Request,Application: WARWICK AMUSEMENTS CORPORATION, ET AL VS. APPLIED UNDERWRITERS, INC., A NEBRASKA CORPORATION ET AL

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                                Nicholas P, Roxborough, Esq. (SBN 113540)

Joseph C. Gjonola, Esq. (SBN 241955)

Ryan R. Salsig, Esq. (SBN 250830)

Jaclyn D. Grossman (SBN 234992)

ROXBOROUGH, POMERANCE, NYE & ADREANI, LLP
5820 Canoga Avenue, Suite 250

Woodland Hills, California 91367

Telephone: (818) 992-9999 | Facsimile: (818) 992-9991

Larry J. Lichtenegger, Esq. (SBN 48206)

THE LICHTENEGGER LAW OFFICE

3850 Rio Road, #58

Carmel, California 93923

Telephone: (831) 626-2801 | Facsimile: (831) 886-1639

Attorneys for Plaintiffs

ELECTRONICALLY
FILED

Superior Court of California,
‘County of San Francisco

07/28/2016
Clerk of the Court

BY-GARY FELICIANO
Deputy Clerk

SUPERIOR COURT OF THE STATE OF CALIFORNIA

COUNTY OF SAN FRANCISCO

WARWICK AMUSEMENTS Case No. CGC-16-551614

CORPORATION, a Delaware corporation;
WARWICK CALIFORNIA CORPORATION,

a California corporation; WARWICK REQUEST FOR JUDICIAL NOTICE

DENVER CORPORATION, a Delaware
corporation, WSF BEVERAGE
CORPORATION, a California corporation;
WARWICK MELROSE DALLAS

CORPORATION, a Delaware corporation; Date:

SILVER AUTUMN HOTEL (N.Y.) Time:

CORPORATION, LTD., a Delaware Department:

corporation, Reservation:
Plaintiffs,

v.

APPLIED UNDERWRITERS, INC., a
Nebraska corporation; APPLIED
UNDERWRITERS CAPTIVE

RISK ASSURANCE COMPANY, INC., an
Towa corporation; CALIFORNIA
INSURANCE COMPANY, a California
corporation, CONTINENTAL INDEMNITY
COMPANY, an Iowa corporation; APPLIED
RISK SERVICES, INC., a New York
corporation; WILLIS OF NEW YORK, INC.,
a New York corporation; and DOES 1 through
50, inclusive,

Defendants,

August 18, 2016
9:30 a.m.

302
06270727-18

REQUEST FOR JUDICIAL NOTICEPlaintiffs, through their attorneys of record, request that the Court take judicial notice
pursuant to Evidence Code sections 452(c) of the following:

1. The precedential Decision and Order of the Insurance Commissioner, Dated June
20, 2016, Before the Insurance Commissioner of the State of California, In the Matter of the
Appeal of: Shasta Linen Supply, Inc. from the decision of California Insurance Company. A true
and correct copy is attached hereto as Exhibit “A.”

2. “Notice of Hearing and Order to Cease and Desist from Issuance of Renewal of
Workers’ Compensation Insurance Policies and Collateral/Ancillary Agreements in Violation of
Insurance Code Sections 11658 and 11735 and California Code of Regulations, Title 10,
Sections 2251 and 2268; Notice of Intent to Seek Recovery of Costs,” Dated June 28, 2016, and
filed by the California Department of Insurance, Legal Division, Before the Insurance
Commissioner of the State of California, In the Matter of the Certificates of Authority of
California Insurance Company and Applied Underwriters Captive Risk Assurance Company,

Inc. A true and correct copy is attached hereto as Exhibit “B.”

DATED: July 28, 2016 ROXBORQUGH, POMERANCE, NYE & ADREANI, LLP

JACL D. GROSSMAN
and LARRY J, LICHTENEGGER
Attorneys for Plaintiffs

2

REQUEST FOR JUDICIAL NOTICEExhibit “A”BEFORE THE INSURANCE COMMISSIONER

OF THE STATE OF CALIFORNIA
In the Matter of the Appeal of: File AHB-WCA-14-31
SHASTA LINEN SUPPLY, INC.
Appellant,

From the Decision of the

CALIFORNIA INSURANCE COMPANY,

Respondent.

a ; DECISION & ORDER
I. Introduction

Shasta Linen Supply, Inc. (Shasta Linen) appeals California Insurance Company’s (CIC)
decision rejecting Shasta Linen’s claims that CIC failed to adhere to its rate filings and sold an
unfiled and unapproved insurance program titled EquityComp.

For the reasons set forth below, the Insurance Commissioner of the State of California
(‘Insurance Commissioner”) finds that CIC’s EquityComp program and the accompanying
Reinsurance Participation Agreement (RPA) constitute a misapplication of the filed rates of CIC
in violation of California Insurance Code section 11737. Further, the Commissioner finds that
CIC’s EquityComp program and the accompanying RPA constitute a collateral agreement
pursuant to California Code of Regulations, title 10, section 2268, and CIC’s failure to file and
secure approval of EquityComp and the RPA, in violation of Insurance Code section 11658,

renders the RPA void as a matter of law.II, Statement of Issues

1, Does CIC’s EquityComp program constitute a misapplication of the filed rates of CIC
in violation of California Insurance Code section 11737?

2. Does CIC’s EquityComp program’s RPA constitute a collateral agreement modifying
the rates and obligations of either the insured or insurer, and is it void as a matter of law since the
RPA was not filed with the Workers’ Compensation Insurance Rating Bureau and the
Department of Insurance before its use in the State of California, pursuant to Insurance Code
section 11658 and California Code of Regulations, title 10, sections 2268 and 2218?

