Board of Director’s Audit Committee Check List

Corporate Governance Suggested Check List for
Captives and Risk Retention Groups

John J. O’Brien JD, CLU, CPCU
A Professional Corporation
Attorney, Insurance Consulting, Expert Services
4862 Marshwood Drive
Hollywood, South Carolina 29449
843-571-0407


The purpose of this check list is to provide some informal guidance for corporate governance for board of director members who serve on audit committees of captives and risk retention groups. Audit Committees have been recommended for public companies since 1939 and pursuant to Sarbanes-Oxley since 2002, the operation and membership of audit committees of the board’s of public companies is carefully governed as the exclusive overseer of the retention and performance of the external auditor. It is suggested that with changes in corporate governance taking place in the regulation of risk retention groups and other discussions taking place amongst regulators concerning the independent status of captive managers who serve as board members of captives they manage that perhaps an audit committee of the board of these non-public groups is a good idea and certainly would stand the group in good stead in the eyes of the regulators. There is talk that the NAIC will soon adopt a corporate governance model regulation that will have many of the same characteristics of SOX. With or without an audit committee, this check list I believe could be useful to the board of a captive or risk retention group. Many of the following suggestions are contained in the Corporate Director’s “Guidebook” published by the American Bar Association and others are ones that I particularly like but that are not be found in other material.


The List

Select members of Audit Committee (carefully) – under SOX, each member must be independent and at least one member must be a financial expert. Look for members who are qualified but who also possesses the qualities of personal integrity and reputation, who exercise common-sense business judgment , and who are vigilant.


The Board and the Audit Committee should define their Core Values and communicate those Core Values. Unquestionable Ethics and Integrity.

Adopt a formal written audit committee charter covering:

the scope of responsibilities

how the committee will carry out these responsibilities

the outside auditor’s accountability to the audit committee

the audit committee’s responsibility to insure the independence of the

outside auditor

Select and retain the corporation’s external auditor and determine for each fiscal
year whether to continue or terminate that relationship.


Review and approve annually the external auditor’s compensation and the proposed terms of engagement, including the scope and plan of the annual audit.

Approve, prior to each engagement, any further audit-related or non-audit services to be provided by the audit firm, based on the committee’s judgment as to whether the firm is an appropriate choice to provide such services and whether the engagement, or the aggregate of such engagements, would interfere with the firm’s independence. Publicly traded companies under SOX might be prohibited from approving any non-audit services to be performed by the outside auditor.

Establish procedures to receive and respond to complaints or concerns regarding the corporation’s accounting, internal controls or auditing matters, including procedures for the confidential and anonymous submission by employees of any such complaints or concerns.

8. Serve as a channel of communication between the external auditor and the board
and between the senior internal auditing executive, if any, and the board.

Discuss the corporation’s procedures for issuing earnings reports to shareholders,
regulators, rating agencies or the financial press.

Review the corporations financial statements and management certifications with
management and the external auditor and discuss with them the quality of
management’s accounting judgments in preparing the financial statements.

11. Review and act upon any communications received from the external auditor.

12. Consider, in consultation with the external auditor, the adequacy of the
corporation’s internal financial controls, which among other things, must be
designed to provide reasonable assurance that the corporation’s books and
records are accurate, that its assets are safeguarded and that the reported
financial statements prepared by management are accurate.

13. Meet periodically with management to review the corporation’s major risk
exposures and consider with management, risk management programs, including
the reduction of present and future litigation risks, and procedures and policies
addressing legal compliance.


14. Review annually, all fronting and reinsurance arrangements to assure that
adequate coverage is being provided and that all contracts are in compliance and
accurately reflect exposures and responsibilities i.e. no side agreements.

15. Approves any related party transactions between the corporations and its officers
or directors, or their family members or enterprises they control

16. Establish or review policies and guidelines for expense reimbursements,
perquisites and other benefits provided to senior executives.

17. Do an annual self evaluation.




Latest revision : May 5, 2007

Expert Opinion Letter - Bad Faith Handling of Claim

JOHN J. O’BRIEN, JD, C.L.U., C.P.C.U.
A Professional Corporation
Attorney, Insurance Consulting & Expert Testimony
lionsthree@aol.com

March 10, 2008

XXXXXXXXX, P.C.
XXXXX Law Firm, L.L.P.
XXXXXXXXXXX
XXXXXXXXXXXXX

Re: XXXXXXXX Matter

Dear XXXXXX:

This will confirm that you have asked me to review a case in which you have represented XXXXXt. You spoke to me briefly over the telephone and on February 12, 2008, you sent me a packet of material which I have reviewed. I am an insurance attorney, consultant, teacher, practitioner and expert. I have been offered as an expert in insurance claims practices and bad faith issues in state courts and federal courts and have been accepted as such by those courts. Although I am an attorney, I hasten to add that typically do not see my role as an advisor on South Carolina law as I believe the lawyers and judges are completely competent to interpret and apply the insurance law of our state. I therefore offer my opinion as someone with experience and knowledge of best practices in the claims area and those behaviors and practices that are unreasonable and arise to bad faith.

Factually, I have determined that XXXXXXXX was involved in an automobile accident on February 13, 2006 where her vehicle was rear ended by a vehicle being driven by a XXXXXXXX. XXXXXX had stopped her vehicle for traffic when XXXXXX ran his vehicle into the rear of her vehicle. The police report indicates that he was engaged in a conversation on a cell phone at the time of the accident. It appears that the accident and any resulting property damage and personal injury were the result of the negligence of XXXXXX. This conclusion can be reached through a review of the police report alone. I also received a criminal record report from you documenting a fairly extensive criminal record and a poor driving record for XXXXXX. In addition, I received photos of XXXXXX’s vehicle and repair estimates. The vehicle sustained substantial damage and was determined that the cost to repair the vehicle would exceed the value of the vehicle.

I was also supplied with medical records of XXXXXX pertaining to the injuries suffered at the accident. It appears that XXXXXX was treated the day following the accident by Health First Rapid Care. She was also treated by Palmetto Primary Care Physicians on February 16, 2006. She presented herself for initial evaluation to Craig D. Harris, MD, PA on February 20, 2006. She was experiencing pain as severe as 9 on a scale of 10 and she had been controlling pain since the date of the accident by medication. The diagnosis was cervical sprain, thoracic sprain and lumbar sprain. She had a previous history of sacroiliac pain that was exacerbated by the motor vehicle accident. I had the opportunity to read the treatment narrative prepared by Dr. Harris.

Those reflect that the pain experienced by XXXXXX continues through May of 2006 and that the doctor cannot rule out a more serious injury such as disc hernia ion/protrusion or other disc abnormality. I also reviewed the records of Southeastern Spine Institute as well s the records of Trident Pain Center, Summerville Medical Center and Charleston Neurological Associates. It appears that I have all the medical records of XXXXXXX relating to her treatment for injuries that resulted from this accident. Obviously, the facts of the accident and the treatment or medical records are important for the insurance company to have to compensate a claimant for his loss.

It appears that XXXXXX was insured by XXXXXXXXX Insurance Company and that his insurance policy had a policy limit for third party damages of only $15,000. You have sent me copies of correspondence from you to XXXXX and to his insurance company. Apparently, you were hired by XXXXXX shortly after the accident because I note that you correspond with both XXXXXX and XXXXX on February 22, 2006. In the letter you indicate that you will be sending a demand letter after you have documentation of your client’s claim. XXXXXX was aware of the claim since they interviewed XXXXXXX on February 15, 2006.

My review of the correspondence demonstrates that on July 13, 2006, you did send a demand letter to XXXXXXXX to the attention of XXXXXX. That demand letter seems well documented as to the condition and damages of your client as a result of the accident. Granted, you are advocating for your client so you are putting your best foot forward but in any case it is clear at this juncture that the insured driver is clearly at fault, that your client has suffered a serious injury requiring continued medical treatment, that she continues to miss work as a result of the incident and that her job pays well and requires considerable physical exertion since she drives for U.P.S. At this juncture, it appears that you do not know the policy limits. You do offer to settle the claim for the policy limits. Your offer is to settle the claim for the lesser of policy limits or your demand of $174,963.84. You indicate your intent to pursue an underinsured motorist claim on behalf of your client. It appears that XXXXXXX of XXXXX has been involved in the case from the initial accident up through trial based on my reading of the file.

