Berkshire’s Applied Underwriters Defends Workers’ Comp Products, Says Brokers Should Not Be at Risk

Legal and regulatory squabbles in New York, California and other states involving Berkshire Hathaway and its Applied Underwriter affiliates over particular workers’ compensation products should not have any negative effects on brokers who dealt with the products, according to a top Applied Underwriters executive.

Counsel for Berkshire’s Applied Underwriters is refuting a number of the allegations brought in lawsuits filed over the products and downplaying concerns over broker liability raised by an Insurance Journal article. Applied Underwriters is contending that brokers should not be at risk, the companies involved are properly licensed, loss reserves are adequate, and “loss sensitive” products like the ones Applied Underwriters offers are not unusual.

Applied Underwriters is seeking to reassure agents and insureds as multi-year loss-sensitive and profit sharing products it sells under the names EquityComp, Premier Exclusive and SolutionOne are coming under scrutiny due to lawsuits and regulatory actions in a number of states.

Under loss-sensitive products, the ultimate cost to insureds can vary depending upon the costs of claims.

Some plaintiffs who are now balking at their costs contend that the products by Applied Underwriters that include a reinsurance agreement have not been properly vetted by insurance regulators. Applied Underwriters says otherwise and is standing behind its products.

In California, Applied Underwriters has agreed to stop selling its EquityComp product after the state insurance commissioner determined it should have been but was never filed for approval and an insured, Shasta Linen, is suing Applied Underwriters.

The products are also the subject of a New York lawsuit filed by Breakaway Courier Corp. This suit calls the program a “reverse Ponzi scheme.”

Vermont and Wisconsin have halted sales of the products as they are currently structured.

The entities tied to Nebraska-based Berkshire Hathaway that are involved in both the New York and California cases include: Applied Group Insurance Holdings Inc. of Hawaii; Applied Underwriters Inc. (AU), a non-insurer in Nebraska; Applied Risk Services Inc., a general agency in Nebraska; and Applied Underwriters Captive Risk Assurance Company Inc. (AUCRA) in Iowa.

Loss-sensitive products offer insureds discounted workers’ compensation insurance along with the potential to share in any underwriting profits but if an insured’s losses are higher-than-average, the insured may be charged additional premium. Some loss-sensitive programs are built using self-retention amounts, or large and small deductibles, or dividends; Applied Underwriters structures its program around reinsurance.

According to Applied Underwriters, its product has three parts: a standard workers’ compensation policy; a separate reinsurance agreement with an Iowa captive acting as a reinsurer; and a separate Reinsurance Participation Agreement (RPA) between the Iowa captive and the insured. The insured thus is a participant in the reinsurance arrangement and receives an allocation of the reinsurance premium and losses. According to Applied Underwriters, the program keeps a separate underwriting account, known as a segregated cell, for each participant. The workers’ compensation carrier cedes a portion of the insured’s workers’ compensation policy premiums and losses to the captive reinsurer. Under the RPA, the insured agrees to capitalize the cell in exchange for a share of any underwriting profits should it have favorable claims experience.

That’s not how the New York plaintiff describes it. The Breakaway Courier complaint offers this view of the operation:

“[V]ictims are led to believe that their ‘capital’ is being paid into ‘protected cells’ which will eventually be returned to them. Instead, Berkshire Hathaway illegally siphons off premiums through an unlicensed, unregistered and undercollateralized Hawaiian entity, leaving New York employers and injured workers without the funds that New York State requires to be available to cover losses due to worker injuries.”

The crux of the disagreement appears to be whether the RPA itself changes the rates or terms of the insurance contract and, if it does, whether it should be state-approved. Plaintiffs say it does affect the insurance and should be approved; Applied says it does not and thus need not be approved.

Applied Underwriters’ patented Reinsurance Participation Agreement (RPA) is designed to give small and medium-sized businesses access to plans that have been available to large employers. Applied Underwriters has been very successful with its RPA products.

New York’s Breakaway Courier, however, claims in its suit that the terms of the complex RPA are “so obscure as to be unintelligible” and that it has been used to shift unlimited liability back onto Breakaway while the captive AUCRA retains the funds. Breakaway says it wound up paying substantially more than its indicated maximum premium and what was allowed by law. It is seeking $18 million in damages.

A recent story in Insurance Journal suggested brokers could face liability because insureds may balk at their premium assessments or the products may be considered investments.

Applied Underwriters refutes the scenario painted by Breakaway and disputes that the products are too risky for agents and brokers to sell.

