TOP 10 STORIES OF 2000

It’s been quite a year for the insurance industry, and when the editorial staff here at Insurance Journal got together to do some serious brainstorming, we had no trouble coming up with a slew of exciting topics-the trouble was narrowing it down to just 10.

Number one was without a doubt the Quackenbush drama, and close runners-up had to be the dire state of the California workers’ comp market, followed by the troubles at once dominant Reliance.

But not all the news is bad news: insurers won a decisive victory this year with the defeat of third-party, bad-faith legislation; and the market is widening with China’s imminent entrance into the WTO.

We hope you will enjoy these encapsulations of all the biggest news stories of 2000. Let us know if you think we got the ranking right or if we left one out-drop us an e-line at ijwest@insurancejournal.com. Happy New Year!

– Sky Barnhart Managing Editor

THE SCANDAL AND RESIGNATION OF CALIFORNIA’S
INSURANCE COMMISSIONER

By Stefani Mingo

Turn the calendar back nine months, and you’ll find the birth of the biggest scandal to hit the insurance industry in years. March 26, 2000, was the day the news broke that California Insurance Commissioner Chuck Quackenbush allegedly abused his authority by diverting insurer settlement money for his own political benefit.

Quackenbush, a Republican, is only the second elected insurance commissioner to serve in California. Prior to being sworn into office on Jan. 4, 1994, Insurance Journal met with the then 40-year-old Insurance Commissioner-elect in his Sacramento office. “All this industry wants from its commissioner is answers, and that’s what they’re going to get with me,” he told IJ during the interview.

Ironically, after five years and eight months of serving as California’s Insurance Commissioner, Quackenbush was forced to resign.

A shocking article in the Los Angeles Times marked the beginning of the end, alleging that Quackenbush collected political contributions from insurance companies, their lawyers and employees, transferring $100,000 of this money to his wife’s campaign accounts. The money was supposedly going to repay Chris Quackenbush for personal loans she made on her unsuccessful campaign against State Senator Deborah Ortiz (D-Sacramento) in the November 1998 election.

The L.A. Times report highlighted certain contributions made by a group of insurers in the wake of the Northridge earthquake to a special fund created by the Commissioner allegedly in lieu of paying fines for unfair claims practices. According to records filed at the Secretary of State’s office, in the last six months of 1999 the Commissioner collected $245,000 in political contributions. Insurance interests gave a total of $216,000.

On March 27, lawmakers demanded that Quackenbush appear at a hearing and produce confidential reports his office prepared on the handling of Northridge quake claims by six major insurance companies.

Records indicated that these insurers agreed to make donations to one or more nonprofit foundations as “settlement” of the CDI’s confidential market conduct investigations. Quackenbush established several private foundations for these contributions. A large portion of the proceedings went to the California Research and Assistance Fund (CRAF), which ran television public service spots starring the Commissioner.

Another Quackenbush-created foundation, the California Insurance Education Foundation, also came under scrutiny. A list of foundation fund recipients was revealed to include social service groups, minority community projects and athletic programs (including Skillz Athletic Foundation which hosts a football camp attended by the Quackenbush children).

On April 22, the L.A. Times reported that the state’s Legislative Counsel determined that the Commissioner does not have the authority to create foundations in lieu of fining companies.

Week after week, allegations of “misconduct in office” piled up against Quackenbush, who insisted that his actions were in the best interest of consumers.

In early May, four California newspapers-the Los Angeles Times, the Sacramento Bee, the San Diego Union-Tribune and the San Jose Mercury News-called for Quackenbush’s resignation. At this point, the Commissioner was walking a tightrope and was left with two choices-quit or face impeachment proceedings in the Legislature.

On May 23, Quackenbush stormed out of a State Senate Committee hearing, refusing to testify based on the advice of his lawyer, who warned the Commissioner to avoid a “political ambush” by the Democrat-controlled Legislature. Before walking out, Quackenbush presented an e-mail exchange that took place 15 months earlier between two staffers. The e-mail urged the senate staffer not to confront Quackenbush about secret settlements with insurers because “we have to set him up first…If we do not completely ambush him, he will slide out of it.”

But, on June 28, doomsday arrived for Quackenbush. “I hereby resign my position as Insurance Commissioner of the State of California effective July 10, 2000,” he wrote in a letter addressed to Bill Jones, Secretary of State; Gray Davis, Governor, State of California; Robert Hertzberg, Speaker of the Assembly; and John Burton, Speaker Pro Tem of the Senate.

The clean-up process is far from over. On Sept. 18, 2000, when Insurance Commissioner Harry Low, a Democrat, took the oath of office, he promised to restore public trust in the position. The 69-year-old retired appeals court judge will serve the remaining two years of Quackenbush’s second four-year term.

On Nov. 20, Attorney General Bill Lockyer and Commissioner Low filed a lawsuit in Sacramento Supreme Court that seeks to undo the agreements made between Quackenbush and the insurers. The complaint comes alongside a continuing criminal probe into the actions of Quackenbush and others involved with the CDI and CRAF.

Quackenbush, meanwhile, has moved his family to the island of Oahu and seems to be keeping a low profile for now.