You point out in your letter that punitive damages could be awarded in this case in view of XXXX’s responsibly and past record. I understand that the policy limits were only $15,000. The reasonable response to your demand in view of all the circumstances of this case and the information which the insurance company had in July of 2006 would be to tender the policy limits. The insurance company owes a duty to the insured to protect the insured’s interest. The insurance company is required to act reasonably under the circumstances presented. In my opinion, the insurance company did not act reasonably in view of the information presented to them and having the opportunity presented here to settle the case for the $15,000 policy limits.

On August 9, 2006, you wrote another letter to XXXX which contained the results of the MRI as bulging discs and stated that the medicals had then reached $13,292.58. Once again, you offered to settle the case for policy limits. At this juncture the insurance company would have been aware that the policy limits were only $15,000 and that the medical bills were nearing that.

Clearly, it was unreasonable and negligent behavior for the company to not tend the policy limits in the case. Your handwritten note on the copy of the letter that I have was that there was no offer or response to your two prior letters and it was a big case and you would be filing suit. You sent the original letter with the note to the insurance company. Still no response was received. Again, in my opinion; the insurance company through its behavior violated the duty of good faith that it owes to its client. There was a clear opportunity presented to settle the matter for the policy limits and to avoid a law suit against their client and a possible verdict far in excess of the policy limits. This opinion is based on my experience and knowledge of what is reasonable as far as settling third party accident claims. Here without going into much investigation at all, there was a clear case of liability, medical expenses alone without considering loss wages, pain and suffering and permanent injury that made the acceptance of your offer the reasonable choice. Ignoring that offer amounted to a breach of the duty the insured company owed to XXXXX in my opinion.

It appears that you filed suit on September 14, 2006 and had the complaint served. On September 12, 2006, you had mailed a courtesy copy of the complaint to the insurance company. The filing of the law suit did not cause the insurance company to tender their policy limits. In fact, an attorney was hired by the insurance company to answer the complaint. You wrote the attorney on January 9, 2007 and sent him medicals now totaling over $16,000.00. At this point it appears that you have learned that the tortfeasor only carried a minimum $15,000 policy and you reiterate your offer to the insurance company to settle for that $15,000. You notified the carrier of the possibility of an excess verdict and in fact, made a note on the letter that the adjuster would have a lot of explaining to do when a large verdict is returned on this case. The reasonable position to take at this juncture would be to settle the case for the $15,000 policy limits and not subject the insured to a law suit.

Medical costs continued to elevate in the case and in March of 2007, medicals had reached over $44,000 and these specials were faxed to the insurance company’s attorney. Despite this situation, the insurance company did not respond to your offer to settle within policy limits. The seriousness of the injuries was also covered during the deposition of February 1, 2007 of the defendant. There was a continuation of your client’s deposition scheduled for February 1 and there is a position taken by the attorney hired by the insurance company that he needed additional time to have you send him medical records. I cannot testify as to what went on there but in any case, it is very clear that any reasonably prudent claims adjuster would have concluded with the information in hand in February of 2007 and in fact, several months before that, that it was reasonable to settle the case for the policy limits. In fact, the insurance company did not come around to offering the policy limits until two weeks before the trial scheduled in October of 2007. The case went to trial and a verdict entered for $65,000.00.

The facts available early on in this case clearly show a case of one hundred percent liability. The question then remains is what is the extent of the injured party’s injuries. The insurance company knew that your client was injured because they were advised of this when they interviewed her two days after the accident. You did a very credible job of supplying them with information where they could weigh the seriousness of those injuries. The background of their insured and driving record of their insured would increase the chances of a large verdict. While medical expenses are not the only consideration to look at in evaluating a claim, when those medical expenses come near to the amount of coverage, it is a reasonable position to offer the policy limits. It is negligence or in some cases reckless, to subject an insured to an excess verdict. I cannot in my opinion see any reason why the full policy limits were not offered within the time frame you were prepared to accept them because within that time frame, the facts and the material that the insurance company had in its possession would dictate that any reasonable and prudent claim person would tender the policy limits. Given your client’s injuries, it was obvious that any verdict would exceed the policy limits and that is what happened. Appraising the circumstances surrounding the accident and the history of the insured, there was no chance that the verdict would not be in favor of your client.

While I said that I do not offer testimony in the law, I believe that under the circumstances the law in South Carolina would require the insurance company to pay the claim since it was unreasonable for them not to settle. Clearly, waiting to make the offer to settle on the eve of the trial is not good faith but smacks more of bad faith since there was no reason for the delay. Also, in this particular case, ignoring the opportunity to settle could arise to intentional bad faith behavior.

It is my understanding that you simply wanted my written opinion; however, I would be available to testify or for a deposition if needed.

Very truly yours,



John J. O’Brien

Expert Affidavit - CGL Policy Coverage Issue

IN THE UNITED STATES DISTRICT COURT


Essex Insurance Company, )
)
Plaintiff, )
)
)
) Civil Action Number:
Vs. )
)
)
Erskine Cooley, Clarence Cooley, )
Cooley & Son et al. )
)
Defendants, )


RULE 26 (a)(2)(B) DISCLOSURE OF EXPERT
TESTIMONY OF JOHN J. O’BRIEN JD, CLU, CPCU

PERSONAL BACKGROUND

I am an insurance professional with considerable insurance experience in both personal lines and commercial lines insurance including commercial general liability lines. This experience ranges from education, teaching, work experience both in the field as an agent as well as in home offices of insurance companies and in addition in the management of insurance companies as CEO of my own insurance management company. My experience is reflected in the curriculum vitae which is attached and made a part of this document as Exhibit “A.”

In addition to my training as an attorney, I hold the two highest credentials
conferred both by the life and health insurance industry as well as the property and casualty insurance industry, namely, the Chartered Life Underwriter designation and the Chartered Property and Casualty Underwriter Designation.

In the area of insurance policy interpretation particularly in commercial general liability, I have participated to drafting these policies, studied them as part of my insurance training, taught classes regarding said policies, and been recognized as an expert on commercial general liability policies by various courts of law. I am familiar with the major treatises on commercial general liability policies and the commercial general liability polices of the Insurance Services Organization.

4. I have acted as a consultant in the area of commercial general liability
language, policy service and claims.

As owner of Charleston Captive Management Company during its operation, I dealt almost exclusively with commercial lines of insurance and their governance and compliance and served in the design and insurance of commercial risk. My team and I designed commercial insurance products on a national scale including, policy language, cancellation provisions and exclusions.

As an insurance attorney and through many years of insurance law practice as well as expert testimony and teaching, I am knowledgeable in the rules of insurance contract as well as insurance contract interpretation. Although I will refer to court opinions in my opinions, I do so to highlight analogous situations to the case before the Court and not as a lawyer would to establish precedent. I recognize that the Court does not require an industry expert to determine legal issues.

In addition to the background pointed out above, I am familiar and knowledgeable with the operation of a commercial lines insurance company and how one would operate in compliance with commercial insurance regulation and service providers they rely upon for guidance as to state by state compliance, policy language, and policyholder service forms and requirements. This includes an organization know as the Insurance Service Organization (ISO).

I have been accepted as an insurance expert by the state and federal courts
in South Carolina.

I have been retained by the Defendants’ counsel to assist the court in certain
areas of this case where my knowledge and experience might be beneficial.



NATURE OF OPINION EXPRESSED

I have been asked to express my opinion or opinions on the coverage
provided by Plaintiff insurance company’s commercial liability insurance
policy. This assignment will, I believe, entail my utilization of information,
experience, training, and practice from the disciplines of insurance law and
practice as well as from the insurance profession and industry standards
and customs and usage there. I consider myself qualified to assume this
responsibility.