If. Contentions of the Parties

Shasta Linen 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
Workers’ Compensation Insurance Rating Bureau (WCIRB)! and the Insurance Commissioner,
Specifically, Shasta Linen asserts the RPA constitutes a collateral agreement pursuant to
California Code of Regulations, title 10, sections 2268 and 2218, and as such must be filed and
approved by the Insurance Commissioner prior to use.” Shasta Linen argues CIC’s failure to file
the RPA violates Insurance Code sections 11658 and 11735, as well as Part 2, Section V of the
Miscellaneous Regulations for the Recording and Reporting of Data.’ Shasta Linen also
contends CIC violated Insurance Code section 381 by failing to specify, in Shasta Linen’s

workers’ compensation insurance policy, the basis and rates upon which the final premium is to

‘ The WCIRB is a rating organization licensed by the Insurance Commissioner under Insurance Code sections
11750 et seq, to assist the Commissioner in the development and administration of workers’ compensation insurance
classification and rating systems. The WCIRB serves as the Commissioner’s designated statistical agent for the
purpose of gathering and compiling experience data developed under California’s workers’ compensation and
employers’ liability insurance policies. (Ins. Code § 11751.5).

? Appellant’s Post-hearing Opening Brief, 4°7-17.

? Provisions of the Miscellaneous Regulations for the Recording and Reporting Data are part of the Insurance
Commissioner's Regulations, codified in California Code of Regulations, title 10, section 2354.be determined and paid.‘ Lastly, Shasta Linen asserts CIC violated Insurance Code section
11658.5, by failing to inform Shasta Linen of its right to negotiate the policy’s dispute resolution
provisions and by failing to secure written receipt of such disclosure prior to issuance of the
policy.’ Shasta Linen urges the Commissioner to bar CIC from enforcing the terms of
EquityComp and the RPA, including the mandatory arbitration provisions. Shasta Linen also
requests the Commissioner order CIC to return all monies contributed to Shasta Linen’s cell
account, except for those used to settle workers’ compensation claims, as well as all fees
collected and disbursed to Applied Underwriters, Inc, and Applied Underwriters Captive Risk
Assurance Company.®

CIC initially asserts the California Department of Insurance (CDI) lacks jurisdiction over
Shasta Linen’s appeal. Specifically, CIC argues: (1) appeals filed under Insurance Code section
11737, subdivision (f) may only deterntine “whether CIC has properly applied its [rate] filings to
determine how much premium to charge” and may not address the potential illegality of the rate
filing;” (2) the RPA is between AUCRA and Shasta Linen, and relief in this forum is not
possible;® (3) whether the RPA is an unlawful collateral agreement in violation of the Insurance
Commissioner’s Regulations is beyond the scope of the CDI’s jurisdiction;? and (4) only the
Insurance Commissioner may initiate a hearing to disapprove an unfiled rate.'°

‘With regard to the merits of Shasta Linen’s claims, CIC argues the RPA is not a collateral
agreement because it does not change the cost of insurance under the CIC policy, does not

impact insurance rates, and does not modify the terms of the CIC insurance policy issued to

* Appellant's Post-hearing Opening Brief, 5:7-13.
* Appellant's Post-hearing Opening Brief, 5:
® Appeliant’s Post-hearing Opening Brief, 6
7 , Respondent’ 's Post-hearing Opening Brief, 21:13-

{ Respondent’ 8 Post-hearing Opening Brief, 22:8-18.

° Respondent’s Post-hearing Opening Brief, 23
‘© Respondent’s Post-learing Opening Brief, 23:21~ 24:6,Shasta Linen." Lastly, with regard to potential remedies, CIC contends the CDI may not void
Shasta Linen’s RPA. Instead, CIC argues that if the Commissioner finds that the RPA violates
the Insurance Code or its applicable Regulations, the Commissioner may issue only a prospective
order to cease use of the RPA, and is not permitted to void Shasta Linen’s RPA.”

IV. Procedural History

On August 29, 2014, Shasta Linen filed an appeal with the Department of Insurance,
Administrative Hearing Bureau (AHB) in response to CIC’s July 31, 2014 decision rejecting
Shasta Linen’s Complaint and Request for Action, On September 5, 2014, the Chief
Administrative Law Judge issued an Appeal Inception Notice and assigned the matter to
Administrative Law Judge (ALJ) Kristin L. Rosi.

On October 31, 2014, the ALJ conducted a telephonic status conference with all parties,

_ During the conference, the parties agreed to a discovery timetable and to the statement of the
issue as identified above. The ALJ set the matter for an evidentiary hearing commencing March
9, 2015.

At the hearing, Craig E. Farmer, Esq., of Farmer, Smith & Lane, LLP, appeared on behalf
of Shasta Linen. Spencer Y. Kook, Esq. and Richard De La Mora, Esq., of Hinshaw &
Culbertson, LLP, appeared on behalf of CIC, The parties submitted documentary evidence and
presented witnesses. The evidentiary record includes witness testimony and all exhibits admitted
into evidence as identified in the parties’ Exhibit Lists.

On March 17, 2015, CIC’s General Counsel and co-author of the EquityComp program,
Jeffrey Silver, invoked the attorney-client privilege and refused to answer any questions

regarding EquityComp’s creation or the RPA’s terms. In order to create a more complete

'' Respondent's Post-heating Opening Brief, 26:1-28:6; 30:15-3 1:7; 37:19-4 1:4.
” Respondent's Post-hearing Opening Brief, 41:6-42:3.evidentiary record, on March 23, 2015, the ALJ convened a conference to discuss the
presentation of an additional witness. During this conference, CIC agreed to present a witness
able to testify about the EquityComp program and the RPA. In response to a joint request by the
parties, on March 26, 2015, the ALJ issued an Order continuing the evidentiary hearing to May
21 and May 22, 2015.

On April 30, 2015, the ALJ ordered additional evidence from both parties. Specifically,
the ALI ordered copies of CIC’s Annual Statements, the total number of EquityComp
participants, the total number of EquityComp participants who received refunds at the conclusion
of the program, a list of complaints and grievances filed regarding the program, the percentage of
EquityComp participants with open claims at the conclusion of the program, and an EquityComp
loss ratio sensitivity analysis for 2013 and 2014. The ALJ also ordered copies of Shasta Linen’s
corporate tax returns, the total amoulits paid in workers’ compensation premium and losses for
policy years 2013 and 2014, and the most recent experience rating modification.