THE CALIFORNIA WORKERS’ COMP MARKET: ON THE VERGE OF COLLAPSE

By Sky Barnhart

At the beginning of 2000, IJ described the California workers’ compensation market as “crazy,” “turbulent” and “chaotic.” Now, at the end of the year, a more fitting description would be “downright scary.”

According to Dave Bellusci, chief actuary of the Workers’ Comp Insurance Rating Bureau (WCIRB), data is continuing to show combined ratios at record highs. “Our estimate, based on June data, shows a combined ratio of 153 for 1999 accident year and 149 for ’98, and losses continue, if anything, to appear to be developing…We’re in the process of looking at September data, and it could go up somewhat based on that.”

The seizure of Superior National Insurance Companies by the California Department of Insurance on March 3 got the year off to an ominous start. In the biggest takeover since Golden Eagle in 1997, the CDI revealed that Calabasas-based Superior National was in “hazardous financial condition” and “severely under-reserved.”

Although Superior National has received some help with its rehabilitation plan from Kemper Insurance Companies, the company’s trek to liquidation is adding a heavy burden to the struggling market.

“You already have Superior National with fairly significant insolvencies in the hundreds of millions that are going to have to be funded through the guaranty fund [California Insurance Guarantee Association],” Bellusci said. “There’s an assessment…that will be assigned to each policy for some time to fund it.”

In September, Lawrence Mulryan, executive director of CIGA, estimated that there were approximately 46,000 claims with a net liability to CIGA of roughly $400 million. “The dollar amount that CIGA will pay depends to what degree these [claims] are offset by assets recovered by the estate,” Mulryan said.

Next comes the scary part: what happens if other companies require liquidation as well?

Fremont General Corp. and related entities are currently under increased regulatory oversight by the CDI, and the company plans to close 16 of its 24 production and claim servicing offices and eliminate 465 jobs as part of continuing efforts to cut costs. It has already cut its workforce by 50 percent since June 30.

There are murmurs in the industry that the only reason Fremont hasn’t been fully taken over is for fear of a market collapse. An order for Fremont to be liquidated would raise serious questions as to where the money would come from.

“That’s a real concern,” Bellusci said. “A one-percent per year guaranty fund assessment wouldn’t do it-whether it was Fremont or anybody else-if there was a second major insolvency of that magnitude.”

Players in the workers’ comp arena are scrambling to keep their heads above water. HIH American Insurance Group recently stopped writing new business in the U.S. and is selling the renewal rights of its Southwest, Midwest and Hawaii regions to Argonaut Insurance Company. Alaska National Insurance Company is buying the renewal rights and other tangible assets associated with HIH’s large account California workers’ comp business.

Western Growers Insurance Co. of Irvine, Calif., which writes workers’ comp for members of the Western Growers Association, is currently in run-off mode and recently sold the renewal rights of its book of business to competitor PAULA Insurance Co. PAULA, a Pasadena, Calif.-based insurer specializing in workers’ comp for agribusinesses, was downgraded by A.M. Best in March from “B++” to “B.” In May 2000, S&P placed California’s largest workers’ comp carrier, State Compensation Insurance Fund (SCIF); and several others, including Zenith Insurance; on CreditWatch, citing a WCIRB study which had indicated a gross loss reserve deficiency of $4.7 billion for the state workers’ comp market. However, several months later, S&P removed State Fund and Zenith from CreditWatch and reaffirmed their “A” financial strength ratings.

Are there any solutions in sight for the shaky market?

On Oct. 20, Insurance Commissioner Harry Low approved the WCIRB’s proposed 10.1 percent average increase in pure premium rates effective Jan. 1, 2001, citing in large part “worsening severity in medical costs.” “I believe that open rating will work in the long run only if insurers act responsibly and charge rates that reflect their actual costs,” Low stated. His approval of the rate increase was praised as a necessary measure.

“This year prices are up in the market almost 20 percent, so that’s obviously a positive thing,” Bellusci said. “It should move rates up a little bit, but it takes a while for those higher rates to work through into income, earned income and so forth. And loss costs are also escalating, so that’s going to eat up part of that, but clearly it’s a step in the right direction in terms of returning to some semblance of results closer to a historical norm.”

SAUL STEINBERG AND THE RELIANCE DEBACLE

By Peter van Aartrijk Jr.

We knew the Reliance debacle had really hit rock bottom when embattled former Chairman Saul Steinberg was served with a particular lawsuit. But more on that in a moment.

After two years of relentlessly embarrassing revelations, Reliance is in “active discussions with insurance regulators, bank lenders and bondholders over the terms of our restructuring,” said Joel Weiden, spokesman for Reliance Group Holdings. “At this point in time it’s premature to say what may happen. The talks are ongoing. We’re hopeful that we will be able to reach an agreement over the terms of the restructuring with those parties.”

The ratings agencies aren’t real hopeful. A.M. Best earlier this month dropped Reliance Group’s rating to “D,” the lowest level before full regulatory control. The company is under watch by the Pennsylvania Department of Insurance, the lead regulator on this case, but it appears more likely that the company might face more formal supervision, said Karen Horvath, Best’s vice president of property/casualty ratings. There’s a greater likelihood of bankruptcy as well, she noted.

“Their major focus now is how to ultimately restructure and pay their claims and hopefully have something left over for shareholders. Which is questionable because they don’t have enough money left to pay their debt,” Horvath observed.