INFORMATION CONSIDERED IN REACHING OPINIONS

The information supplied to me by counsel appears to be all the pleadings
and discovery of the case to date. I have on my own reviewed case law from
around the country, law reviews and treatises, material of Insurance Risk
Management, various treatises such as Commercial Liability Risk
Management by Don Malecki et al., George E. Rejda’s Priniciples of Risk
Management and Insurance, the Insurance Professionals Policy Kit and
other materials. Where I thought it might be helpful to the Court, I have
referred to various industry materials to support the opinions that I have
reached. Additional information and/or documentation might cause me to
modify my opinion but at this juncture, I cannot foresee what that
additional information could be.



BACKGROUND IN SUPPORT OF OPINION

I think it is important that the Court understand that almost uniformly, the
property and casualty insurance industry employs forms and rates
supplied by an organization know as the Insurance Service Organization.
It will be helpful to see how commercial and personal lines are delineated
by the Insurance Service Organization. These distinctions are uniformly
accepting by the insurance industry, regulators and insurance attorneys.

The personal lines insurance policies offered to the industry include
personal auto, homeowners, dwelling and personal inland marine. These
forms encompass the personal lines of insurance. These are the types of
insurance policies offered to individuals to cover real and personal
property. Commercial lines are those policies offered to businesses to cover
the property and liability of the businesses. Any coverage provided to
individuals under personal lines would be excluded under commercial
lines. The commercial policies offered by ISO include commercial auto,
crime, boiler and machinery, farm, commercial fire, general liability,
professional liability, inland marine, business owners, employee related
practices, market segments, commercial liability umbrella, capital assets
(output policy) and management protection.

I was first contacted to offer an opinion in the companion case of Mosley,
et al. v. Cooley, et al. The fact situation of that case as I understand it was
that Sonya Mosley and Aaron Stoddard owned a house with the address of
438 Speedway Drive, Fountain Inn, South Carolina, 29644. They
contracted with Cooley and Son House movers to have the house relocated.
Movement of the house apparently required that the house be cut into two
sections. After the house was relocated it was not put back together or
placed properly. I noted it was mentioned that someone else was supposed
to cut the house but that Cooley undertook to do this work himself. This
may have been outside of his normal operations as a house mover but was
part and parcel of the activities that would be covered by his insurance.

The scope of damages to the house included not properly repositioning the
house resulting in it being structurally unsound, sustaining major rain
damage because the house was not properly protected from the elements,
removing and not replacing support beams resulting in an unleveled floor
system and sagging of the roof.

Apparently the original contract to move the house was entered into on or
before July 25, 2006. The pleadings reflect different versions as to who was
responsible for various parts of the house move. In this opinion, I have not
made any determination of fact concerning these matters. I suspect that the
activity of house moving in itself is one where, because of its nature,
damages to the house structure and interior are likely to occur even when
the best practices are employed.

It was my understanding that Cooley and Son insurance company claimed
that the commercial general insurance policy did not provide coverage. At
the time I was asked to offer an opinion, I did not know if the insurance
company was relying upon a particular exclusion in denying coverage.

As an insurance expert, for purposes of determining coverage, duty to
defend and duty to indemnify, I typically review the pleadings and the
insurance policy. It appears that plaintiff has set forth a factual scenario
that included elements of negligence in not properly cutting the house, in
not provide sealing and covering to prevent rain from entering the house, in
improperly removing and not replacing interior supports, and not properly
setting in the house at the new location.

I was provided with a copy of the insurance policy issued to Cooley. I
reviewed the policy to see if the policy should provide coverage for the
damages to the house. The policy is written by Essex Insurance Company.
Essex is a wholly owned subsidiary of Markel Corporation. Markel
underwrites specialty insurance products nationwide. Essex is an excess
and surplus line carrier marketing light to medium loss exposures
specializing in general liability, product liability, property and tough- to-
place and unusual exposures.

Coverage will be determined based upon the four corners of the insurance
policy and perhaps the intent of the parties under the rules of
interpretation universally accepted by the courts in the interpretation of
insurance policies. Those rules of interpretation provide that the policy is a
contract of adhesion and must be interpreted to provide coverage whenever
there is ambiguity.

The policy is described as a commercial liability policy. The dec sheet
describes Cooley House moving as the Named Insured and Item 4 describes
Cooley’s business as “House Moving. It is significant that the business
description and the name of the insured disclose that the business of Cooley
is to move houses and all that that activity entails. The policy is designed as
a special lines policy that a person involved in house moving activities
would view as providing coverage for the risks inherent in his particular
business.

The Supplemental Declarations set forth the policy limits which are
essentially set at $300,000. This section provides after Products Completed
Operations Aggregate Limit the word “Excluded.” This is intended to
connote that there is no coverage for completed operations and it is a
standard provision.

The insurance policy describes the hazard insured against as “Building
Structure- Raising or Moving.”

The commercial general liability policy used by Essex is essentially the
Insurance Service Properties form. The insuring agreement duplicates that
form and would provide coverage for property damage caused by an
occurrence (accident) that takes place in the coverage territory unless
specifically excluded.

Without addressing the specific exclusions of the ISO form, in my opinion,
the policy would cover damages that result from occurrences during the
performances of Cooley’s house moving activities. The term occurrence is
important because if there is an occurrence that causes damage, then there
will be coverage.

It is important to note that Cooley is actually engaged more in a service
industry rather than in producing a product. He is not a contractor that
improves a property or constructs a property; rather, he moves houses.
The insurance he purchases should provide coverage for mishaps that occur
when Cooley pursues house moving operations while recognition is given to
the fact that the insurance company is not a guarantor of the good
workmanship of Cooley nor does the insurance company provide coverage
for breach of contract. Generally, a liability policy provides coverage for
only certain activities or sources of liability. Two approaches are possible:

Comprehensive liability insurance covers all activities or sources of liability
that are not specifically excluded.


Specific liability insurance contracts state the activity or source of liability
that is covered.

It is noteworthy that the policy specific referred to the activities that the
parties intend to cover, namely, house moving and it is also significant that
the company that offers the coverage is engaged in special lines business or
makes its markets by providing coverage designed for specific industries.

Faulty workmanship arising out of breach of contract is not generally
covered under a general liability policy; however, under a completed
operations hazard, accidental harm caused to other’s property by the
defective work product is covered.

Generally, there might be an argument that the cost to correct the work is
not covered. In the Cooley case that I reviewed, it appears that the damages
are substantially related not to the cost to correct the work but the cost to
repair and replace damages that resulted directly from the operations of
Cooley. Examples of this would be the extensive water damage cause by the
failure of application of material to protect the house from the elements and
the sagging caused to the house by not placing it properly and not
repositioning the interior supports. So for example the cost to replace the
interior supports would not be covered; however, the resulting damage
brought on by the negligent placement of the supports would be covered.
The claims for moisture damages here are not claims for the costs of re-
protecting the house but instead claim to repair the damages to the house.
These are not corrections to the work product of Cooley but are instead
damages caused to the property of another brought on by an occurrence,
i.e. the introduction of the elements into the interior of the house and these
damages were proximately caused by the negligence of the insured.

Also in my opinion I did entertain the notion as to whether Cooley, because
of the declarations sheet language, viewed this as a builder’s risk policy that
would have application in precisely the situations we have presented here.
The risks insured against were the risks presented in house moving. I
would suspect that Cooley felt that this was the type of coverage he was
buying.
Exclusions are part of the ISO policy. Those exclusions generally include:
Expected or intended injury;
Care, custody, or control exclusion;
Owned, rented, or occupied property exclusion;
Exclusion of property loaned to the named insured;
Exclusion of that part of the work on which operations are being performed; and
Exclusion of that part of the work that must be replaced because of faulty
workmanship on it.