On May 8, 2015, CIC filed an Objection and Request for a Continuance in response to
the ALJ’s Order for Additional Evidence. CIC objected to the production of additional evidence
arguing: (1) the ALJ lacks authority and jurisdiction to issue such an order; (2) the information is
irrelevant; and (3) the information is confidential to third-party participants,

On May 18, 2015, the ALJ overruled CIC’s objections and ordered CIC to comply with
the April 30, 2015 Order. On May 19, 2015, CIC informed the ALJ it would not comply with the
ALJ’s Additional Evidence Order. At the hearing on May 21, 2015, CIC called Patrick Watson,
to testify in response to the ALJ’s request for a person most knowledgeable regarding
EquityComp and the RPA.

On July 24, 2015, the parties filed concurrent opening briefs and on August 10, 2015, theparties filed their concurrent reply briefs.

On August 11, 2015, CIC requested the ALJ take official notice of the Summary Denial
issued in Sportsmobile West, Inc., AHB-WCA-06-7 and the Notice of Hearing and Order to
Show Cause filed by the CDI against Zurich American Insurance Company of Illinois on
February 27, 2012. On that same date, CIC also requested permission to file a supplemental
declaration by Ellen Gardiner, pursuant to California Code of Regulations, title 10, section
2509.66. On August 24, 2015, Shasta Linen filed objections to CIC’s additional evidence and
request for official notice, On September 16, 2015, the ALJ rejected CIC’s request to file
additional evidence. On that same date, the ALJ granted, in part, and rejected, in part, various
requests for official notice and ordered the record closed.

On October 29, 2015, the ALJ reopened the record to cost the parties’ executed
Stipulated Protective Order. By that same Order, the ALJ reclosed the record,

On November 20, 2015, the ALI:submitted her Proposed Decision and Order, which was
adopted by Order of the Commissioner on January 21, 2016.

CIC filed its Petition of Reconsideration dated February 5, 2016, and Shasta Linen also
filed a Petition for Reconsideration dated February 17, 2016.

On March 22, 2016, the Insurance Commissioner issued an Order Granting
Reconsideration and Notice of Non-Adoption of Proposed Decision.

Vv. Findings of Fact
A review of the record found, by a preponderance ‘of evidence, the following material

facts, that are adopted. herein,'?

'? References to the transcript of the evidentiary hearing are “Tr.” followed by the page number(s) and, where line
references are used, a “:” followed by the line number(s). Thus, a reference to Tr. 35:14-18 is to page 35, lines 14-18
of the transcript. Exhibits are referred to by the numbers assigned to them in the parties’ Exhibit Lists,A Shasta Linen
L Company History

Shasta Linen is a privately-held family-owned California corporation in the linen rental
business.'* Founded in 1948, Shasta Linen originally operated as a laundry and dry cleaning
service. In the 1950s, the company ceased operating as a laundry and dry cleaning service and
entered into the linen rental business. Shasta Linen’s customers include restaurants, hotels,
surgery centers and doctor’s offices.!

Shasta Linen employees pick up soiled linens and garments from their customers and
transport them back to Shasta’s Sacramento laundry facility. There, the linens are counted,
sorted, washed, dried and pressed, '® Shasta Linen employees then return the cleaned linens to
the customers. The laundry facility employs approximately 63 people who work five days a
week,'7

Prior to December 2014, Shasta Linen had two owners; Tom Hammer, President, and
Gordon Macauley, Vice-President. Mr. Hammer and Mr. Macauley each owned 50% of the
corporation. In December 2014, Mr. Hammer passed away and his 50% share was divided
between his daughter, Noel Richardson, the current President of Shasta Linen, and his surviving
spouse, Phyllis Hammer. Ms. Richardson received 20% of the corporate stock and Mrs,
Hammer received the remaining 30%.'*

2. 2009 Purchase of EquityComp Program

For decades, Shasta Linen employed Sacramento Valley Insurance Services (SVIS) as its

yr, 106:23-107:2,
5 Tr, 107:12-16.
Tr, 108:5-11.
Tp, 108:23-25.

8 Tr. 100:7-9.insurance broker.!? In each of these years, SVIS secured Shasta Linen’s workers’ compensation
insurance through a guaranteed cost policy. From 2002 through 2008, Shasta Linen’s experience
modification ranged from 66% to 80%, demonstrating that Shasta Linen had a more favorable
loss experience than other businesses in its industry.”

In 2009, Shasta Linen anticipated an increase in its experience modification factor due to
several earlier claims. In late 2009, Shasta Linen’s broker presented the EquityComp program as
an alternative to the traditional guaranteed cost policy and as a means to counter the effects of an
increase in experience modification. At that same time, the broker presented quotes from other
insurers offering guaranteed cost policies.”! The quotes were presented in descending cost order
with Zenith Insurance Company quoting an annual premium of $446,541 and Insurance
Company of the West (ICW) quoting an annual premium of $301,091. The broker placed
EquityComp on the line below ICW, with a note that stated “see attached.” Attached to the
rate quotes was a Program Proposal and a Rate Quote from Applied Underwriters’ (“AU”)
EquityComp program. The EquityComp rate quote indicated a minimum single-year premium
of $107,541 and a maximum premium of $3: 22,623.73 The broker did not present Shasta Linen

with a copy of the Reinsurance Participation Agreement nor had the broker read the RPA at the

'9 SVIS was subsequently acquired by Pan American Underwriters, a wholly-owned subsidiary of Ascension
Insurance Services. (Exh, 271-9).

?° Exh, 65. The WCIRB promulgates experience ratings for each qualified employer pursuant to the rules set forth in
the California Workers’ Compensation Experience Rating Plan (ERP); Experience rating utilizes a policyholder’s
past claims experience to forecast future losses by measuring the policyholder’s loss experience against the loss
experience of policyholders in the same classification to produce a prospective premium credit, debit or unity
modification. (Ins. Code § 11730, subd. (c)). The rules governing the reporting of loss data are found in the
California Workers’ Compensation Uniform Statistical Reporting Plan (USRP). Provisions of the ERP and USRP,
including the Standard Classification System, are part of the Insurance Commissioner’s regulations, codified at title
10, California Code of Regulations, section 2352.1.