Steinberg has personally lost $1 billion as majority shareholder of the once venerable, worldwide brand name.

The story of Steinberg’s flashy lifestyle is well- chronicled. The company was leveraged for years. There were losses in construction, marine, aviation and toxic waste transportation lines. The failed Unicover workers’ comp reinsurance pool resulted in a $117-million charge.

The death knell came in June: a buyout deal with Leucadia National fell through, and A.M. Best hammered Reliance by dropping the rating to a “B++” from “A-.” For huge chunks of ratings-sensitive areas-such as government entities and banks-Reliance was out of play for brokers, even if they wanted to do business with the company. At that point, Reliance stopped writing any business.

Best’s Horvath figures the Unicover mess “was one symptom of a greater problem… [T]his company grew very rapidly in a very soft market. They really lost control of the quality of the business in the book as well. And because they didn’t have the appropriate
controls, they were underreserving for this business. Unicover was part of that. Negative publicity associated with that was a greater problem.”

At the same time, Reliance had adverse reserve developments in other lines of business, Horvath said. Debt came due and the company had been taking a lot of capital out of the insurance subsidiaries to pay debt and shareholder dividends. And a significant portion of its assets was invested in common stocks-and concentrated in a select few issues to boot.

“If you take any one of those factors by themselves they probably would have been okay. But not a confluence of all,” Horvath said.

David Schiff, editor of Schiff’s Insurance Observer, has written extensively on Reliance and the Steinbergs. Many insurance companies can fail, he offers. A hurricane can come along and wipe them out, for example. But Reliance “was a long-term disaster,” Schiff stated. “They were speculating their long-term strategy, and it caught up with them.

“What they did was a little too much of everything. They grew during an unlikely time, which is easy to do in the insurance industry. You just offer more coverage at a lower price, and if you get lucky, you can write your way out of it. But they didn’t…Steinberg’s strategy was to walk on the edge. They played everything so dangerously. It was a reckless strategy.”

Some 75 percent of Reliance has been sold off, consistent with the plan to run off the company, spokesman Weiden said. The Hartford took Reliance’s D&O, E&S and inland marine lines-plus a bunch of employees. Claims processing was outsourced to Aon’s Cambridge unit. Markel purchased renewal rights to childcare, social services and healthcare books. Combined Insurance, another unit of Aon, bought the accident and health book.

Travelers bought the surety business and renewal rights to middle-market accounts. Kemper bought renewal rights to large risk casualty and construction wrap-ups. Sounds to me like a Moroccan bazaar.

“Obviously this is a very difficult period for long-term employees of Reliance,” Weiden added.

It got more difficult-or shall we say “ugly” -last September, when The Wall Street Journal reported that Anne Steinberg, 83, is suing her son for allegedly failing to repay a $4.7-million loan.

Sure, this is business and there are three sides to every story (Saul’s side, mom’s side and the truth), but this is nuts. Can it get any worse than your own mother suing you?

Even this jaded Jersey boy shudders at the thought.

Peter van Aartrijk Jr. owns a communications firm specializing in the independent agent distribution channel.

THE ROLLERCOASTER RIDE THAT WAS THE ‘YEAR OF THE DOT-COM’

By Catherine Tapia

At this time last year, everybody-even those who weren’t convinced that the world would turn into a pumpkin at midnight on Jan. 1, 2000-seemed to be focused on the power that computers held over the world. But rather than an entrance into the netherworld of Y2K, the first months of the New Year brought on a different phenomenon-the “Year of the Dot-Com.”

In the early part of the year, business interests of all types, including those related to insurance, were eager to get involved. According to a study entitled “e-Insurance, The Convergence of Insurance, Technology and Capital” by Friedman Billings Ramsey & Co. Inc., with the insurance industry generating $1.8 trillion transactions annually, “it is the sheer magnitude of the industry that has inspired so many Internet companies and industry participants to begin to explore and employ the Internet.”

But as the year progressed, a decidedly more sobering reality has set in. Tech stocks started to take a severe beating, and the rollercoaster ride has continued up to the present. Many initially well-financed dot-coms, failing to quickly deliver the IPOs of their backers’ dreams, began to struggle to maintain financing. Others, already having achieved an IPO, simply could not reach a level of previously anticipated profitability. By the end to 2000, staff cuts, mergers or outright shutdowns had become increasingly more frequent.

One example occurred in October, when Esurance, a direct-to-consumer, onlineprovider of personal lines insurance, cut approximately 25 percent of its staff. The company, after experiencing very rapid expansion during the first part of 2000, put a hold on plans to introduce new product lines and promptly went in search of a buyer, which came along in the form of FolksAmerica Holding Co.

A recent study conducted by Forrester predicted a “Dot-Com Shakeout” that would continue over the next several years in three waves. During the first wave in 2000-2001, dubbed “The Purge,” a huge number of dot-coms will fade away from the marketplace as their funds are depleted. During the second, or “Fortification” stage, as buyers and sellers become more exacting in their demands, there will be more merging between weaker players and a scaling back of all-inclusive ventures.