Tort liability is not excluded. Although negligence is not specifically
mentioned, it is covered by the ISO commercial general liability form where
the insurer promises to: pay those sums that the insured becomes legally
obligated to pay as damages because of “bodily injury” or “property
damage” to which this insurance applied…The “property damage” must be
caused by an “occurrence” and occurrence is defined in the policy as: “an
accident, including continuous or repeated exposures to substantially the
same harmful conditions.”

When initially retained I was informed that the insurance company claimed
that the damages to the Stoddard property was excluded under Cooley’s
policy although there was no letter from the insurance company setting
forth the exclusion the insurance company was relying upon. Consequently,
I reviewed the exclusions of the policy and make certain assumptions that
the insurance company might be relying upon that exclusion and then
addressed it.

The exclusion section of the insurance policy begins on page 2. Subsection
J contains the damage to property exclusion. The sections that might apply
are sections (5) and (6) which generally provide for no coverage to damage
to particular parts of real property where the insured is performing
operations and where the damage results from the operations. The damage
to product or work would not apply because the insured is not a contractor
that has manufactured the house.

A careful reading of the remaining parts of the insurance policy does not
demonstrate the existence of any exclusion that would apply.

This property damage exclusion would not apply because of its broad form
nature but also because the damage to property and damage to work
exclusions are eliminated by the addition of a combination contractor’s
endorsement. This is essentially an effort to provide coverage for a
contractor by modifying a commercial general liability policy rather than
having a stand-alone builder’s risk policy. The intent is to provide
coverage for negligent acts of a contractor like Cooley but not to become a
guarantor of his work.

The endorsement redefines “occurrence” to not include “defective work,”
defective workmanship, defective construction and negligent construction.
Again, in my opinion, the intent of this language is to preclude claims
relating to the work product of the contractor and have the insurance
company become a guarantor of the contractor’s work. It should not be
read to eliminate any coverage where the insured is pursuing his livelihood.

The history of the CGL policy is that pre-1986 damage to property that the
contractor was working on was excluded and then in 1986, this was
broadened and only the part of the property that the contractor was
working on was excluded - thus coverage was provided for the remaining
part. The underlying Cooley policy has the broad form post -1986
language. The contractor’s endorsement on the Cooley policy specifically
deletes the damage to property coverage; however, this is not an attempt to
restrict the coverage to pre-1986 treatment but instead should be viewed as
an expansion of coverage with specific terms to demonstrate and govern
how it would be applied to the activities of a house mover. For example,
coverage will not be provided if the insured does not check for weather
prior to opening a roof, water that comes from a broken pipe is excluded
and movement of the house while it is actually up on the vehicle moving it
is excluded. The use of the terms “water” and “rain” have significance. The
intent is to exclude water that leaks from devices or backs up from
plumbing systems and to exclude rain that is admitted say from open
windows. Attempts to eliminate rain that enters a structure because of
negligent efforts at preventing its entry would require a specifically worded
exclusion. The definition of occurrence is further modified but only to
reiterate that the insurance company is not a guarantor of the
workmanship of the insured. It is clearly the intent of the parties that
consequential damages that stem from the work of Cooley unless
specifically excluded are intended to be covered. Otherwise, there would be
no coverage provided by the policy at all. The coverage description
provided is not unlike the coverage discussed in a treatise on the CGL as
follows:


“Burlington cites Ohio appellate cases from the First and Eleventh
Districts to support its position. In Heile v. Herrmann,136 OhioApp.
3d, 351,736 N.E. 2d 566 (1st Dist. 1999), where the definition of
"occurrence" was identical to the definition at issue, the court held that
"defective workmanship is not what is meant by the term 'accident' under
the definition of 'occurrence.'" Id. at 354. This conclusion is based upon the
principle that "policies do not insure an insured's work itself; rather, the
policies generally insure consequential risks that stem from [*6] the
insured's work." Id. at 353. The Heile court also explained that CGL
policies are not intended to protect business owners from "business risks,"
which are those risks that are the "normal, frequent, or predictable
consequences of doing business, and which business management can and
should control or manage." Id. In Rombough v. Angeloro, 1998 Ohio App.
LEXIS 3510, No. 97-L-131, 1998 WL 553148 (11th Dist. 1998), the court
found that a claim of failure to perform in a workmanlike manner did not
allege an accident, and therefore did not allege an occurrence. 1998 Ohio
App. LEXIS 3510,[WL] at *1-2. Under this analysis, CGL policies "do not
insure an insured's work itself; rather, the policies generally insure
consequential risks that stem from the insured's work." Heile, 136 Ohio
App. 3d at 353.
Burlington also cites cases from the Supreme Courts of Iowa and New
Hampshire, and courts of appeal from Michigan and Arizona. 1 These cases
support the argument that "mere faulty workmanship, standing alone,
cannot constitute an occurrence as defined in the policy, nor would the cost
of repairing the defect constitute property damages." US Fidelity &
Guarantee Corp. v. Advance Roofing & Supply, 163 Ariz. 476, 482, 788
P. 2d 1227 (1989).”


This logic is expressed somewhat in a South Carolina Supreme Court case
involving Bituminous Insurance Company. However even in that case the
Supreme Court noted:

“The CGL policy may, however, provide coverage in cases where
faulty workmanship causes a third party bodily injury or damage to
other property, not in cases where faulty workmanship damages the
work product alone.”

The Cooley case is clearly a case where the homeowner is claiming
that faulty workmanship by Cooley damaged his home.

The contractor’s endorsement in providing coverage for the house moving
activities, as I have already noted, attempts also to limit or eliminate coverage
from events that historically have cause great damage in the contractor’s and
builder’s risk field i.e. EIFs and failure to determine weather conditions before a
roof is removed and replaced. The provisions of subparagraph (g) in the Essex
policy for example are enlightening. Implied in the language there is that there
would be coverage for exposing the interior of a house during a roofing job but
creates an obligation on the part of the insured to check weather conditions and
to securely cover the open roof during operations.

One would normally expect that in a house moving exercise, structural damage
as well as water damage from weather conditions would be a normal part of the
risk insured against. The language of the contractor’s endorsement lends weight
to the position that rain caused by the contractor’s negligence is covered. Water
seepage from inherent structural deflects like plumbing and EIFS are not
intended to be covered. This is affirmed in endorsements to the policy as well.

It is noteworthy is that the combination general endorsement states that
coverage is limited to the “business description’ in the dec section i.e. “house
moving” and that also the endorsement excludes from coverage that period after
a building is set on mobile equipment for moving and begins to be removed
from the mobile equipment at the new location implying that any mishaps that
occur outside that period are covered.

There is an additional endorsement that excludes the products completed
operations coverage provided in the original policy.

I concluded under my original review that Cooley was provided coverage for
mishaps or accidents that involve house moving but that there is no intent to
cover faulty workmanship. The insurance company will not pay to redo the
work of the insured. Again, this is for the same reasons as under the original
ISO policy that the insurance company should not become a guarantor of the
workmanship of the insured.

Unlike the South Carolina Bituminous case, Cooley does not have an actual
physical product that he delivers. He has tools and machinery and people that
he applies to other people’s property in order to move that property to a new
location. As he performs these functions, accidents and consequential damages
can occur which stem from the house moving activities, either stemming from
faulty workmanship or not, and that is the specific risk that the insurance
company has described as how the premium was set and the risk intended to be
insured. The Court must not lose sight of the fact that Cooley purchased
insurance and the insurance company sold him insurance that was intended to
cover bodily injury and property damage that were proximately caused by any
claimed negligence of the insured.

Subsequent to my original opinion, I have received a copy of the declaratory
judgment action filed by Essex Insurance Company. This document specifies
the exclusions that Essex Insurance Company is relying upon. They can be
summarized as follows:

1. Defective workmanship is not caused by an occurrence;
2. Contractual liability is excluded;
3. Defective work (your work) is excluded;
4. That particular part of real estate on which you are working is
excluded;
5. Invasion or existence of water and damage suffered in the course
of movement;
6. Again, the repeat of the damage suffered when the building is being
carried on a vehicle exclusion (the intent of this is to exclude situations
where other insurance might apply, i.e. commercial auto). This
exclusion is not applicable because the damage occurred after the house
was removed from the mobile equipment;
7. Leakage or overflow water exclusion; and
8. Pollution exclusion.