2 Exh, 271-14; Exh 272-22,

22 Bxh, 272-22. The Commissioner notes for the record that the broker named Applied Underwriters as the insurance
carrier. The broker made no mention of CIC anywhere in his presentation,

® Exh, 201-3.time he presented the program.”*

After reviewing the premium and claim amount tables in AU’s marketing materials,
Shasta Linen agreed to enroll in the three-year EquityComp program.” In December 2012, the
final month of the three-year program, Shasta Linen received a monthly bill for $77,593.66.
By that time, Shasta Linen had already paid $934,466.60 in EquityComp costs over the three
years and its captive cell held approximately $200,000.” In January 2013, one month after the
program ended and the workers’ compensation insurance policy expired, Shasta Linen received a
bill for an additional $166,619.75." Shasta Linen has not paid the additional $244,213.31
arguing that such payments exceed the guaranteed cost policy’s quoted amount, were not fully
explained and are inconsistent with the guaranteed cost policy.2? CIC continues to compound
interest on these unpaid charges each month, In January 2014, CIC calculated Shasta Linen’s
final payment at $290,524.58.°°

B. CIC and Its Affiliated Entities

1. Organizational Structure

CIC California Insurance Company is a licensed property and casualty insurance
company, domiciled in California and licensed to transact business in 26 states. CIC is wholly-
owned by North American Casualty Company, a non-insurer, which is in turn wholly-owned by
Applied Underwriters, Inc. (AU), a Nebraska corporation.*’ AU is an indirect subsidiary of

Berkshire Hathaway Inc. AU‘is also the parent company for Applied Underwriters Captive Risk

* Bxh, 271-26. The broker had never enrolled a client in EquityComp prior to enrolling Shasta Linen,

25-The guaranteed cost policy had an effective date of January 1, 2010. Shasta Linen did not enroll in EquityComp
until January 5, 2010.

% Exh. 213-23.

71 Tr, 819:8-11; Tr. 232:3-7; Exh, 31-2.

8 Exh, 214-1.

® $77,593.66 + $166,619.75 = $244,213.31.

3 Bxh. 214-16.

3! Exh, 234-5; Tr. 1150:6-16.Assurance Company, BVI (AUCRA) and Applied Risk Services (ARS). The following flow

chart provides the organizational structure relevant to this proceeding:

enous

Gpeurentes
ene

AU is a financial service corporation that provides payroll processing services and
underwrites workers’ compensation insutance through its affiliated insurance companies to small
and medium-sized employers, AU manages all of CIC’s underwriting, investment,
administrative, actuarial and claim services through a Management Services Agreement,” AU
also administers the EquityComp program on behalf of CIC. All EquityComp documents
presented and signed by Shasta Linen bear the name and logo of Applied Underwriters, Inc.
EquityComp is a registered trademark of AU and all AU employees work on CIC issues.”

AUCRA is an insurance company organized under the law of the British Virgin Islands

and domiciled in lowa.** AUCRA’s sole purpose in the Berkshire Hathaway family is to serve

» Exh, 274-7.
8 Exh, 203-1; Tr, 706:23-707:4.
4 Tr. 620:2-3.

10as CIC’s reinsurance arm.°* It does not reinsure any other entities or perform any other
functions.

Applied Risk Services (ARS) is the billing agent for EquityComp and serves as CIC’s
service agent. Under an Agency Agreement, ARS receives premium fiom policyholders and
pays commissions to brokers on behalf of CIC. For this service, CIC reimburses ARS for the
paid commissions. ARS and CIC are also parties to a Claims Services Agreement wherein ARS
pays losses and loss adjustment expenses on CIC policies.?” CIC reimburses ARS for all losses
and allocated loss adjustment expenses incurred on CIC claims.

The Boards of Directors for CIC, AU, and AUCRA are identical in composition.?® Mr.
Silver, CIC’s and AU’s General Counsel, serves on each of these Boards, as well as on the Board
of ARS. Ms. Gardiner, AU’s Chief Actuary, is an officer of all the entities involved in this
litigation, namely, AU, CIC and AUCRA.

7 CIC is also a party to an intercompany pooling agreement” with its affiliated Berkshire
Hathaway carriers. In 2010, the pooling agreement included CIC and Continental National
Indemnity Company (CNI), with CIC assuming an 85% share and CNI assuming the remaining
15%.” In 2011, the pooling agreement expanded to include Illinois Insurance Company (IIC).
CIC remained the lead company with an 80% share, while CNI assumed 15% and IIC assumed
5%. In 2013, affiliate Pennsylvania Insurance (PIC) was added to the pooling arrangement. As

aresult, CIC’s share reduced to 75%.

% Tr, 1154:3-15,

6 Tr, 1154:17-23; Exh, 234-6.

37 Exh, 274-8,

%8 Tr, 1193:2-4; Tr, 863:1-3,

>? In pooling atrangements, entities share exposures to possible loss. Casualty Actuarial Society, Foundations of
Casualty Actuarial Science, (4"" ed, 2001), pp. 49-50.

“ CIC's 2010 Annual Statement, Management Discussion and Analysis. CIC’s Annual Statements are available on
the California Department of Insurance’s website. The Commissioner takes Official Notice of CIC’s Annual
Statements from 2008 through 2014,

i2. CIC’s Workers’ Compensation Policies

CIC offers workers’ compensation insurance through a guaranteed cost policy and a

profit-sharing program. Each program is relevant to the underlying issue and described below.
a. Guaranteed Cost Policy

A great majority of California employers receive workers’ compensation insurance
coverage through guaranteed cost policies.“! Under a guaranteed cost policy, the insured
company pays a fixed annual premium for the policy term, regardless of subsequent loss
experience, The fixed premium is the sum of the average losses and the basic fees. Average
losses take into account the base rate for each classification assigned to the policy and the
employer’s experience modification factor. The fees are the estimated costs of providing the
insurance; that is sales, underwriting, profit and other fixed costs. Thus, a company with average
losses of $500,000, may be char'ged $750,000 in premium; $500,000 to cover expected loss
payments and $250,000 in basic fees.

