Applied Underwriters’ EquityComp Program under Fire in California
Jing Liu

Applied Underwriters’ EquityComp Program under Fire in California

Jing Liu July 12, 2016 Posted in: Blog Posts, Workers’ Compensation
On June 20, 2016, California Insurance Commissioner Dave Jones announced what he called a “precedential decision” in a major workers compensation insurance case between a small employer, Shasta Linen Supplier, and a Berkshire Hathaway company, California Insurance Company (CIC). With this decision, he condemns the way CIC has been doing business with its EquityComp program along with another Berkshire Hathaway company, Applied Underwriters (AU), in California, and effectively declares the EquityComp program void and unenforceable.

Background on CIC and Applied Underwriters
CIC is a licensed property and casualty insurance company domiciled in California. The majority of its book of business consists of California workers compensation. AU, an indirect subsidiary of Berkshire Hathaway Inc, is a financial service corporation that provides payroll processing services and underwrites WC insurance through its affiliated insurance companies to small and medium-sized employers. It is also the parent company for Applied Underwriters Captive Risk Assurance Company, BVI (AUCRA). This flow chart highlights the organizational relationship between the various companies.

AUCRA is an insurance company organized under British Virgin Islands law. According to CDI documents, AUCRA’s sole purpose in the Berkshire Hathaway family is to serve as CIC’s reinsurance arm and it does not reinsure any additional entities. CIC, AU and AUCRA all share the same Board of Directors.

Background on EquityComp
EquityComp is a multi-year profit-sharing loss sensitive program marketed by AU and offered through CIC. In order to enter into this program, employers have to buy a guaranteed cost workers comp policy from CIC. 

In June of 2010, AU filed a United States Patent application for a “Reinsurance Participation Plan” (RPA). The patent was subsequently granted in March of 2011. The patent describes the “invention” of EquityComp. Many states only allow loss sensitive programs to be sold to large employers because of the general belief that larger employers are more likely to have the sophistication needed to evaluate the cost effectiveness of these types of insurance policies. Through EquityComp, AU attempts to provide a mechanism for small and medium-sized employer to gain access to a loss sensitive rating scheme by creating a “reinsurance-based approach to providing non-linear retrospective plans to insureds that may not have the option of such a plan directly.”

To implement this multi-year profit-sharing loss sensitive program, AU introduced a company called AUCRA to the mix. When an employer wished to participate in the EquityComp program, CIC would issue an annual guaranteed cost workers comp policy to the insured, while AUCRA would enter into a separate 3-year RPA with the insured and establish a segregated cell for the insured under AUCRA. The cell would be funded by the premium ceded by CIC on the risk, as well as capital funding provided by the employer. All the insured’s losses would be paid from the cell. The mechanical details of the “profit-sharing plan” are described in the RPA document. Based on the patent documents, if the insured had lower-than-average losses in the next year, then the reinsurance company could provide a premium reduction according to the participation plan. If the insured had higher-than-average losses in a given year, then the reinsurance company would assess additional premium accordingly.

Shasta Linen vs. AU and CIC
Shasta Linen, a privately-held, family-owned California Corporation linen rental business, entered into a three-year EquityComp program through CIC. Shasta Linen contends that after 3 years, it paid approximately $934K of EquityComp cost. One month after the termination of the program, it received an additional bill from AU for approximately $220K. Shasta took action against CIC and AU, as it felt that the total amount of premium they paid was higher than what they would have paid under the guaranteed cost policy, and significantly higher than their total losses during the three-year period. It also contends that, despite multiple request, CIC/AU was unable to provide them with detailed documentation supporting the amount of premium they were charged.

The legal question in dispute is whether or not the RPA that Shasta Linen signed to take part in AU’s EquityComp program is an unfiled WC rate plan or a collateral agreement, and, therefore, illegal under California insurance regulations.

Shasta contends CIC violated numerous Insurance Code provisions, as well as the California Code of Regulations, by failing to file the EquityComp program and the RPA with the WCIRB and the Insurance Commissioner. 