After reading all of these exclusions, my opinion is that coverage should still be
provided for the damage to the structure that was caused by the negligent actions
of the contractor or damages that can be traced to his negligence. For example if
he did not provide adequate protection – plastic or rain resistant material or did
not secure it properly, the resulting water damage is covered. If he did not
provide proper supports or set the house incorrectly and this resulted in further
property damage to the Stoddard property, there is coverage.

I can agree with Essex that there is no coverage for correcting the workmanship
i.e. replacing the supports; that there is no coverage for damage to the house
while being transported; that the insurance company does not become a
guarantor of the contract of its insured but they do provide coverage for the
damages that result from their insured’s negligence; that damage to the particular
part of real estate that is being worked on i.e. the contractor breaks windows or
doors while exerting too much pressure reinstalling them; that there is a
pollution exclusion but that it has no applicability in this case; that under certain
conditions water damage is excluded but that limited exclusion should not be
relied upon to state that the damage suffered by the Stoddard’s property caused
by the negligent placement and protection of the property is totally excluded.

Specifically, on the last point of water damage, if the ISO form intended to
exclude any and all rain damage or exposing third parties house negligently to
the elements, a specific exclusion clearly stating that would have to be drafted.
Essex seems to be claiming that the limited accidental discharge of water
exclusion would exclude coverage in this case.

The ISO material and International Risk Management material relates that the
limited water damage exclusion relates to: a. Flood, surface water, waves, tidal
water, overflow of a body of water, or spray from any of these, whether or not
driven by wind. Water which backs up through sewers or drains or which
overflows from a sump . Water below the surface of the ground, including
water which exerts pressure on or seeps or leaks through a building, sidewalk,
driveway, foundation, swimming pool or other structure and Water emanating
from appliance and the like.

This exclusion eliminates coverage of liability caused by various forms of water
damage at scheduled premises or at other premises from water discharges that
originate at the scheduled premises or from other related causes. Specifically,
the exclusion applies to leakage or overflow from plumbing, refrigeration, or
heating and air-conditioning system, appliances, or automatic sprinkler system.

Also excluded is damage caused by the collapse of a tank or other components
of a sprinkler system and damage caused by rain or snow that enters the
building through structural defects or open doors or windows.” The exclusion
does not apply to the damage suffered by the Stoddard’s.

Typically the exclusion specifies that it would apply to property owned by the
insured or occur from property owned by the insured:

"(m) under coverage B, with respect to division 1 of the Definition of
Hazards, and under coverage D, to any of the following insofar as any of
them occur on or from premises owned by or rented to the named insured
and injure or destroy buildings or property therein and are not due to fire: * *
(3) rain or snow admitted directly to the building interior through defective
roofs, leaders [***5] or spouting, or open or defective doors, windows,
skylights, transoms or ventilators.”

The reasoning used by another court in finding coverage under business
risk coverage for damage caused by rain is worth reading as it demonstrates
the reasoning applied by Courts to arrive at the conclusion that in analogous
situations, in applying the terms of a commercial general liability policy, an
occurrence or accident that is covered by the insurance policy was proven.
This is contrary to the Essex position that appears to be that there was no
“occurrence.”

“The evidence discloses that appellant commenced the roofing operations
on the Glover residence on the morning of October 16, 1956, and finished
on October 18, 1956. Appellant started working at approximately 7:30 or 8:00
A.M. on the morning of October 16, 1956, and about that time on said date he
telephoned the Weather Bureau and inquired if there was any reasonable
amount of assurance that there would be no moisture in sight for at least 24 to
30 hours. The Weather Bureau said "there is no rain in sight" and appellant
testified that the weather was clear at that time. Appellant also testified as to the
day of October 16, 1956, saying "It was a dry warm day and the sky was clear."
Appellant left the Glover operation about 5:00 P.M. and later about 6:30 or
7:00 P.M. on October 16, 1956, he telephoned the Weather Bureau again to
ascertain the forecast at that time. Appellant testified "it was the same forecast,
no rain in sight." On the night of October 16, 1956, or the early morning of
October 17, 1956, the rain occurred and the Glover residence was damaged.
Appellant testified on cross-examination that showers in October do not occur
too often, but in the summertime in July and August he has seen it happen quite
frequently. Appellant "considered October a pretty safe month for roofing in
this country," but that it did occasionally rain. Although it is not in the record,
the calendar for the year 1956 shows that October 16 fell on a Wednesday and
October 17 was Thursday.

The word "accident" is not defined in the insurance policy.

Appellant raises two points upon which it relies for reversal: (1) That the trial
court erred in granting appellees' motion for directed verdict for the reason that
a prima facie case had been made out by appellant; and (2) that it was error to
dismiss count two of appellant's complaint. Appellant contends that under the
factual situation in this case and the law applicable thereto, that appellant was
covered under its policy of insurance.

It has been held that where the term "accident" is not defined in the policy, the
term must be interpreted in its usual, ordinary and popular sense. M. Schnoll
and Son, Inc. v. Standard Accident Ins. Co., 190 Pa. Super. 360, 154 A.2d 431.

The term "accident" has been variously defined. In United States Mutual
Accident Association v. Barry, 131 U.S. 100, at page 121, 9 S.Ct. 755, at page
762, 33 L.Ed. 60, "accidental" is defined as meaning "happening by chance,
unexpectedly taking place, not according to the usual course of things, or not as
expected."

In Ocean Accident & Guarantee Corp. v. Penick & Ford, 8 Cir., Iowa, 1939, 101
F.2d 493, 497, the court said:

“In determining the meaning of the term 'accident', as used in this policy, the
question is not what it might mean to a scientist or one skilled in the subject
involved, but what it means to the average man. Lewis v. Ocean Acc. &
Guarantee Corp., 224 N.Y. 18, 120 N.E. 56, 7 A.L.R. 1129; Massachusetts
Bonding & Ins. Co. v. John R. Thompson Co., 8 Cir., 88 F.2d 825. Unless some
technical meaning was obviously intended, the words 'accident' and 'accidental'
should be given the meaning they impart in common speech. Lickleider v. Iowa
State Traveling Men's Ass'n, 184 Iowa 423, 166 N.W. 363, 168 N.W. 884, 3
A.L.R. 1295 * * *."

Webster’s New International Dictionary, Second Edition, Unabridged, defines
“accident” as follows:

"1. Literally, a befalling. a An event that takes place without one’s
foresight or expectation; an undesigned, sudden, and unexpected event.
'Of moving accidents by flood and field.' b Hence, often, an undesigned and
unforeseen occurrence of an afflictive or unfortunate character; a mishap
resulting in injury to a person or damage to a thing; a casualty; as, to die by
accident. c Chance; contingency.”

This court, speaking through Chief Justice Brice, in Stevenson v. Lee Moor
Contracting Co., 45 N.M. 354, 115 P.2d 342, 350, after reviewing many
authorities, including the English cases, stated:

"We are satisfied with the conclusions of these courts, and hold that
‘injury by accident' means nothing more than an accidental injury, or an
accident, as the word is ordinarily used. It denotes 'an unlooked for mishap,
or an untoward event which is not expected or designed.'

Citing Fenton v. Thorley, (1903) A.C. 443.



We also said in the Stevenson case:

"The test as to whether an injury is unexpected and so if received on a
single occasion occurs 'by accident' is that the sufferer did not intend
or expect that injury would on that particular occasion result from what
he was doing. The element of unexpectedness, inherent in the word
'accident' is sufficiently supplied either if the incident itself is unusual,
the act or conditions encountered abnormal, or if, though the act is usual
and the conditions normal, it causes a harm unforeseen by him who suffers
it."