Every guaranteed cost policy must adhere to the Insurance Code and its applicable
Regulations, All rates charged in a guaranteed cost policy must be filed with the WCIRB and
approved by the Insurance Commissioner prior to use. In addition, every guaranteed cost policy
must contain statutorily-required dispute resolution and cancellation language.”

CIC’s guaranteed cost policies contain standard language approved by the Insurance
Commissioner. For example, each policy states CIC’s rates are filed with the Commissioner and
open to public inspection. CIC warrants that it adheres to a single uniform experience rating

plan and applies such experience rating to each policy.”* In addition, CIC’s guaranteed cost

“Tr, 310:4-6,
” Tn. Code § 11650 et seq.
* Bxh. 209-17.

12policies notify employers of the dispute resolution process provided under California Insurance
Code section 11737, subdivision (f). CIC’s Policyholder Notice provides that:

If you are aggrieved by our decision adopting a change in a
classification assignment that results in increased premium, or by
the application of our rating. system to your workers' compensation
insurance, you may dispute these matters with us. If you are
dissatisfied with the outcome of the initial dispute with us, you
may send us a written Complaint and Request for Action as
outlined below.

You may send us a written Complaint and Request for Action
requesting that we reconsider a change in a classification .
assignment that results in an increased premium and/or requesting
that we review the manner in which our rating system has been
applied in connection with the insurance afforded or offered you.
Written Complaints and Requests for Action should be forwarded
to: California Insurance Company, P.O. Box 281900, San
Francisco, CA 94128-1900, Phone No. (877) 234-4450; Fax No.
(415) 508-0374.

Pursuant to Califdrnia Code of Regulations, title 10, section 2509.44, CIC must
acknowledge the complaint within 30 days and indicate whether the complaint will be reviewed.
If CIC agrees to review the complaint, it must issue a decision within 60 days of the
acknowledgment letter. An insured dissatisfied with CIC’s decision may appeal to the Insurance
Commissioner. The policy’s dispute resolution provision does not provide for binding
arbitration or any other alternative dispute methods.

CIC’s guaranteed cost policies also include a cancellation provision and a “Short Rate
Cancellation” Notice, as required by the Insurance Code.** Part 5, subsection E of the CIC
policy provides that following cancellation, the final premium will be determined as follows:

1. Lf we cancel, final premium will be calculated pro rata based on

the time the policy was in force. Final premium will not be less _
than the pro rata share of the minimum premium.

“ Bech. 208-15.
xh. 208-93; See also Ins. Code § 481, subd. (©).

132. If you cancel, the final premium will be more than pro rata; it

will be based on the time this policy was in force, and increased by

our short rate calculation table and procedure. Final premium will

not be less than the minimum premium."*
The Short Rate penalty is a percentage of the full-term premium based on the number of days of
coverage in the canceled policy.*” The Short Rate Calculation Table in CIC’s guaranteed cost
policies quotes subsection E and provides a formula for determining the early cancellation
penalty. For example, an employer who pays an annual premium of $300,000 and cancels its
policy after 100 days will owe $114,000; $82,192 in actual earned premium and $31,808 in
penalties.“* After expiration of the policy, an employer may change insurance carriers without
penalty,

CIC’s guaranteed cost policies also set a minimum and estimated annual premium based
on an employer’s payroll estimates, experience modification factor, and CIC’s rates per $100 of
payroll for each applicable classification. After estimated taxes and fees, the guaranteed cost
policies provide an, employer with an annual premium estimate. The final premium due is
calculated using actual payroll amounts assigned to a specific classification of the policy and the
employer’s experience modification factor. The final premium is not impacted by the actual

losses incurred during that same policy period.

b. The Guaranteed Cost Policies are the Sole Insurance
Agreements

The guaranteed cost policies issued by CIC in this matter all contain the same language
that the policies are the sole insuring agreements between CIC and Shasta Linen and go on to

state that, “The only agreements relating to this insurance are stated in this policy. The terms of

“° Exh, 208-87,
“7” The short-rate penalty discourages employers from switching insurers mid-policy year.
“8 Exh, 208-20 to 208-22,

14_ this policy may not be changed or waived except by endorsement issued by us to be part of this
policy”?
In addition, a standard form Policy Amendatory Endorsement—California is attached to
each of the policies and state, “It is further agreed that this policy, including all endorsements
forming a part thereof, constitutes the entire contract of insurance. No condition, provision,

agreement, or understanding not set forth in this policy or such endorsements shall affect such

contract or rights, duties, or privileges arising thereftom.”*” [Emphasis added.] No endorsement

is attached, endorsed, or included to the policies adding any provisions or changes relating to the
RPA,

Finally, the policies each state on page five, under Part Six—Conditions, C. Transfer of
Your Rights and Duties: “Your tights or duties under this policy many not be transferred
without our written consent.”

e EquityComp

In conjunction with AU, CIC offers a “profit-sharing” loss sensitive program titled
EquityComp. Loss sensitive programs are ones in which the premium for the policy year is
impacted by the actual cost of claims incurred during the policy year.’ By definition, loss
sensitive plans are “profit-sharing.”** Generally, carriers market loss sensitive programs
exclusively to large employers.® In fact, many jurisdictions restrict the sale of loss sensitive
programs to employers whose annual premiums exceed $500,000. Large employers are typically
better able to cope with loss and experience modification variations and are in a better position to

control claims costs. Also, given the sophistication of larger companies, these employers are

“ Exhibits 208, 209, and 210.