Finally, during 2002-2003, eMarketplaces will hit critical mass and enter the “Reconciliation” phase of the shakeout. The study reported that, “At that point, eMarketplace mystique will fade and rational practices will set in. With user adoption taking off, surviving eMarketplaces will have more to do and less need to fight over small bits of turf-drawing the lines of truce…”

According to a separate report released by Challenger, Gray & Christmas Inc., since December of 1999, about 31,056 jobs have been cut in the dot-com sector, with 40 percent of that total coming from service industries. Layoffs reached record levels in November 2000, when the Internet industry announced 8,789 job cuts. Of 383 companies tracked, 20 percent had gone under by year’s end. Who will make it from the purge to reconciliation?

Perhaps one of the answers to that can be found in yet another study, “Personal Property and Casualty Insurance Online Premium Volume Forecast and Analysis (2000-2004),” conducted by the International Data Corporation. Among its findings were that in 2000, the number of people who purchased online was about 0.4, and the percentage of those that initiated the transaction online but then went on to contact an agent to complete the transaction was 54.6 percent. Those that abandoned the online shopping process before purchasing totaled 45 percent. However, by 2004, those percentages are expected to be 6.3 percent, 65.8 percent and 28 percent, respectively.

What this would seem to suggest for insurance agents is that far from being distintermediated by the Internet, as was feared or even proclaimed earlier on, the new buzz is that those agents may play one of the most vital roles in the successful online sale of such a complex product.

According to Ron Davidson, co-founder of the online storefront InsurePoint, the early attitude held by some participants in the commercial insurance environment that e-agencies could disintermediate agents and write coverage for the world was not a very prudent one. “Roughly 95 percent of the commercial insurance marketplace in the U.S. is written by independent agents…[who] have very good relationships with their customers on the whole,” Davidson noted. “You’re not going to destroy and cannibalize those relationships by becoming an e-agency. We started InsurePoint with an agency force behind it. We think we have to empower the agency force to become Internet-enabled and to understand how you use new mediums to market and build relationships.”

However, at least in the short-term, the survivors will most certainly be the companies that are able to generate revenue quickly. Or as Max Carter, CEO of the online B2B insurance exchange, iwix.net, put it: “If you don’t get any revenue, you’ll run out of money before you make it.”

THE SOUND REJECTION OF THIRD-PARTY, BAD-FAITH
LAWSUITS

By Catherine Tapia

The insurance industry scored a landslide victory in the highly publicized political battle over whether third-party bad-faith lawsuits should be reinstated in California. When the question was put to voters in the form of two referenda last March, the response was overwhelmingly negative: for Prop. 30, 68 percent opposed; for Prop. 31, 72 percent opposed.

The genesis of Props. 30 and 31 occurred when two closely related bills, authored by California Senator Martha Escutia (D-Whittier), were signed into law in October 1999 by Governor Gray Davis as the Fair Insurance Responsibility Act of 2000. According to proponents, the intent of the explicitly connected bills was to restore a consumer’s right to sue an insurance company that was unreasonably or illegally delaying or denying payment of a legitimate claim.

According to information dispersed by the office of the California Secretary of State, such lawsuits were not allowed in California until March 1979, when the state’s Supreme Court ruled in favor of a third party suing an insurance company for unfair claims practices. These include failing to provide a prompt explanation for why a claim has been denied or the offer of a compromise settlement, or the failure to act in “good faith” in the settlement of a claim when liability is reasonably clear. Such practices are prohibited under California law. Accordingly, policyholders have recourse to sue their own insurance companies in first-party lawsuits.

However, the same high court overturned that ruling which extended the same right to third-party claimants in 1988.

The 1999 legislation allowing for the reinstatement of third-party lawsuits in certain circumstances would have gone into effect on Jan. 1, 2000. However, the opposition, including the insurance industry, which had lobbied heavily against the bills during legislation, decided to take its case directly to the people through the employment of a rarely used procedure: the referendum.

Before the signed laws went into effect, enough signatures were collected to force reconsideration of the legislation by the entire electorate of the state of California. Voters were asked to approve or reject the new laws, to be represented on the March 2000 ballot as Props. 30 and 31.

The insurance industry then launched a vehement campaign against the two ballot measures, noted primarily for a number of hard-hitting television spots. Voters were told that passage of Prop. 30 would cause increases in both the insurance rates for average consumers and the number of frivolous lawsuits filed by personal injury attorneys. Furthermore, it was maintained that an affirmation of Prop. 30 would allow drunk drivers and uninsured drivers to sue and collect punitive damages, and result in increased occurrences of fraud.

The efforts paid off. In failing, Prop. 30 rejected the stronger of the two laws; Prop. 31 rejected certain limitations that would have been applied had Prop. 30 been endorsed by voters.

One issue that was referred to frequently in press coverage of the ballot measures was the disparity in the amounts of money spent by the forces at the opposite ends of the spectrum. While those in favor of the measures raised $5 million to mount their campaign, the opposition raised a sum unofficially estimated as high as $60 million.

According to Sam Sorich, western regional manager and vice president of the National Association of Independent Insurers (NAII), such an expenditure was necessary because of the limited time frame presented for blocking the legislation; the effort necessary to research and develop messages that would make a complex issue understandable; the fact that trial lawyers were among those who favored the laws; and, most importantly, the belief held by the “No” on Prop. 30 campaign that a reinstatement of the doctrine of third-party bad faith would result in annual increased insurance costs of approximately $1.5 billion a year.