“The Applied entities are the primary defendants in the current pending lawsuits,” said Jeffrey Silver, executive vice president at Applied Underwriters Inc., adding that brokers should not be at risk.

Insurance Journal’s story included a quote from an unnamed source saying the affiliates were “trying to throw brokers under the bus.”

Applied Underwriters says that’s not true.

“We do business with brokers,” Silver said. “We respect brokers and we are not ever going to throw brokers under the bus as somebody claims we do.”

Silver also said these products are legal for brokers to sell and are not uncommon, as is implied by the New York lawsuit.

“That is a very, very common product sold throughout the United States,” Silver said. “Loss-sensitive products are very, very common in the workers’ compensation field.”

Programs using cell captives are also common, he added.

“The notion that somehow what we’re selling is a bad product is misleading- it’s a relatively common product,” Silver said.

Silver addressed other issues cited in the complaints that AUCRA and Applied Underwriters are not rated by A.M. Best and that Applied Underwriters is not licensed to do business in New York.

Silver says those are not valid complaints.

“Applied Underwriters Inc. is not an insurance company,” he said, adding that means it wouldn’t need to be licensed in New York.

He said Continental Indemnity Co., the insurance company that actually provides the workers’ compensation coverage to New York employers, is licensed in New York and rated A+ by A.M. Best.

The New York lawsuit also alleges that Applied Underwriters is using an unlicensed insurance company to divert premiums to another unlicensed entity.

“That statement is unfounded,” Silver said. “The fact of the matter is that the insurance company issuing the workers’ compensation insurance policies in New York is Continental Indemnity Co., which is licensed in New York and retains exclusive responsibility to pay any and all workers’ compensation claims that occur under its policy.”

Silver said there have been claims made under Breakaway’s workers’ compensation policy, and all have been adjusted with one open claim currently reserved at $40,000.

Another allegation in the New York suit is that the affiliates are able to keep less in loss reserves than other carriers, giving them a competitive advantage – a statement Silver also said is unfounded.

“AUCRA has significant capital and surplus in excess of what is required by the Iowa Division of Insurance,” Silver said, referring to an audit of AUCRA by Iowa regulators. The Iowa Insurance Division performed a routine audit of AUCRA U.S. on Dec. 31, 2013 and found that the company was compliant with insurance laws in the state of Iowa.

Silver also said AUCRA’s reserves have been reviewed by the private services firm, Milliman, and found to be adequate.

Silver addressed one other issue raised in the New York suit. Citing an Iowa Division of Insurance audit, Breakaway Courier said that AUCRA BVI, the British Virgin Islands domiciled affiliate of AUCRA US, ceased to exist on Dec. 9, 2011 following its merger with AUCRA US.

Breakaway clams this is material because after its Premier Exclusive policies expired on June 30, 2012, it agreed to purchase a renewal option from Applied Underwriters Inc. for a product called SolutionOne. Breakaway subsequently signed a second RPA in July 2012. The second RPA document states that the agreement was made and entered into between Breakaway and AUCRA, “a company organized and existing under the laws of the British Virgin Islands.”

This led Breakaway to suspect that the second RPA was negotiated with a non-existent entity. However, according to Silver, AUCRA BVI merged with AUCRA US in 2011, meaning that AUCRA US assumed all liabilities and assets from AUCRA BVI following the merge.

“[The RPA] may have been issued before the merger actually happened,” Silver said in response to concerns about the document’s wording. He added that after the merger, AUCRA BVI was no longer considered a foreign entity, in response to another question as to why it isn’t listed on NAIC’s alien insurance company approved list.

The New York Department of Financial Services that regulates insurance told Insurance Journal it had no comment on this matter.

In the California case, Shasta Linen, which purchased an EquityComp policy from California Insurance Co. and AUCRA, objected to loss assessments it was billed for and questioned the legality of the policies before the state insurance department.

California Insurance Commissioner Dave Jones called out Applied Underwriters for not having filed the RPA for state approval, which he said is required because he determined that the RPA affects the workers’ compensation premiums rates and terms. Applied Underwriters agreed to stop selling EquityComp in that state but it is appealing Jones’ decision favoring Shasta Linen, arguing that Jones exceeded his authority and that the RPA should not be subject to rate and form approval because it does not provide any insurance coverage nor does it modify the obligations of either the workers’ compensation insurer or insured. Applied Underwriters says California regulators have reviewed its loss-sensitive programs with its RPA in the past and never found fault.

California Insurance Co. and AUCRA are also fighting a lawsuit filed by Shasta accusing them of unfair business practices and fraud. Applied Underwriters has said this suit is without merit.