Millions wasted by State Fund

Times Staff Writer

California’s scandal-plagued government-run workers’ compensation insurance company spent more than half a billion dollars over the last decade for outside marketing help that often provided “minimal services,” a scathing new state audit shows.

About half that money went to organizations with direct financial ties to two former board members of the State Compensation Insurance Fund, said the audit to be released today. The company sells workers’ compensation insurance to 220,000 California employers.

Some marketing groups were paid millions of dollars for merely sending members quarterly newsletters, providing few other services, the report said.


The report paints a picture of an obscure rogue operation with more than $22 billion in assets, little oversight, minimal public checks and balances, and indiscriminate spending with little attention until recently from top state officials such as the governor and the insurance commissioner.

The quasi-governmental company has been under investigation for more than a year. Since the fall of 2006, State Fund has replaced two board members, several marketing executives, the general counsel to the board and the president. The California Highway Patrol, the state Department of Insurance and the San Francisco County district attorney’s office are conducting a joint criminal investigation.

The 10-month audit offers the first comprehensive look at the extent of organizational and management problems at the San Francisco-based agency, which was created by the Legislature in 1914 and is run by state employees. Its five-member board, appointed by the governor, meets in secret, contending that it is not subject to the state’s public-record or open-meeting laws.

In response to the audit, State Fund said it recognized “serious shortcomings” in the way it managed group insurance in the past. Responsible executives have been replaced, and “the new program contains explicit safety requirements, safety performance metrics and auditing requirements,” it said.

Ordered by Insurance Commissioner Steve Poizner, the audit was conducted by RSM McGladrey Inc., an international business consulting and accounting firm.

It cited lax corporate oversight and governance at State Fund, loose control of more than $300 million spent on technology vendors and unnecessary payments of nearly $20 million in penalties for delaying the processing of medical bills and disability benefits for injured workers. It also questioned the need for a fleet of 2,000 motor vehicles -- 1 car or truck for every 4 employees.


The audit “revealed what we expected -- serious structural and operational issues,” Poizner said in a statement. He said he would work with the governor and state legislators next year to pass bills needed to restructure State Fund’s board, management and business practices to “ensure that it operates lawfully and in a manner that is not hazardous to its policyholders, injured workers, creditors or the public.”

A financially healthy State Fund is a crucial part of California’s economy because it serves as an insurer of last resort, especially for small and medium-sized companies, which have a difficult time getting affordable, legally required workers’ compensation coverage, Poizner said.

A spokesman for Gov. Arnold Schwarzenegger said the governor’s office was reviewing the audit findings and was pleased that State Fund “is taking steps to improve its operations.”

The firm currently accounts for about a quarter of California’s workers’ compensation insurance market total annual premiums, ranging from a high of $7.6 billion in 2003 to $3.5 billion in 2006.

The fund’s new president, veteran insurance executive Janet Frank, said that she welcomed the insurance commissioner’s audit and that she already had begun to act on many of its findings. It “will serve as a clear road map as we continue our work to bring efficiency, transparency and accountability to State Fund’s operations,” Frank said.

Moves to tighten sales of group insurance are well underway, said State Fund spokeswoman Jennifer Vargen. The audit noted that contracts for the group sales “were poorly written, which allowed associations to provide minimal services and still be in compliance with their contract.”


Despite the large amounts of money, State Fund’s former management and board never completed any internal audits of fees paid to outside administrators of the group association programs.

State Fund sells a significant portion of its policies through group insurance programs, which were run by third-party, for-profit administrators as well as professional associations and trade groups.

The groups, such as the California Restaurant Assn., the Golden State Builders Exchange and other organizations of similar businesses, act as intermediaries between State Fund and policyholders.

It was the marketing by some of these groups that drew the attention of State Fund’s board as well as the auditors.

The marketing groups help State Fund find and screen more customers. The associations seek low-risk customers for the fund, and in turn those customers get a 6% discount on their workers’ compensation insurance premiums. The associations are then paid marketing fees based their volume.

State Fund, after undertaking “an exhaustive business review,” has concluded that the group programs, when done correctly, “produce value,” Vargen said.


The historical lack of openness at the nearly century-old agency has been the target of criticism from State Fund’s private-sector competitors, legislators, the state auditor’s office and regulators at the Department of Insurance.

State Fund operates in the competitive insurance market as an independent financial entity, even though its employees are civil servants and its five-member board is appointed by the governor.

The group association business and other State Fund programs and management practices, as well as the activities of current and former top executives, are part of the broad criminal investigation by the Highway Patrol, the state Insurance Department and the San Francisco County district attorney’s office.

State Fund’s board requested the criminal probe, which was announced in late July, after hiring an outside law firm to conduct an internal review.

The review led to the firings of James Tudor, the State Fund president, and Renee Koren, the vice president in charge of group sales, in March. In November 2006, board members Frank DelRe and Kent Dagg had resigned under pressure from the governor’s office.

DelRe was appointed by Democratic Gov. Gray Davis in 2003, and Dagg was appointed by Schwarzenegger, a Republican, in 2004.


According to the audit, “potential conflicts of interest were noted” with DelRe and Dagg. From 1996 to 2007, State Fund paid more than $140 million in group administrative fees to DelRe’s company, Western Insurance Administrators. During the same period, it paid $125 million to building-trades associations with which Dagg had a business relationship.

The audit said State Fund board minutes, which are confidential and not available to the public, indicated that the two men had no conflict of interest. Nevertheless, auditors stressed that “the fact that board members might have gained monetarily from the fund’s decisions creates the appearance of a potential conflict.”

Auditors further noted that the board on Oct. 1 decided not to renew its business with DelRe’s company. Neither DelRe nor Dagg responded to requests for comment Monday.