One area where there did seem to be partial agreement between those on both sides of the issue is that the media’s blanket description of the parties at odds over Prop. 30-“Trial Attorneys against The Industry”-was somewhat exclusive.

“The fact is there were over 120 groups that joined the coalition to oppose these propositions, and 115 of them had nothing to do with the insurance industry,” Sorich said, adding that even Voter Revolt, the consumer group that supported Prop. 103 in 1988, opposed Prop. 30. “I think the magnitude of the victory is attributable to the fact that this was not just the insurance industry vs. trial lawyers,” he said. “You had a broad constituency.”

So far, legal precedent has been followed in that the California legislature sitting this year has not attempted to again pass legislation that has been so resoundingly rejected by the state’s voters.

Will third-party bad faith emerge again someday in a different form to be reintroduced to future legislatures? Or is the third-party bad-faith concept “dead in the water” for the foreseeable future?

Only time will tell.

THE FIGHT AGAINST BRINGING NORTHRIDGE CLAIMS BACK TO LIFE

By Stefani Mingo

As the majority of the country was preparing a feast on the eve of Thanksgiving, the insurance industry was busy filing suit in the California Supreme Court to rule on the constitutionality of SB 1899, one of several high-profile insurance measures of the 2000 legislative session.

Authored by Senate President Pro Tem John Burton (D-San Francisco), and signed into law by Governor Davis, SB 1899 allows certain Northridge quake victims to take an unfair insurer to court if they were previously denied that right due to a statute of limitations.

The suit was filed by Century National Insurance Co. and three of the big industry associations-the Association of California Insurance Companies (ACIC), the Personal Insurance Federation of California (PIFC) and the National Association of Independent Insurers (NAII). The groups believe that the Burton bill would pave the way for class-action lawsuits that could result in huge awards from insurers.

The law provides policyholders who were denied the right to sue their insurer because of a one-year statute of limitations, access to the courts to seek remedy against the unfair and illegal behavior of their insurance carrier. It reopens and extends the statute of limitations for filing suit against an insurer that has unnecessarily denied or undervalued a legitimate earthquake-related claim for one year.

On behalf of the petitioners in the lawsuit, Sam Sorich, vice president and western regional manager of the NAII, issued a statement on Nov. 22, the day the action was filed. “The implications of SB 1899 are far-reaching,” Sorich stated. “Without immediate Supreme Court review, a tidal wave of litigation will surely engulf the Los Angeles trial courts and all divisions of the Second Appellate District in Los Angeles, creating a potential for contradictory decisions on the various constitutional issues and a cloud over all contractual relationships in California.

“The stability of contractual obligation is a cornerstone of business and personal relations in the modern world…we rightly respect that state government will not-indeed cannot-alter the contracts we have made with each other.”

Barry Carmody, ACIC president, voiced his concern about the bill’s effect on the integrity of the judicial system by setting a dangerous precedent retroactively extending the filing period for Northridge earthquake claims that was previously limited under both California law and the policies between insurers and their customers.

“If a statute of limitations can be changed retroactively for filing these earthquake claims, it can be changed retroactively for any type of claim,” Carmody said. “Businesses ultimately could be affected and the uncertainty created by retroactive changes in the law will be factored into the price all consumers pay for all goods and services.”

By attempting to change the provisions of the contracts, Sorich added, SB 1899 “poses a threat to the stability of every commercial enterprise in California because commerce cannot thrive without full assurance that a contract means what it says.”

Current law requires claims to be filed within a year after the quake, and insurers say that one-year filing period is a standard deadline in their contracts. The handling of the claims captured attention during legislative hearings into Quackenbush’s conduct in office.

The new law opens a one-year window-from Jan. 1, 2001, to Jan. 1, 2002-in which Northridge victims can reopen damage claims. It was six years ago (Jan. 14, 1994) that the quake rumbled through the Los Angeles area, killing dozens of people and causing roughly $15.3 billion in uninsured losses.

As it now stands, the law applies to those who made claims before Jan. 1, 2000, and who have not reached a court resolution or a written settlement on the claims in which the insureds had legal representation.

Consumer advocates have accused insurers of dragging their feet on these claims, leaving homes, condominiums and apartment buildings in disrepair. They argue that thousands of Californians who lived through the Northridge quake have yet to receive full and fair compensation from their insurance company to cover the costs incurred as a result of the quake.

According to PIFC President Dan Dunmoyer, the insurance industry settled 99.75 percent of all 600,000+ Northridge claims. So that’s 600,000+ claims that could be re-opened-and could invite the filing of stale and fraudulent claims. PIFC feels that SB 1899 is “nothing but a ploy by plaintiffs’ lawyers who stand to make hundreds of millions of dollars on the backs of satisfied customers who have received payment for their Northridge losses.”

Nevertheless, the high court denied the petition to hear the case, but did not deny the case on its merits. As a result, the plaintiff insurer groups need to review their options. “Additional legal action on the part of the insurers is likely to happen,” NAII’s Sorich said.

Now the insurance industry has to wait and wonder: will the specter of Northridge be brought back to life and what form will it take?

THE ESCALATION OF CONSTRUCTION DEFECT LITIGATION

By Sky Barnhart

Every day it seems that California’s parking lots get more crowded and the freeways get more congested-but where do all these people come from, and more importantly, do we have enough room for them? Not really, according to the California Department of Finance. The state needs 250,000 new housing starts per year in order to accommodate the population; yet only 139,000 units were built last year.