15better able to evaluate the cost effcctiveness of the types of insurance policies available. In
essence, large employers are more prudent shoppers and can evaluate whether their costs match
with an insurer’s quote.°> Loss sensitive programs are issued as endorsements to guaranteed cost
policies and require the Insurance Commissioner’s approval.°*

EquityComp’s profit-sharing plan is reflected in a Reinsurance Participation
Agreement.>” ‘Neither CIC nor its affiliated entities filed or sought approval for the RPA or the
EquityComp program.°* The EquityComp program, and its accompanying Reinsurance
Participation Agreement, is discussed in Section C, infra.

3. Financial Statements, Ratios and Market Share

CIC is primarily a workers’ compensation insurance carrier. Approximately 98 percent
of its book of business is written in California workers’ compensation.® EquityComp currently
generates 80 percent of CIC’s policy premium.” That percentage has steadily increased since
the program’s inception in 2008.

© In 2009, CIC’s net earned premium totaled $71,512,000 with incurred losses and loss
adjustment expenses (LAE) equaling $55,615,000." This resulted in a net loss ratio of

771.1% and a combined ratio of 109.7%.” Accordingly, CIC had a negative net income

of $4,419,116.9

Tr, 310:17-23.
Str 3114-11.
56 Tp, 875:2-4; An endorsement to an insurance policy “is an amendment to or modification of an existing policy of
insurance” that “aay alter or vary any term or condition of the policy” and that “may be attached to a policy at its
Heeption or added during the term of the policy.” Adams v. Explorer Ins. Co. (2003) 107 Cal.App.4" 438.

r. 621:2-16.

© Tr, 865:19-22. Mr. Silver's testimony contradicted that of Ms. Gardiner on this issue. The Commissioner credits
Ms. Gardiner’s testimony on this issue, as Ms. Gardiner serves as the chief underwriter for AU and CIC.

“' CIC's 2010 Annual Statement, Statement of Income.

© The net loss ratio is the sum of incurred losses and incurred loss adjustment expenses divided by earned premium.
‘These amounts are found on lines 1 through 3 of CIC’s Statement of Income.

® CIC's 2010 Annual Statement, Five-Year Historical Data.

16In 2010, CIC’S net earned premium increased to $87,444,676, while its incurred losses
and LAE dramatically decreased to $17,151,456. As a result of the significant decrease
in losses, CIC net loss ratio dropped to 19.6% and its combined ratio declined to 54%.
This resulted in net income of $28,516,390.

In 2011, CIC’s net earned premium rose 34 percent to $117,505,149 with incurred losses
and LAE’s of $34,725,831. That year, CIC’s net loss ratio equaled 29.5% and its
combined loss ratio equaled 55.7%.*° CIC’s net income for 2011 also increased to
$36,573,042.

In 2012, CIC saw a 16 percent eared premium increase with net earned premium
totaling $135,598,473, CIC’s losses and LAE equaled $17,116,000, for a net loss ratio of
12.6% and a combined ratio of 43.2%.5? CIC’s net income in 2012 equaled $47,582,838.
In 2013, CIC’s net earned premium increased another 37 percent to $186,034,034. CIC’s
losses and LAE totaled $59,854,816, for a net loss ratio of 32.1%. After underwriting
expenses, CIC combined ratio equaled'61 8%. CIC recorded net income of $48,928,910
for 2013.

In 2014, CIC’s net earned premium rose another 29 percent to $240,474,973. CIC’s
incurred losses and LAE’s for that year equaled $72,484,214, for a net loss ratio of
30.1%. CIC’s combined ratio for 2014 totaled 60% and CIC reported a net income of

$65,540,948.

CIC's 2010 Annual Statement, Statement of Income & Five-Year Historical Data.

$5 CIC’s 2011 Annual Statement, Managemont’s Discussion and Analysis, p. 4.

6 CIC's 2013 Annual Statement, Fivo-Year Historical Data.

® CIC's 2012 Annual Statement, Management’s Discussion and Analysis, p. 4.

® CIC’s 2013 Annual Statement, Management’s Discussion and Analysis (Amended), p. 5.
® CIC's 2014 Annual Statement, Management’s Discussion and Analysis, p. 4.

17In sum, CIC’s profits since EquityComp’s 2008 inception equal $227,713,912. The following

chart illustrates CIC’s increase in net earned premium and net income:

Fig. 1: CIC's Net Earned Premium and Income
(in millions)
300

250

200 >

150 — owe Net Eamed Premium
100 aaNet Income

50 eto

0 a

2009 2010 2011 | 2012 2013 2014

~50 +
i

In comparison, CIC’s total ¢ombined profit for the three years prior to EquityComp’s
2008 inception totaled $47,172,997."

From 2009 through 2014, CIC also posted significantly lower loss and combined ratios
than other comparable carriers. CIC’s calendar year ratios versus those of the industry as a

whole are shown below:”!

7 CIC’s 2010 Annual Statement, Five-Year Historical Data, p. 17.
7 WCIRB's Insurer Experience Report on December 31, 2014, released April 20, 2015, This Report is available on
the WCIRB’s website. The Commissioner takes Official Notice of the WCIRB’s Insurer Experience Report,

18Fig. 2: CIC's Net Loss Ratio v. Industry Aggregate
120.00%
100.00%
80.00%
60.00% &@ CIC's Net Loss Ratio
i Industry Aggregate Loss Ratio
40.00%
20.00% +
0.00% :

2009 «2010 2011-2012 2013. 2014

Fig. 3: CIC's Combined Ratio v. Industry Aggregate
140.00% .
120,00%
100,00%
80.00% CIC's Combined Ratio
60.00% Industry Aggregate Combined

Ratio
40.00%
20.00%
0.00% —_...
2009 2010 2011 «2012 «2013-2014

In fact, CIC recorded the lowest loss ratio among the top 30 workers’ compensation insurance

carriers in 2013, and the lowest loss ratio among the top 15 workers’ compensation carriers in

192012.”

From 2008 through 2014, CIC also saw its market share increase. In 2008, prior to the
inception of the EquityComp program, CIC ranked 37" in total written workers’ compensation
insurance premium with 0.867 percent of the market.” By 2010, CIC ranked 29" in total written
premium and its market share increased to 0.963%.” In 2013, CIC ranked 10" in total written
premium as its market share increased to 2.366%", and by 2014, CIC ranked 7" in total written
premium with a market share of 2.92%."