My professional opinion is that is that while some of the exclusions might have
application on the Stoddard claim for example the correction of work performed
and might cause an adjustment in damages, none of the exclusions preclude
coverage. There is coverage for negligence and thus there was an occurrence
resulting in loss. Water damage claims caused by negligence of contractors in
not properly securing roofs are standard claims to be expected under a
commercial liability policy as are faulty workmanship claims where the claim is
not to cover correction of the faulty workmanship but claims for the damages
caused by the occurrence of the negligence and the resulting damage to a third
party’s property. The fortuitous event was the unforeseen and unexpected
damage that resulted from the negligence of Essex’s insured. Cases from other
domiciles are worth noting. In First Texas Homes, Inc. v. Mid-Continent
Casualty Co., Texas federal court held that allegations of negligent workmanship
were broad enough to allege an "occurrence," thereby giving rise to the duty to
defend. In this case, a homeowner sued his builder, First Texas, alleging that the
home was not constructed in a good and workmanlike manner and that the
foundation was insufficient. First Texas' insurer, Mid-Continent Casualty
Company, refused to provide a defense on the grounds that the petition did not
allege an occurrence under the policy. "First Texas then filed [a] declaratory
judgment action to determine the respective rights and duties of the parties under
the policy."

“The issue in the declaratory judgment action was whether the insurer had a duty
to defend First Texas in the underlying litigation. The policy defined
"occurrence" to mean "an accident, including continuous or repeated exposure to
substantially the same general harmful conditions." The court noted that "courts
have interpreted the term 'accident' in this context to include damage that is the
'unexpected, unforeseen or undesigned happening or consequence of an insured's
negligent behavior.'" The court then looked to a Fifth Circuit decision holding
that "defective performance or faulty workmanship by the insured that injures the
property of a third party is 'accidental under this definition.'" The court noted that
"a builder who failed to abide by the specifications of a contract, for example by
substituting a weaker building material, may, by that breach, produce expected
property damage to his or her work, and may thus fail to show a covered
'occurrence.'" The court explained that "the relevant inquiry is not whether the
insured damaged his own work, but whether the resulting injury or damage was
unexpected and unintended."

“In this case, the petition alleged that the home was "not of proper quality and
was not designed or constructed in a good and workmanlike manner and that the
foundation was insufficient and resulted in a foundation and home that were not
properly designed or built." The court noted that the allegations were broad and
any doubts about whether the petition alleged a covered cause of action must be
resolved in favor of the insured. Thus, the court concluded that the broad
allegations could be construed to support a claim that the damages were neither
expected nor intended by First Texas.”

“What about coverage of damages resulting from the contractor's inadequate work
such as mold growth from improperly applied stucco to a home? In Ind. Ins. Co.
v. Alloyd Insulation Co., the Delaware Library Board alleged that a roof,
installed by Alloyd Insulation Co., ("Alloyd") was faulty due to improper
workmanship and that the defects in the workmanship resulted in rust and
corrosion. The court held that defective workmanship is not covered by a CGL
insurance policy but that consequential damages such as rust and corrosion are
covered because such consequential damages are fortuitous. Although the CGL
policy did not cover costs of having Alloyd rebuild another roof, the policy did
provide coverage for the clean up of the rust and corrosion, as those costs could
not have been anticipated from Alloyd's faulty workmanship.

Applying the analysis in Alloyd in the context of mold claims, it is likely that
courts would hold that costs to re-install stucco resulting from the original
improper application of stucco would be barred pursuant to the "Your Work
Exclusion" in the contractor's CGL policy. However, the consequential damages
to repair or clean up mold from resulting water damage would be covered in a
CGL policy.”

CONCLUSION

I do not have a complete file on the damage aspect of the case nor the
statements or depositions of the parties. With the material I do have and
although there are disputed facts, it appears that the substantial damage resulted
from rain mitigation and having placing the house on a surface where it was not
properly supported and related incidents such as a tree fall. It is incumbent
upon the insurance company to do a thorough investigation and adjustment of
this claim. Based on the material I do have it appears for instance that Cooley
did take steps to shield the house from rain and also that he felt that perhaps
someone else was responsible for establishing the proper level at the new
location. In any case without my going into a detailed claim analysis, these
damages appear substantially to be consequential damages resulting from the
movement of the house by Cooley and that coverage should be provided under
his house moving liability policy. The resulting damages were not expected. If
there are claims for correction of work that is alleged to be faulty then that could
be sorted out from the overall claim but overall, the claim is not one where the
insurance company is being asked to correct the faulty workmanship of its
insured or one where the insurance company is being asked to become a
guarantor of the work of its insured. Therefore, it is a claim arising from an
occurrence or fortuitous event that is not clearly and unambiguously excluded
under the terms of the insurance policy. My conclusion is that coverage is
provided under the Essex insurance policy for the claims of the injured
homeowners




______________________________
JOHN J. O’BRIEN JD, CLU, CPCU





Sworn to and subscribed before me this

_________ day of April, 2009.



____________________________________

Expert Case Opinion - Duties of Agent & Respondeat Superior

JOHN J. O’BRIEN, JD, C.L.U., C.P.C.U.
A Professional Corporation
Attorney, Insurance Consulting & Expert Testimony

255 Land’s End Drive (843) 737-2738
Charleston, South Carolina 29407 lionsthree@aol.com


January 29, 2009

XXXXXXXXXX
Attorney at Law
XXXXXXXXX
XXXXXX, Florida 34994

Dear Mr. XXXXXXX,

In reference to the case of XXXXXXXXXXXXXXXXXXXXXX et al, I have been asked by you to express my opinion or opinions on industry practices regarding hiring insurance agents, due diligence in the supervision of insurance agents, suitability of particular insurance products, the practices of “churning” and “twisting,” replacement of insurance products, the duty of an insurance company to monitor an insurance agent and measure the suitability of recommendations made to policyholders and activity in the client’s accounts. This assignment will entail my utilization of information, experience, training, and practice from the disciplines of insurance law and regulation, best practices in the insurance industry both in the field and in the home office and industry standards within the insurance industry and customs and usage there. I consider myself qualified to assume this responsibility.

I am an insurance professional with considerable insurance experience in both personal lines and commercial lines insurance including life insurance and annuity sales. This experience ranges from education, teaching, work experience both in the field as an agent as well as in home offices of insurance companies and in addition in the management of insurance companies as CEO of my own insurance management company. My experience is reflected in the curriculum vitae, which is attached and made a part of this document as Exhibit “A.”

In addition to my training as an attorney, I hold the two highest credentials conferred both by the life and health insurance industry as well as the property and casualty insurance industry, namely, the Chartered Life Underwriter designation and the Chartered Property and Casualty Underwriter Designation. The Chartered Life Underwriting Designation was conferred based on completion of five years of testing and training in areas of life insurance, annuities, product suitability, estate planning and law.

In the area of insurance regulation, I have participated in drafting insurance law and regulations in the state and at the NAIC level. I have drafted insurance product language and policy forms including life insurance and annuity forms. I am familiar with the legal and regulatory requirements that govern personal and commercial lines as well as life and health insurance. The National Association of Insurance Commissioners is the regulatory body that formulates and adopts model legislation that individual state insurance commissioners present for enactment in their individual states. I have participated in and I am familiar with this process and have been for the last thirty years.

I have testified and served as a consultant on the regulation and compliance of personal lines, life and health insurance as to policy language, policy service and claims. In addition, I have been qualified and testified concerning agent’s activities and licensing and suitability of insurance products. I am familiar with the high standards required for the recruitment and hiring of insurance agents and the duties to monitor an agent’s activities and ethical performance after hiring.

I have been trained in the various types and lines of insurance and have an understanding of the various segments of the industry, industry practices, marketing, service organization and the operation of commercial insurance companies from capitalization, regulation and operation and even through insolvency and run off. I am familiar with the traditional operations of life and health companies including sales and underwriting and agency administration.

I have been licensed as an insurance agent for sales of annuities, life insurance and variable annuities including NASD licensing. I have worked in the home offices of life and health insurance companies and advised the agency department on licensing and disciplinary issues involving life insurance agents.