The shortage of housing is due in part to gun-shy builders and developers who have seen a rising tide of construction defect litigation in the last few years. The litigation factor has in turn squelched the willingness of insurers to provide coverage for multi- and single-family housing starts in California and the western states.

The building boom of the 1980s brought a new supply of developers to the market, not all of whom had the necessary skills to build this kind of housing. The result: some shoddy construction and an increase in defects.

The trouble is that many so-called “defects” are actually cosmetic issues or maintenance problems. The lack of clarity about what is and is not a defect has been a key factor in the increase in litigation. “It’s all a result of this whole phenomenon of people coming in and literally stripping down houses to count nails to make sure they’re spaced correctly,” said Gary Hambly, president and CEO of the Home Builders Association of Northern California. “It’s amazing how issues that used to be customer service issues…now turn into litigation issues because people look to their attorneys as the first and last resort, rather than trying to work with the builder.”

As the number of law firms specializing in construction defect litigation has steadily increased over the years to almost 100 in California alone, the number of insurance carriers who will write the coverage has declined from more than 40 admitted companies in the early 1980s to only a handful today.

Part of the trouble is that each lawsuit can balloon quickly to involve many parties; typically, if a construction defect is alleged, the homeowners association will sue the general contractor, who may then file suit against any of the 40 or more subcontractors who worked on the project.

David Golden, director of commercial lines for the National Association of Independent Insurers (NAII), pointed out that exploitation of the additional insured status is a growing trend. “We’re seeing the additional insured status exploited to where a subcontractor can end up having to pick up the liability of the general contractor for whatever is wrong, even though it may not be directly related to the work that the subcontractor was doing,” Golden said.

This is not a development that insurers were prepared for-“the premium charged for additional insureds never really contemplated taking on the responsibility of another contractor in any specific case,” Golden explained.

According to the California Research Bureau, these types of lawsuits can take from one to two years to come to trial. Most cases are settled before reaching court, with an average settlement of $1 million to $2 million.

And the litigation is no longer limited to just California condos, but is spreading to other states and other specific types of defects: soil problems in Colorado, EIFS issues in Washington, and multi-family housing defects in Nevada.

“I think it started with homeowners associations and condominiums, but that was six or seven years ago,” said Bill Newton, president of Lemac & Associates Inc. in Los Angeles. “It spread pretty quickly to single-family dwellings, and over the last three or four years, single-family dwellings have been as bad as condominiums.”

However, within this dire picture is one bright spot. A welcome victory for insurers, as well as builders, was recently won on the construction defect litigation battleground.

The California Supreme Court ruled on Dec. 4 that homeowners cannot sue builders for negligence unless there has actually been damage to property or bodily injury. According to the San Diego Union-Tribune, justices decided that homeowners already have access to other remedies available through builder warranties and contracts, which can cover periods of one to 10 years.

The decision came out of two San Diego cases that centered on “allegations of negligent construction and building code violations that made the homes more vulnerable to damage from fire and earthquakes,” the Union-Tribune reported. The cases involved more than 240 homeowners living in a single-family subdivision and a condominium development in Carmel Mountain Ranch. The developer was Newport Beach-based William Lyon Co.

The ruling helps to more closely define where the liability falls and may serve to lessen the fears of both builders and insurers. California may get its condos after all-not to mention more crowded freeways and parking lots!

THE RISE OF CYBER-CRIME AND THE GROWING NEED
FOR E-COVERAGE

By Philip S. Pierson

The headlines are beginning to sound much too familiar: “Leading Websites Under Attack!” “Customer Database Hacked.” “Extortionist Attacks Online Customers.”

And the losses are beginning to mount much too quickly. Cyber-attacks cost U.S. companies an average of $266 million last year-more than double the average annual losses for the previous three years, according to a study by the San Francisco-based Computer Security Institute (CSI) and the San Francisco FBI Computer Intrusion Squad.

Perhaps one of the most shocking cyber-attacks occurred in October, when Microsoft’s internal networks were penetrated by malicious hackers in an act of industrial espionage, or “netspionage.” The hackers created an intelligent software agent, called a worm, to rummage independently through networks for valuable information and steal priceless digital blueprints of future products. As Microsoft struggled to assess the potential financial losses, its attackers disappeared into cyberspace.

Welcome to crime in the 21st Century-and welcome to the newest headache for insurance brokers across the planet.

It doesn’t matter who your customers are, or how big or small their businesses may be-they are targets for cyber-crime. In fact, 90 percent of the 273 survey respondents in the 2000 CSI Survey had detected cyber-attacks within the last year. And 70 percent reported serious computer security breaches, such as theft of proprietary information, financial fraud, system penetration from outsiders, denial of service attacks and sabotage of data or networks.

According to the American Society for Industrial Security, Fortune 1000 companies sustained losses of more than $45 billion from thefts of proprietary information in 1999. This type of theft has been called the greatest threat to U.S. economic competitiveness in the global marketplace. Is one of your clients destined to be the next cyber-crime poster child? It’s not unlikely. And if they were, what are the chances their exposures would be covered by insurance? If your answer is “very unlikely,” your client is not alone. According to the “May 2000 e-Risk Survey,” conducted for Assurex by the Human Resource Institute (HRI) of Eckerd College, many of the nation’s largest Fortune 500 companies are not prepared to handle e-business risks. Few employers have implemented the type of comprehensive e-risk crisis management program that can limit electronic exposures, or the kind of insurance coverage that can help reduce e-liability and financial losses.

