.

"The court should grant review in this case to provide sorely needed guidance to the lower courts as they deal with the inevitable flood of litigation to follow," the petition contends. "The crisis in New York’s self-insurance market is a microcosm of a broader nationwide crisis in unfunded pension and health-care liabilities."

It seems to me that the US Supreme Court has made its view pretty clear with the Howard case - workers' compensation is unlike pensions in that it is not a wage payment. Equating a state requirement of joint and several liability, to which the trust members agreed going into the arrangement, to a pension or health-care liability, which are employee contract obligations, doesn't seem to hold up to legal analysis.

If the US Supreme Court does take up the challenge it could be a game changer. workers compensation, work comp, injured worker