In 2006, the CDI conducted a financial examination of CIC’s management practices,
assets and liabilities from 2002 through 2006.”” The financial examination noted that CIC offers
an EquityComp program to medium-sized businesses.”* The 2006 examination also noted that
EquityComp is similar to an incutred loss retrospective rating plan.” The report does not
indicate CDI reviewed the RPA or any other EquityComp program documents. The CDI
conducted a follow-up financial examination for the period of January 1, 2007 through :
December 31, 2009. The 2009 financial examination also made a passing reference to CIC’s
EquityComp program, again noting the program is similar to a retrospective rating plan." In
2013, CDI issued yet another financial examination for CIC. The 2013 exam mentions the
EquityComp program and its accompanying “Profit Sharing Plan” sold through CIC’s affiliate,
7 2012 & 2013 California P & C Market Share Report, Workers’ Compensation Line. The Market Share Report is
published by the CDI and available on the CDI's website, The Commissioner takes Official Notice of these Reports.
© 2008 California P & C Market Share Report, Workers’ Compensation Line,

749010 California P & C Market Share Report, Workers’ Compensation Line.

75.9013 California P & C Market Share Report, Workers’ Compensation Line.

76 Ms, Gardiner testified CIC's market share totaled less than 1%, (Tr. 866:15-20.) This testimony lacks credibility
given the CDI’s published report. In addition, CIC failed to present any documentation contradicting the CDI’s
calculations,

” Exh, 233.

7 Ms. Gardiner testified the BquityComp program began in 2008. (Tr. 867:1-4). Ms. Gardiner’s testimony is
apparently inaceurate given the discussion of EquityComp in the 2006 report,

” Bxh. 233-11.

© Bxh. 234,
8 Bxh, 234-7.

20AUCRA.” The 2013 Exam does not explain the “Profit Sharing Plan’s” terms nor does the
report indicate CDI inspected the RPA. Lastly, in 2014, the CDI issued a Market Conduct
Report regarding CIC’s operating practices. The scope of the confidential examination included
a review of CIC’s rates, rating plan, forms and underwriting rules, as well as CIC’s marketing
materials and active complaints,** The Market Conduct Report makes only a passing reference
to EquityComp. There is no evidence CDI examiners reviewed the RPA or EquityComp
materials for statutory compliance, nor did either party call witnesses to discuss these
examinations.

Cc, The EquityComp Program

AU promotes EquityComp as a loss sensitive, profit-sharing plan appropriate for “middle
market” insureds. AU began marketing this product in 2008 and since that date, the number of
programs sold has increased exponentially each year. In California alone, AU writes
approximately 10 new EquityComp policies per month." As noted above, EquityComp
comprises approximately 80 percent of CIC’s policy premium.*°

CIC has not filed the terms or rates of the RPA or EquityComp with the WCIRB or the
Insurance Commissioner.

1, Trademark and Patent

On June 24, 2010, AU filed a United States Patent application fora Reinsurance .

Participation Plan.®° Authored by Mr. Silver, CIC’s Chief Executive Officer Steve Menzies and

three other AU employees, the application sought to patent the EquityComp/RPA concept sold to

® Exh, 274-9,

© Exh, 235.

Ste 1331:10-14,

® CIC refused to provide the total number of EquityComp participants for each year from 2008 through 2014
despite being ordered to do so on two separate occasions,

86 ALF Exh. 1; Tr. 1181:5-9.

21Shasta Linen, and other California employers.*” The federal government granted the RPA patent
on March 15, 2011. The “Reinsurance Participation Plan” patent application explains in detail
the motivation behind the program and the terms thereof.

Under the traditional guaranteed cost policy, there is frequently a mismatch between what
the insurance company feels is a fair premium and what the employer considers a fair premium.®*
This is in part because an insurer considers an employer’s average losses to be its expected
losses, whereas most employers consider the median losses to be their expected losses. This
dichotomy led to the development of linear retrospective rating plans.

Pricing a guaranteed cost policy is straightforward. Under a guaranteed cost policy, the
insured company pays a fixed premium regardless of its subsequent loss experience during the
policy term. The fixed premium is the sum of the expected average losses and the basic fees, A
linear retrospective rating plan varies the premium an employer will pay based on the employer’s

_actual losses during a coverage period. The minimum premium covers the basic fixed fees. The
premium then increases linearly with respect to actual losses until it reaches a maximum plateau.
The standard equation describing the relationship between premium and actual losses in linear
retrospective plans is:

Premium = Basic Fees + C*Actual Losses, where C is a constant
Loss Conversion Factor.

But only large companies with expected losses of over $500,000 can qualify for
retrospective rating plans in the United States, This rule is meant to protect small and mid-size
employers who are presumably less sophisticated insurance consumers and who have less of an
ability to predict their future losses.* In addition, until the advent of EquityComp and the RPA,
8? 1179:10-15.

* ALJ Exh. 1, col. 3, lines 38-44.
© Tr. 310:10-23.

22all retrospective ‘plans were linear retrospective rating plans. This was due in part “to
governmental and other regulatory requirements as well as computational difficulties inherent in
providing premium quotes for a broad range of companies.””°

With the invention of EquityComp and the RPA, AU altered this landscape by
introducing a “non-linear retrospective premium plan for medium sized companies.”®! The non-
linear retrospective premium function comprises an initial relatively steep portion, a breakpoint,
a subsequently shallow portion and a plateau. Like the linear retrospective premium plan, the
minimum premium covers the basic fixed fees and costs.” There is a breakpoint early in the
function and then a shallow increase in the curve until the premium plateaus. Because of the
early breakpoint in the function, the plateau portion, i.e. the maximum premium due, can be
significantly lower than the plateau on d'linear retrospective plan.”* AU achieves this result with
the initial steep curve which results in more premium collected at lower loss levels, where most
insurers will end up.”