Agents today have an obligation, as much as an opportunity, in the e-insurance marketplace. They must help educate employers, especially small business employers, regarding the potential exposures and costly e-liabilities that threaten today’s business survival.

“As a basic foundation, employers should carry business interruption insurance in case they are the victims of a denial of services attack,” said Rick Jones, president of Talon Technology International, a security company that partners with insurers to help them develop coverages for cyber-risk and cyber-loss. “In a DOS attack, losses begin the second the networked system stops working. Those losses can be massive; including lost transactions in play, lost intended transactions, and finally, loss of future transactions due to erosion of customer confidence.

“Employers who want to be in business tomorrow must take control of their e-risks today by purchasing e-insurance policies to reduce first-party losses and limit third-party claims,” Jones continued. “And brokers need to be the guiding light that brings employers into this insurance safe harbor.”

Overall, the “May 2000 E-Risk Survey” confirmed that employers are not yet taking full advantage of the protections offered by many e-insurance products. Brokers must work proactively with employers to assess their potential exposures from a network attack, then establish a comprehensive e-risk management program that combines computer network security with e-insurance policies to help reduce electronic exposures and mitigate financial losses following a network intrusion.

“By listing on a chart the potential cyber-perils the employer faces, along with their potential costs, you will be able to clearly focus the team on the very real potential losses of a cyber-attack,” said Donna F. Williams, president of Tripwire Insurance Services, which offers consulting services that combine technology solutions with risk financing strategies. “Equally important is to list on the other side of the chart the insurance policies already in place to cover key losses. Here, your team will begin to see the gaps and exposures that remain, and the potential financial losses from those exposures.”

Once you can engage senior executives by presenting e-business risk management as a business issue, not just a technology issue, you’re well on your way to both meeting the obligations and reaping the benefits of e-business insurance.

Philip Pierson is vice president-technology products for Sherwood Insurance Services and is founder and manager of Sherwood’s e-Sher Underwriting Managers. e-Sher provides insurance products and risk management services for e-business.

CHINA’S LONG MARCH TO JOIN THE WORLD TRADE ASSOCIATION

By Charles E. Boyle

The Emperors of the Chou Dynasty, who began the construction of the Great Wall of China in the 4th century B.C., intended it to keep out the barbarian hordes that periodically invaded the Middle Kingdom. After 1,800 years, the Wall extended over 1,500 miles but was never entirely successful. Walls, however, have two sides, and the barrier affected the development of Chinese civilization by both physically and mentally restricting access to other cultures beyond the wall.

China’s real GDP has grown more than 5 percent every year since 1979. It topped $1 trillion in 1999, and is on track to grow another 8 percent this year. Most of that growth has been export-driven. At the end of the third quarter, China’s exports had risen more than 32 percent for the year to $205 billion, and its overall trade surplus is expected to top $25 billion.

China has gained a place in world trade, and its leaders have for the last 10 years sought entry into the World Trade Organization. Membership would insulate China’s exports from protective trade barriers, open new markets for expansion and facilitate the importation of needed technology.

The WTO, however, is based on free trade principles, and, as a member, China will be required to open its economy to competition and to abide by WTO rules. Can its leaders force through the necessary reforms, and see them observed, given China’s bloated, inefficient, state-run economy and the corruption of many officials? The answers should begin to emerge, as it appears almost certain that China will join the WTO in 2001.

Two major barriers fell this year. The U.S. concluded and ratified a treaty providing for “Permanent Normal Trade Relations, a milestone in U.S./China relations. It did more than eliminate the annual debate over China’s “most favored nation” status. The European Community then negotiated its own bilateral trade agreement with China. Both pacts provide essentially the same benefits and obligations, but the EU gained some additional concessions, notably the acceptance of agents and brokers as part of the insurance accords.

These agreements were essential before WTO membership could be approved, and most of their provisions are contingent upon China’s joining. They cover the rights of western companies to enter previously protected markets, mainly telecommunications, agriculture and financial services.

European and U.S. insurance companies enthusiastically supported the trade agreements. AIG CEO Maurice Greenberg said, “The best way to promote positive change in China is to trade with China.” Both PNTR and the EU deal provide for more licenses to foreign insurers, and a loosening of the stringent restrictions on where they can operate. Other than Hong Kong, foreign insurers are mostly confined to the Shanghai and Guangzhou regions. Eventually they hope to gain increased market share, and the opportunity to offer their products to 1.3 billion Chinese consumers.

So far, however, China hasn’t been exactly generous in granting new licenses. AIG and Aetna already had them; Chubb and John Hancock were accepted in April. European insurers AXA, Allianz, Royal & Sun, CGNU and Winterthur were also approved before the accords were signed. Afterwards, only Generali and ING Group have received licenses, although Gerling, Skandia and Transamerica/ Aegon have applications pending.

