Audit Hits Kentucky Cities’ Insurance Provider Over Spending, Conflicts

A state audit of a Kentucky municipal association — the second in as many months — has found problems with compensation, spending, conflicts of interest and procurement matters including in the operation of the organization’s insurance services.

State Auditor Crit Luallen said her agency’s examination of the Kentucky League of Cities (KLC) found a “staff-driven” organization with weak board oversight that resulted in executive staff receiving unprecedented salaries and exorbitant retirement bonuses that cost more than $500,000; more than $350,000 in excessive or questionable spending; and numerous conflicts of interest – including inappropriate relationships with KLC vendors.

Many of the abuses occurred with little or no board knowledge or understanding, the report said.

Among the allegations is that KLC executive staff did not inform the executive board of a harassment investigation that raised concerns involving KLC’s chief insurance services officer, who was said to have possibly “unethical business practices” and “explosive” outbursts. The independent report recommended KLC perform an independent audit of the finance and insurance department. That audit, however, never occurred.

The KLC audit was released just weeks after Luallen issued a critical report on the Kentucky Association of Counties (KACo). That report found a “self-serving” culture that resulted in more than $3 million in excessive or questionable spending over a three-year period.

Luallen’s office announced its plans to audit KLC and the Kentucky Association of Counties (KACo) in July after media reports raised questions about the spending and finances at both agencies.

Both KACo and KLC are non-profit associations funded primarily with public dollars that offer insurance services, training, lobbying and other services for member government entities. KLC members include 382 cities.

“Our findings clearly point out the need for the board to strengthen policies and procedures to ensure that it maximizes benefits back to its member cities,” Luallen said about the KLC audit, echoing her comments after the KACo audit.

Overall, the auditor’s exam makes 30 findings and details more than 140 recommendations to improve board oversight and management operations at KLC.

The findings have been referred to state and federal law enforcement agencies for further review, as well as to the Internal Revenue Service (IRS) and the Kentucky Departments of Revenue and Insurance.

KLC, which is currently searching for a new executive director, said it has already assigned task forces and taken some steps to address the issues raised by the audit but has more work to do.

“The auditor’s findings and opinions give us definitive points of clarity in areas integral to our organization and further inspire us to continuously improve our measurement systems,” said Michael D. Miller, mayor of the city of Jackson, who is current president of KLC. He said there has been some disagreement among KLC leaders over some steps that should be taken.

KLC’s operations include KLC Insurance Services (KLCIS), which operates self-insurance and/or third-party insurance operations, including the KLC Worker’s Compensation Trust and the KLC Unemployment Compensation Reimbursement Trust.

Another entity, KLC Insurance Agency, Inc. (KLCIA), sells health, life, and bonding insurance to municipalities and markets the insurance services offered by KLCIS. KLCIS pays a commission to KLCIA for member accounts marketed or serviced by KLCIA.

In fiscal year 2008, 87 percent of KLC revenue came from the administrative fees and commissions paid by the insurance and financial programs administered by KLC staff. The remaining revenue sources of membership dues, interest, and conference revenue, account for only 13 percent of KLC’s total revenue.

From fiscal year 1998 to fiscal year 2008, KLC’s revenues increased 155 percent from $4.3 million to $11 million, thanks to higher fees paid by KLCIS and its related insurance trust programs and to bigger commissions earned by the KLC insurance agency.

Among the concerns cited in the report is that the insurance programs of KLC have not been independent of KLC’s other member association activities, a matter that has also concerned the state’s insurance regulator. In July, the Kentucky Department of Insurance (KDOI) requested that KLC implement a distinct separation between the activities of KLC and KLC’s insurance programs. KDOI said this was needed to guard against illegal inducements in the purchase of insurance.

According to Luallen, KLC has begun to enforce a separation but further separation may be needed because, the audit said, the insurance program boards consist of several of the same members that serve as officers of the KLC executive board and there is an appearance that KLC’s executive director is also directing the insurance programs, as well as other membership services.

Salaries

The exam found executive staff salaries increased dramatically from 2002 through 2009. The executive directors’ salary jumped 95 percent – $170,248 in 2002 to $331,186 in 2009. The deputy executive director’s salary increased 80 percent – $141,753 to $255,258, while the chief insurance services officer’s salary increased 93 percent – $123,909 to $238,867.

The exam notes KLC has 19 positions with salaries that exceed $100,000 a year. The executive board was unaware of individual salaries and only approved the total amount for salaries as a line item in the overall KLC budget.

Retirement bonus

KLC staff also benefitted from a retirement bonus in the form of a forgivable loan as an incentive to “remain with KLC and to reward past loyalty and dedication.” A board committee set aside $400,000 for this bonus – the principal amount of which was to be forgiven over a five-year period.

The exam found that KLC’s actual total cash outlay for the five years of payments was $218,000 for the executive director. To date, the total cost of the bonus compensation program is in excess of $533,000.

Auditors also found that the total gross amount of the loan/bonus payments for the executive director, deputy executive director and the chief insurance services officer were not paid back or recaptured by KLC in cash.

Conflicts of Interest

The exam uncovered numerous conflicts of interest at KLC including:

• KLC spent $1.4 million for legal services with a law firm where the spouse of KLC’s executive director is a partner.
• KLC made payments of $14,413 to the wife of the chief insurance services officer who provided decorating services. The spouse was also paid $1,000 to travel to New York City to select artwork.
• Several family members of the chief insurance services officer either currently work or previously worked for vendors of KLC.

• A current KLC executive board member, who also serves as the chairperson for KLC’s Insurance Services (KLCIS), serves as a private independent insurance agent for insurance products sold by KLC.

The audit also lists numerous gifts and gratuities executive staff received from KLC’s vendors including:

• Housing and other expenses were paid annually for the chief insurance services officer, the administrator of product development, the general counsel and their spouses at a vendor president’s home in Bonaire, a small island in the Dutch Caribbean.

• The chief insurance services officer and his spouse accepted two trips to Naples, Florida from a reinsurance vendor.

• Lodging in Munich, Germany was provided to the deputy executive director and the chief insurance services officer and their spouses by a reinsurance vendor.