Cities Put Off Insurance Pool Until Court ‘Validates’ It

An unusual insurance pool being set up by cities in Los Angeles County that cannot obtain or afford liability insurance from private carriers will not get under way this month as originally planned.

Creation of the cities-run insurance pool will be delayed for several months because of concerns over the enforceability of contracts between member cities and the pool, according to officials involved in setting up the pool.

The cities--including six from the South Bay--had planned to sell up to $25 million in tax-exempt certificates of participation, which are similar to bonds, to create an interest-bearing reserve for the pool. Member cities would sign contracts requiring them to pay annual premiums to the pool that would be used to pay the debt service on the certificates, establish additional reserves and pay claims awarded against cities. Large claims would be paid from the reserves.

But members of the Independent Cities Risk Management Authority, which is setting up the insurance pool, have decided to seek a court ruling confirming the legality of contracts between the cities and the pool before selling the certificates to investors, according to David Casnocha, a partner with Brown & Wood, a San Francisco-based bond counsel helping the authority to establish the pool.

“Because there has not been tax-exempt financing of this kind for capital raising before, there haven’t been insurance contracts like this before,” Casnocha said. “If the contract was not enforceable, then the investors would not be paid. We would get great comfort having a court agree with us that the contract is enforceable. It makes the transaction much safer for all parties.”

The cities have agreed to file a “validation” complaint in Los Angeles Superior Court that would allow a judge to hear arguments for and against the financing arrangement. The judge would then issue a judgment about the legality of the arrangement, Casnocha said.

The authority “is doing something that has never been done before,” said Casnocha, noting that the pool is believed to be the first of its kind in the state. “It is very natural to seek a level of comfort.”

Casnocha called the validation process a “slam dunk” and predicted that the judge will approve the arrangement. If the judge should raise objections to the financial arrangement, however, the authority would need to restructure the pool or even abandon it if the objections were too serious to overcome, he said.

The validation process, if successful, will probably delay the start of the insurance pool until the middle of September, according to David Smith, a management consultant for the authority.

Smith said a temporary pool will be set up by the authority to give cities some coverage while they await the permanent pool. The interim pool, expected to get under way in mid-June, will be funded solely by premiums and will not involve certificates of participation or any other form of tax-exempt financing, Smith said. It will offer $5 million per claim in coverage, he said.

Twenty-four cities have tentatively agreed to join the permanent pool, which will act much like a cities-run insurance business. Ten other cities, including Torrance and Gardena, had expressed an interest in the pool but have decided not to join--at least not right now, Smith said.

Options Considered

Lynn Shall, risk-management technician in Torrance, said the city, which is self-insured, is still considering its insurance options. “It is still a possibility, but we aren’t going to jump into anything,” she said.

Gardena City Manager Kenneth Landau said Gardena’s bond counsel recommended that the city seek state legislation to govern insurance pools that use tax-exempt financing before the city gets involved. Gardena has insurance coverage through September, and Landau hopes the city will be renewed by its private carrier at an affordable premium.

“The validation would alleviate some of the concerns, but legislation is the safe way to go,” Landau said. “The validation argument is good after you have state law already authorizing the issuance of certificates of participation for this purpose.”

Casnocha, however, said his firm is opposed to state legislation at this point because it could jeopardize the pool being set up by the Independent Cities Risk Management Authority.

‘Too Little Time’

“There is too little time left in this session to properly draft legislation that could answer all of the questions that could be brought up,” he said.

Officials from cities that have decided to join the pool said they have turned to the authority for coverage because municipal liability insurance from private carriers has become either too expensive or unavailable.

El Segundo, Hawthorne, Hermosa Beach, Inglewood, Manhattan Beach and Redondo Beach have all given conceptual approval to the pool. El Segundo and Hawthorne currently have no municipal liability insurance, while the other four cities could lose their coverage or face large premium increases between now and December, city officials said.

To join the pool, cities must sign a 20-year contract, which can be terminated after three years, that will require them to pay premiums to the pool based on a mutually agreed upon financing plan, Casnocha said. The pool will offer $10 million in coverage per claim.

Pool members will have to pay all claims up to a certain dollar amount, but risks above that level will be shared by all pool members. In the case of Manhattan Beach, for example, the city will pay claims up to $250,000, but the pool will pay for any claims above that amount, said Gary Martin, risk manager for that city.