U.S. Commerce Secretary Norman Mineta recently complained that no U.S. insurers have so far received new permits. It appeared the Chinese were going ahead with their pledge to grant seven new licenses to the Europeans, Mineta indicated, but were holding back on their promise for an equal number to U.S. insurers. They may even be planning to cut the number to just four, he added. New York Life, Met Life, Cigna and others are still waiting.

Licenses alone won’t guarantee entry into the Chinese market. Two major obstacles exist. In the euphoria over signing the PNTR agreement, people conveniently overlooked the fact that China isn’t a country where legality and contract law are highly valued.

Greg Mastell, vice president of the Economic Strategy Institute, summed it up in his testimony before the Senate Finance Committee in March 1999: “The central problem is that China has neither a rules-based country, nor a true market economy. The former head of the Chinese people’s Congress is fond of saying ‘China is a country of strong leaders, not strong laws.’ This lack of rule of law has a direct impact on U.S. concerns ranging from human rights to trade.” Trying to get Chinese bureaucrats to adopt regulations is already seen as a problem.

Secondly, China’s culture goes back over 2,200 years and functions in ways that are uniquely Chinese. Dr. Herbert Gooch, chairman of the political science department at California Lutheran University, observed that: “While there is a tradition of family and clan (tong) pooling of venture capital, traditional capitalist insurance concepts of impersonal, much less individual, sharing of risk may be hard to translate and sell well in the Chinese culture.”

THE BIG PINCH IN COVERAGE FOR NURSING HOMES

By Constance Parten

The nursing home market, in a state of deterioration for several years now, has become increasingly barren. Most insurers say the legal community has found a new weak spot, targeting the area as one ripe with potential for litigation.

A lack of commercial carriers willing to write nursing home coverage currently exists in most states, but California, Texas and Florida are considered some of the most challenged states, with few admitted carriers still offering new coverage.

In states where carriers are available, they are often too overwhelmed with submissions to get quotes out in a timely fashion. In some cases, per-bed costs have escalated to more than $6,000.

“The nursing home market has tightened up considerably over the past six to nine months, mainly because of an increase in severity and frequency of losses,” said Bill Yurek of Avreco Inc. in Chicago. “The insurance companies that were writing business in the past, the standard market…their loss ratios have really skyrocketed, so they pulled out of certain tough states such as Texas, Florida and Alabama.”

The punitive nature of recent court rulings hasn’t helped the situation. For example, the nursing home liability market in Texas dwindled over the last year to just one admitted company writing new coverage in the state. Huge losses due to liability claims, questionable and otherwise, are partly to blame.

Both Texas and Florida have considered reopening the state’s Joint Underwriting Association. Many insurers, like Ray Thomas, president of Bunker Hill Agency in Houston, say allowing even nonprofit facilities to purchase coverage through joint underwriting associations is a “Band-Aid solution.”

“The JUA does not change the underlying problems with nursing homes,” Thomas said, stressing that most nursing homes are providing good care, but are falling prey to a litigation-happy society. He called for tort reform that would establish reasonable caps on punitive and mental anguish damages. He also suggested privileged records should not be admitted into court. Thomas also pointed out that “the surplus lines market is working,” and to offer coverage through the JUA would undermine the free market.

Several factors are to blame for the nursing home crunch, including Medicare cuts. “Most recently, because of the balanced budget act, their Medicare reimbursement was cut dramatically,” Thomas explained. “Their income has been lowered so that maybe the quality of care has been reduced because they’re not spending the kind of money they need to keep the facility running efficiently. That’s not to say that’s happened in every nursing home, but that has happened in some nursing homes around the country.”

Another problem is a high turnover of personnel in the nursing homes, which can lead to difficulty in obtaining a highly experienced staff knowledgeable in the procedures involved in patient care.

Some of the most common claims in nursing homes have to do with wound care, particularly bedsores. Others deal with patients wandering off from the facility as a result of a disease like Alzheimer’s or a lapse in security at the facility.

A recent example in California involves the Windsor Gardens Convalescent and Rehabilitation Center, a San Diego nursing home which was recently shut down by the California Department of Health Services. Officials indicated they will request the California Attorney General’s office of Medi-Cal Fraud and Elder Abuse to consider criminal charges.

The action follows the release of the department’s 167-page report, containing numerous, documented allegations that patients received poor care at the 99-bed facility, which health officials ranked in the worst 4 percent of California nursing facilities. According to the San Diego Union-Tribune, Windsor Gardens now faces fines of $3,000 per day from Oct. 11 until such a date that the facility reaches compliance with state regulations. In addition, the California Board of Registered Nurses has been asked to examine the competency of Windsor Garden’s staff.

Many are hopeful that a White House proposal pumping $16 million into improving nursing home oversight will make a difference. Others, such as Senator Charles Grassley (R-Iowa), chair of the Senate Special Committee on Aging, said more money won’t guarantee better quality because the government does a poor job ensuring that state inspectors enforce federal laws.

Most of the money proposed would go to state agencies responsible for inspecting nursing homes. The money would be specifically earmarked for training the inspectors, inspecting the nursing homes during off hours such as evenings and weekends, and providing more inspections of the facilities with the worst compliance records.

The proposal could very likely shut down some of the worst facilities, but would also improve others, which could eventually lead to decreased litigation and fewer bankruptcies. That would be good news for the facilities, legislators and insurers who have watched dozens of nursing home providers file for Chapter 11 protection over the last year.