AU acknowledges that one of the challenges of a “fundamentally new premium
structure” is that “the structure must be approved by the respective insurance departments
regulating the sale of insurance.” In addition, many states prohibit the sale of retrospective
plans to small and medium size companies. AU’s response to this regulatory challenge is “a
reinsurance based approach to providing non-linear retrospective plans to insureds that may not

have the option of such a plan directly.”

© ALJ Exh. 1, column 4, lines 47-55.
>! ALJ Exh. 1, column 4, lines 62-63,
» ALJ Exh. 1, column 5, lines 42-43,
® ALJ Exh. 1, column 5, lines 44-47,
® ALJ Exh, L, column 5, lines 47-49,
°5 ALJ Exh, 1, columm 6, lines 22-26,
** ALJ Exh. 1, column 6, lines 39-42.

23AU attempts to achieve this compliance by introducing a “reinsurance” company into the
mix. The so-called reinsurance company enters into a separate Participation Agreement with the
insured whereby a credit or debit is assessed on the insured as a function of the losses it
experiences. First, an admitted insurance company seeks approval from a state regulator “by

using an industry standard Guaranteed Cost policy and filing premium rate requests with the

97

insurance department.””’ The insurance department, already familiar with such guaranteed cost

policies, approves the rates. The insurance carrier then sells these policies, along with the
unregulated participation plan, to a targeted group of employers, in this case small to medium
sized companies,”® The participation plan requires the employer to fund a segregated cell from
which all the insured’s losses are paid, According to the Patent for the RPA, the result is the

following:

. The reinsurance company can now provide funds to implement a

_ hon-linéar retrospective rating plan as a “participation plan.” The
teinsurance company does this by entering into a separate
contractual arrangement with the insured. Ifthe insured has lower
than average losses in the next year, then the reinsurance company
can provide a premium reduction according to the participation
plan. If the insurance has higher than average losses in a given
year, then the reinsurance company will assess additional premium
accordingly. ‘The insured can now, in effect, have a retrospective
rating plan because of the arrangement among the insurance
carrier, the reinsurance company and the insured even though, in

fact, the insured has Guaranteed Cost insurance coverage with the

insurance carrier.

In essence, CIC sells employers a guaranteed cost workers’ compensation policy that is then
superseded by the terms of a participation plan. Premium owed under the guaranteed cost
policies is replaced by premium paid for EquityComp under the RPA. The participation plans

have a three-year term, in contrast to the one-year term of the guaranteed cost policies,

°7 ALJ Exh. 1, column 6, lines 53-56,
% ALJ Bxh, 1, column 6, lines 60-63.
° ALJ Exh. 1, column 7, lines 42-54 (emphasis added).

24Although titled a “Reinsurance Participation Agreement,” the RPA is not “reinsurance”
as defined by Insurance Code section 620, but instead a separate contract entered into as part of
the EquityComp program. Reinsurance is the process by which an insurance company buys
insurance on its own risks. Respondent stipulated that the RPA is not a reinsurance contract. !°

2. Sales and Marketing

AU employs approximately 40 salespersons dedicated solely to selling EquityComp
nationwide.'*'. Of those 40, four salespersons specifically service California brokers,!© Every
salesperson is a licensed insurance broker and all work out of AU’s home office in Omaha,
Nebraska,!% Sales professionals receive two and one-half weeks of EquityComp training.
Salespersons do not receive any follow-up EquityComp training.“ AU’s training department
performs all required training,!°*

As part of the sale and marketing of EquityComp, AU issues a five-page Program
Proposal and Rate Quotatién (Program Proposal) to each potential insured.!°° AU’s
underwriting staff generates the Program Proposals and forwards them to the Sales department
for dissemination.!" Potential participants do ‘not generally receive a copy of the RPA until they
have agreed in principle to the EquityComp terms. In fact, AU’s Sales division does not

108

disseminate the RPAs, requests for service or officer exclusion forms. "" AU’s New Business

109 Ty, 614:24-615:10.

'l-Te, 1271:20-21,

1 Tr, 1274:8-9.

Ty, 1276:1-17.

1 Tr, 1275:13-22; Tr. 1278:10-18.
*© Ty. 1277:2-17.

"6 Exh. 201.

1) Ty, 1337:12-21.

'8-Tr, 1299:8-17.

25department presents the RPA to potential participants on the day participants sign all
EquityComp documents.'?

The Program Proposal introduces potential participants to the “Profit Sharing Plan”
central to EquityComp. The Program Proposal notes the reinsurance plan is separate from the
guaranteed cost plan and that an insured’s “risk retention is created by your participation in, and
cessation of allocated premiums and losses to our facultative reinsurance facility, Applied
Underwriters Captive Risk Assurance Company.” The Program Proposal further states that the
profit sharing plan “is not a filed retrospective rating plan or a dividend plan” and that a
minimum three-year commitment is required, Taking into account a patticipant’s estimated
payroll, AU provides the participant with a projected one-year and three-year minimum premium.
and maximum premium. The Program Proposal also notes that AU determines the final net cost
of the program using the participant’s ultimate claims costs, along with the factors and tables set
forth in the RPA.!® Those “factors and tables” are not provided within the Proposal. Instead,
AU informs participants they must maintain capital deposits in their cell accounts equal to: (1)
the estimated annual loss pick containment amount multiplied by 10% during the first year, 10%
during the second year, or 10% thereafter; and (2) outstanding reserves limited so not to exceed
the maximum permissible cost. AU also informs participants that loss development factors,
outlined in the RPA, will be applied to all claims to estimate their ultimate cost.

Under EquityComp, an employer is charged rates per $100 of compensable payroll.!!!
These rates do not match those provided in the guaranteed cost policy sold to the employer.!!? A

participant’s “loss pick containment rate” (per $100 of payroll) is multiplied by a “pay-in factor”

1 Ty, 1297:13-19.
NO Beh 201-3,
"1 Bxh, 201-4,
12-Tp, 1299:13-17.

26based on the pa