I have participated in drafting replacement regulations and testified before legislative groups concerning their adoption particularly as they relate to suitability of insurance, annuity and investment products to policy holders and efforts to avoid twisting a consumer’s insurance and annuity programs.

As an attorney, I have worked with life underwriters and insurance agents on designing pension and investment and products for clients to meet a client’s estate planning and investment goals. I have also represented agents on disciplinary matters and represented insurance companies on issues involving agencies particularly in recovering agent’s commissions or debit balances. I have represented agents in matters before the insurance commissioner and administrative hearings.

I have taught insurance agents in the life and health insurance fields, worked with the American College in designing curriculum for life insurance agents and I am familiar with the qualifications and requirements for hiring and supervising insurance agents and the industry standards applicable thereto. I am also familiar with education material related to agency administration at the home office level offered by Life Office Management Association as well as educational materials and industry practices reflected in the curriculum of the Life Insurance Training Counsel, the American College and The Life Insurance Agency Management Association.

As owner of Charleston Captive Management Company during its operation I have developed business plans for insurance companies, formed companies, designed policy forms, licensed companies and worked with agents in licensing and offering products to third parties.

As an insurance attorney and through many years of insurance law practice as well as expert testimony and teaching, I am knowledgeable in the rules of insurance contract as well as insurance contract interpretation.

In addition, I am familiar and knowledgeable on compliance issues concerning sales and marketing material having reviewed same for insurance companies to assure compliance with state insurance statutes and regulations.

I serve on the boards of captive insurance companies, reciprocals, and risk retention groups as an independent director and member or chairman of the audit committee. As such I bring and promote high ethical standards within those companies. I have addressed industry groups on ethics and what motivates an individual and company to engage in behavior that is less than ethical. I teach the web based ethics course to insurance professionals in this company and abroad for the International Center for Captive Insurance where I also serve on the board of directors of ICCIE. I am an adjunct professor at the College of Charleston teaching a junior level course on Principles of Risk Management and Insurance including sales practices and consumer protection including twisting, rebating and licensing of insurance agents and brokers.

I have been accepted as an insurance expert by the state and federal courts.

I have been retained by you at the hourly rate of $300 to assist the court in certain areas of this case where my knowledge and experience might be beneficial. The information supplied to me by counsel appears to be all the pleadings and discovery of the case to date including all depositions taken in the cases.

It is my opinion that XXXXXXXXX should not have allowed XXXXXXXXXX to represent XXXXXXXXX in the sale of insurance and annuity products. In my testimony I will emphasize the high standards required of insurance professionals and the reasons for these high standards. The character of an individual who is given permission to represent a leading insurance company in advising customers and handling customer’s money should be beyond reproach for obvious reasons such as placing this individual in a position where that individual will be handling substantial amounts of a customer’s funds. I have concluded that XXXXXX at the home office level and in the branch office saw XXXXXXX as an extraordinary producer with a large circle of influence. It is my opinion that the criteria employed for the selection of agents should not fall influence to expectation of production numbers.

You have alleged in your complaint that:
The XXXX Companies should have known that XXXXXX was engaging in or otherwise had the propensity to engage in fraudulent conduct like that committed by him on the XXXXX. The XXXXX Companies knew or should have known that XXXX was not fit to be employed by XXXX based upon a myriad of factors, including but not limited to his own financial instability, trustworthiness and character. However, XXXX overlooked XXXX’s short-comings in order to bring in someone whom they considered a “big producer.”

My professional opinion would support your position. Based on my review of the pleadings and documents is that XXXX should not have hired XXXX based on the information produced at the time of application and that they should have removed him after that and that they should have known that XXXX was engaging in fraudulent conduct. His ethics are questionable in that he does not take responsibility at all for any of his actions. In my opinion he simply was not fit to serve as a XXXX representative. I cannot imagine that XXXX would attempt to rationalize and suggest that he was.

There are several areas of concern each, by itself and definitely taken together would be reason not to hire XXXX. These include his misrepresenting his education record, his being embroiled in a controversy with XXXXX Insurance regarding clients funds that were not applied and left in files and that a U5 could not be issued, a Choice Point credit report that displayed the fact that he had a history of not paying his bills, unpaid taxes, driving records disclosing twelve unpaid tickets leading to suspension of his driver’s license, and that he was subject to a complaint from a XXXXXX customer that he had misdirected clients funds to a company in which he had an ownership interest in. During the application process, it is my opinion that XXXXX placed too much credence on XXXXXXX’s explanations without going further in its due diligence inquiry. There is a pattern of explanation on almost every issue where XXXXX takes no responsibility and blames the problem on others. These are indications of at least rationalization on his part if not actual deceitfulness. At the very least XXXXXX should have questioned how the information they had gathered concerning his financial conditioned paired with a claim that he was a member of the Million Dollar Round Table. Members of that group usually are high-income earners and have control of their personal finances. XXXXX was embroiled in a controversy with the XXXXX Insurance Company regarding a client’s funds. The only explanation that seems plausible for XXXXX decision to hire XXXX seems to be that they were influenced by his claimed potential to produce business.

XXXXX seems to give credence to XXXX explanation on all issues rather than conducting an independent inquiry. For example, XXXX informs XXXXX that he was let go by XXXXXX because of a delay in XXXXX issuing a U5. XXXXX was investigating him at the time of his termination for possible fraud. It also appears that Choice Point National Credit Report discloses accounts that were not kept current and were in fact turned over for collection. Further inquiry and due diligence would have disclosed that taxes were also unpaid by XXXXXX.

The Choice Point Agency Series Employment Record discloses that twelve driving tickets were issued and that there is a pattern of not paying the fines. XXXXXXX is a very reputable company and had discharged the applicant because of the failure to receive clearance from XXXXXXXX according to XXXXXX. Further inquiry with XXXXX would disclose that XXXX had transferred funds of a XXXXXX customer without authorization to a company in which XXXX had an interest.

There is evidence even during the application for employment process of not taking responsibility for his acts. He was an applicant with a poor credit rating. He exaggerated his academic degrees. He was dismissed by a previous employer and his activities were under review. He had a questionable driving record. Clearly, considering the position that he was being paced in where honesty and integrity are of paramount importance, he should not have been hired.

Further investigation would likely disclose that XXXX had transferred funds and made trades without the customers consent. This was done while employed by his two previous employers.

The material indicates an applicant with a history of financial difficulties and a recent departure from XXXXXX and XXXXX. Due diligence would have suggested that further inquiry be made of these two companies particularly with a company like Vector One that investigates agents’ debit balances and related matters with prior companies.

Dishonest agents often engage in “churning” and “twisting” where they are constantly misrepresenting the actual costs of products, preying on a client’s other products and actually closing large amount of business but it is not good business or suitable business for the customer and there are typically charge backs on the agents account when the customer learns of the true facts and lapses the product. This practice is driven in part by large first year commissions.
Life insurance agents are placed in a superior position representing well-known and well respected insurance companies. It is sometimes difficult to make a new sale; however, clients might have money available in annuities, mutual funds and whole life policies. Dishonest agents make commissions on the sale or transfer of these policies when they replace or transfer them when such action is not in the best interest of the clients.

It appears that none of the information disclosed during the application process prompted XXXXX to engage in a more thorough review of XXXX’s application for employment but it should have done so.

Further investigation of the situation at XXXXXX was warranted. Failure to remit is a serious matter. Essentially, the applicant had a bad credit report, exaggerated his education history, had a dismal driving record and failed to properly apply clients’ monies. Despite all this, he was appointed as a XXXXXX Life agent on February 14, 2000.

