Injured Workers talk about insurance fraud and they have it sort of correct, but not what they think. Injured Workers speak of carrier fraud in terms of denial of benefits. But for something called fiduciary duty, though, carriers would just as soon give the money away. In the long run, it is not their money, it is employer's money. Workers Compensation is a cash flow system only. Carriers make their money off of investments, which cash flow enables. Workers Compensation is not traditionally an underwriting game (in other words, carriers have very very rarely made money off of underwriting).

The real fraud that was perpetrated and which no one in the Department Of Insurance will admit to because they had the wool pulled over their eyes as well is broker fraud, and in the case of events leading to SB 899, reinsurance broker fraud primarily, and bid rigging secondarily.

The recent Fremont lawsuit is illustrative of what happened, and also illustrative of the fact that Department Of Insurance doesn't want to take the blame for approving reinsurance treaties that they had to know would result in denied reinsurance claims.

It may be difficult to comprehend the scope and magnitude of this fraud, but I will try and simplify it.

1995 John Pallat, broker, starts Unicover pool. He puts together host of life insurance companies to underwrite reinsurance. Life insurance companies think they are underwriting just the medical portion of Workers Compensation claims, which they like because it is a fairly safe risk since Workers Compensation is a long tail claim product, meaning that it pays out over a long period of time instead of all at once like a catastrophe claim. Total reinsurance market during this period is around $8 billion, and Pallat gets these guys to write $2.8 billion - one third of the total reinsurance market. Pallat and his buddies make $250+ million on these deals. Others jump in and squeeze out another $250 million.

They sell these reinsurance deals to primary carriers such as Fremont and Superior National at strike points that are just 10% of the traditional strike point. In traditional Workers Compensation reinsurance, a claim does not qualify for reinsurance until it hits $500,000+, i.e. a catastrophic claim. Most of that is medical... Unicover sold deals to the primaries where reinsurance started kicking in, at tiered levels, starting at $50,000. In 1996 the AVERAGE Workers Compensation claim was $38,000 so you can see it's not that hard to get to the $50K liability.

Remember at this time the California market was deregulated so price competition was fierce. The Fremont, Superior National and other guys that bought in to this scheme in actuality thought they were being prudent insurance business people. Here is a contract, a reinsurance treaty, backed by big companies, that freed up their cash flow on a scale of ten times!! This gave them, or so they thought, unbelievable investing power.

And what better to invest in during the late 90's than the stock market, which was posting 100% gains on a quarterly basis!

Then around 1998 the claims started pouring in to the reinsurers, and the reinsurers did what insurance companies do - deny the claims. They just did not pay them. They said they were duped. Unicover got taken to court in NY, and the trial court noted that all these treaties had arbitration clauses putting the litigation off shore, and there they went - out of media attention, and out of American jurisdiction.

In the meantime, primary carriers were now cash poor - the stock market dried up, reinsurance claims were not paid, and reserves were too low.

In 1997, a good friend of the author of this article who was working for a brokerage at the time, and is one of the most intelligent people he knows concerning work comp and how this whole business works, called him up and told him about Unicover. They both were astounded that reinsurance was being sold at such low strike points, but neither of them gave it another thought. They just figured the reinsurers were being stupid. What they didn't realize was the scope of this fraud, and the huge, devastating consequences it would have not just on California but on the nation.

It is no coincidence that virtually every state in the nation experienced a "crisis" in work comp and that 28 states in 2004 passed over 40 "reform" laws. The industry was successful in duping the employer community into believing that benefits were too high, that injured worker and medical fraud was rampant, and that treatment costs were out of control. The math doesn't add up but the employer community was pissed about premiums (which had to escalate and rapidly in order to recapitalize the work comp system, which as noted above, almost instantly lost nearly $3 billion in capitalization), and Injured Workers and Doctors were easy targets since they are the least organized and/or no one really cares about them.

So, what's the bottom line - don't get pissed at the carriers. They are doing what they do best - taking advantage of the times to minimize their risks and thereby their profit. It was the brokers who boiled the system. I think our government though has a lot of explaining to do - why did they let this happen? why didn't someone explain this to the legislators? who's going to fix this so it doesn't happen again (and it will, this story has been repeated time and time again - Workers Compensation is BIG MONEY with little risk for brokers).

Arnold Schwarzenegger was a pawn. He has no idea what's going on because this set of circumstances is beyond his understanding. Chuck Poochigian was likewise in the dark. Steve Poizner is our real target. He is our new Insurance Commissioner. He will either get it, or he will just do what all other Insurance Commissioners have done and stick his head in the sand. Our only hope for a solution to this mess is Jerry Brown, and I hope that he, as our new Attorney General, will do what he does best and rattle some cages. If we want some change, we need to get Jerry Brown to take a look at this, and either extract some big money settlements ala Spitzer, or jail some white collar criminals and set a precedent for others to look at.