CIC and AU argued that the reinsurance participation agreement1:

  • is not a collateral agreement since it does not modify CIC’s indemnity obligation
  • does not alter the rates charged to Shasta Linen
  • does not modify any other terms of the guaranteed cost policy

The Commissioner rejected all three of these arguments2:

  1. The Commissioner insists relevant statute and case law support a much broader interpretation of collateral agreement. For example, Section 11658 states that all policies, as well as endorsements to an insurance policy, must be approved prior to use. An endorsement has been defined in prior case law to be an amendment or modification of existing policy that alters or varies any terms or condition of the policy. The Commissioner believes this finding is also supported by other cases, such as American Zurich Insurance Co. vs. Country Villa Serv. Corp.

  2. The Commissioner believes the RPA modifies rates charged by the guaranteed cost policy. He cites testimony by one of the sales managers for EquityComp, who stated that the terms of EquityComp and the RPA supplant those of the guaranteed cost policy. In fact, the guaranteed cost policy terms are irrelevant in determining the premium and fees under the RPA. The case document also shows the difference in rates quoted in the guarantee cost policy vs. those in the RPA agreement.

  3. The Commissioner pointed out that, in addition to modifying the rates, the RPA also altered other provisions to the guaranteed cost policy, such as choice of law, dispute resolution requirements and early cancellation terms.

Furthermore, the Commissioner cites statements made in AU’s own patent application, which says the RPA would create a “non-linear, retrospective rating plan.” Since all loss sensitive plans must be filed with the WCIRB, approved by the Insurance Commissioner and attached as endorsements to a guaranteed cost policy, failure to do so renders the plans unlawful.

In conclusion, the Commissioner writes3

  • Shasta Linen met its burden of proof in demonstrating that it is aggrieved by CIC’s misapplication of its filed rates as a result of an unfiled and unapproved collateral agreement that modified the terms and conditions of the guaranteed cost policy, in violation of Insurance Code Sections 11737 and 11658 and California Code of Regulations Title 10, Section 2268.

  • CIC’s EquityComp program’s Reinsurance Participation Agreement constitutes a collateral agreement modifying the rates and obligation of the insured and the insurer, and is void as matter of law since it was required to be filed with WCIRB and DOI before its use in CA.

  • Shasta Linen is only responsible for premium and costs associated with the three guaranteed cost policies issued between 2010 and 2012. 

What’s Next?
Even though the California Insurance Commissioner has made his ruling on the case and the EquityComp product, the full ramifications of this decision are still unclear. Based on case documents, 80% of CIC’s workers comp book of business is related to EquityComp. The Commissioner has ordered the DOI to take affirmative actions against AU and CIC that could include market conduct examinations, financial examinations, and potentially enforcement of actions. 

Despite these decisions, it appears that AU is going to compel arbitration which the RPA requires with various employers who have filed complaints. Their lawyers appear to be proceeding with these arbitrations as scheduled.

On June 29, 2016, Commissioner Jones issued a cease and desist order for the Equity Comp program. California is the third state to stop the sales of Applied Products, along with Vermont and Wisconsin. Furthermore, by declaring his decision “precedential,” Commissioner Jones allows his decision to control all future cases brought against AU. There are several other cases against AU currently pending, including a class action law suit.

One thing is certain: This story is far from over. Stay tuned for more as the saga continues.

Jing Liu is a Consulting Actuary with Pinnacle Actuarial Resources, Inc. in the San Francisco, California office. She has over 15 years of experience in the property/casualty insurance industry, in both actuarial and underwriting capacities. Her experience includes assessing reserve and funding adequacy for captives, managing a portfolio of reinsurance treaties as well as ratemaking and filings. Jing is a Fellow of the Casualty Actuarial Society and a Member of the American Academy of Actuaries.

  1. Case document File AHB-WCA-14-31
  2. Case document File AHB-WCA-14-31
  3. Case document File AHB-WCA-14-31
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