Despite an application that called out at least for further due diligence and that reflected an applicant with questionable ethics, XXXXX was appointed. The relationship appears to gotten off to a rocky start and XXXXX became aware that tax liens were filed, that XXXX was a defendant in civil litigation involving a customer who claimed XXXXX had diverted funds to an account that XXXXX had an interest in, and that XXXX was misrepresenting himself as a financial advisor. In addition he was using unapproved marketing material that was not reviewed by his management or by corporate legal. XXXXX continues to not take responsibility for his actions, blaming his tax lien on his accountant. XXXX’s pattern of blaming others rather than himself reaches a high level in a letter dated June 1, 2000 to Healthy Woman Magazine where he chastises them for running an ad and asks for a retraction because the ad had not received clearance from XXXXX Life legal. Clearly, Healthy Woman would have received the ad from XXXX himself. Mr. XXXXX in view of this information and the information already in his file should have been dismissed or at least suspended and a complete investigation made. Instead, it appears that XXXXXX readily accepted XXXX’s own explanation on these new issues.

XXXXX began receiving significant amounts of money from XXXXX in late January and Early February of 2001. A withdrawal of $152, 908.61 from XXXXX Life is clearly indicated as a withdrawal from an annuity. These funds were used to fund the XXXXX Life purchases. Withdrawals from annuities in early years are not a good idea unless there is no other choice. The surrender charges are substantial. It appears that there was no oversight exercised on XXXXX on this transaction. Safeguards and checks should always be in place to make sure annuity clients understand withdrawals from annuities and the early surrender charge. XXXXX ignored this issue and freely moved money out of the XXXX annuity and put money into XXXXXX and then transferred it out of there for a fraudulent real estate investment. XXXXX should have had safeguards in place to assure itself that these withdrawals were with the consent of XXXXX. Carter and that he understood the consequences. Companies in situations where the agent is driving the surrender should always verify that full disclosure has been given to the client by a direct written or verbal contact with the customer. The withdrawals from XXXXX were substantial and early in the life of an index annuity when penalty charges would be substantial. The transaction should have caused an alert within the XXXXXX organization that required assurances that the customer was aware of what he was doing.

Copies of checks from XXXX disclose that annuities were being cashed in to pay into XXXXX. Surrendering annuities is not a good idea because of the surrender charges that a policyholder incurs in the early years because of the load factor and the nature of the annuity where the early individuals who pass on help fund the lifetime benefits of those who stay on. I suspect that there would be little reason to make this transfer as annuities performance with insurance companies are usually similar and the surrender charges would imply that XXXX lost money on the transaction. It is clear though that XXXXX made the transaction relying on XXXXX’s affiliation with XXXXXX Life a company of which XXXXX had a good opinion concerning. The indications are that the agent is engaged in twisting and was more interested in earning a commission than in taking action that was beneficial to XXXXXX. This is an indication that XXXX was engaged in the transactions that would result in high commissions but that were not in the best interest of XXXXX Life’s customers.

In addition the XXXXXX applied for two policies with XXXXXX Life. These policies were not suitable for the XXXXX and the annual premium was misrepresented. When the true facts were learned, then the policies lapsed but the XXXXX were out the premiums they paid. The commissions generated to XXXXX would be greater than XXXXX’s loss and the behavior represents a pattern of behavior that XXXXX was engaged in that should have been evident to XXXXXX Life and he should have been dismissed. The only motivation for such transactions was to derive placement commissions for him without regard for the benefit that the particular product had for his clients.

During 2001 and perhaps before, it appears that other problems began to surface including XXXXXX bouncing checks, negative balances in client’s accounts, XXXXX obtaining a loan from a trust client for the purchase of his home, disclosure that XXXX had check writing problems with XXXXX and that XXXXX Life had threatened legal action against XXXXX for return of $90,000 to XXXXXX Life, that two clerks had been sent over to review his files and the files were not in good shape and had to be brought up to date. XXXXX blamed this again on an assistant and not him. This is reminiscent of his explanation in regards the unapplied funds at XXXXXX. Also, it appears that XXXXX relied solely on an explanation of the situation at XXXXX Life by XXXXXX despite threats of law suits against XXXXX by XXXX and an actual complaint by a XXXXX Life client that XXXX had misdirected funds from XXXXX to an investment company that XXXX had an ownership interest in. Due diligence would require that XXXXXX explore the XXXXXX status of XXXXX more closely. It appears to me more than the simple delay in the R5 filing as XXXXX had used to explain his dismissal by XXXXX Life at the time of his hire. I have reviewed as part of my material a complaint filed by a XXXXXX customer against XXXXX and XXXXX alleging loss of over $600,000 of funds. It appears that XXX was engaging in fraudulent activities’ while serving as agent for XXXXX, XXXXX and XXXX. The information that XXX was engaged in personal loans from clients or client’s family members and that he might have directed a client to invest in a company that he had an interest in clearly deserved more due diligence and would be reason alone for termination.

Despite all of this information XXXX Life in 2001 seems to be satisfied that the problems with XXXXX relate to a misunderstanding of the XXXX Life system and disorganization. XXXXX Life seems to take responsibility only in so far as to chastise itself for not providing better training and monitoring when XXXXX was hired. Indications are very clear of churning, twisting, misuse of funds, personal financial problems, bad credit, recommending transactions that are not in the best interest of the client, lying, unpaid tax liens, misrepresenting qualifications, using unapproved advertising material, and a pattern of consistently not taking personal responsibility and blaming the situation on others whether it be previous employers, accountants, the IRs, clerks or even unsuspecting magazine editors. The point is simply that this individual should have never been unleashed on the investment public carrying the label of a company with XXXXXX Life’s stature. In my opinion, he should not have been hired and once hired when these problems developed, he should have been terminated. These patterns indicate that clearly where there is smoke, there is fire. The agent is placed in a fiduciary position where clients will deliver money to him based upon the reputation of XXXXX Life. XXX Life fosters this reputation thought their marketing and public relations campaign which sends a clear message that the client will be in good hands with XXXX Life. XXX has the highest duty of due diligence to assure itself that the individuals representing it will protect the clients and the client’s assets. In the area of financial and insurance products, it is difficult to imagine how a company would consent to hiring and retaining a financial and estate planning specialist when that person’s own house is in such disorder.

Rather than suspending XXXXX in 2001, a plan was developed by XXXXX Life to complete the year 2001. That plan made the blanket assumption, again based on what appears to be XXXX’s assurances, that a client’s attorney or accountant would always be involved in any dealings that XXXX has with a client. A clerk was assigned to work with XXXXX’s assistant to bring XXXX’s files up to date now that the files had been apparently organized. In addition, unannounced monthly visits were to be made to review XXXX’s overall operation.

I cannot find any evidence that this plan was actually carried out but there is evidence that the situation continued to deteriorate. If there were meetings established for XXXX to attend, it appears that he did not show up.

In addition at an early stage of the relationship, XXXX began to develop significant debit charges on his accounts. The compensation arrangements under life and annuity contracts are such that there is a significant load factor or first year omissions. Typically a first year commission on a life insurance contract could be as high as 90% of the first year premium. So for a million dollar policy, an applicant could pay only the first month premium of $3,000 for example and the agent receives a commission of $30,000. If the policy then lapse, it can cause a charge back in the agent commission account. A memo from XXXX in 2002 indicates that XXXXX had substantial lapses in 2002 and also indicates that XXXX is going through some “trying financial times.” Again, the situation is such that would call upon XXXX to assure themselves that their policyholders are being protected. Clearly, accounts should have been audited and action taken to put XXXX and his activities under supervision and/or suspension.

In addition XXXX was selling and servicing 419 plans and making checks payable to XXXXXXXXXX. XXXXX prohibits sales of 419 plans. Also there was evidence of checks written by XXXXXX customers to XXXXX’s personal marketing assistant. He was selling products that were not approved by XXXX. Checks were being written to companies other than XXXXX.

It is difficult for me to understand what XXXX was thinking in allowing XXXXX to continue to represent them. In 2001, instead of termination, he was placed under some type of supervision. However, whatever the plan was, it was not working, as to XXXXX. XXXXX continued to put him into unsuitable investments, sold him life insurance products that were unneeded and lapsed and moved his money out of an annuity into an unsecured real estate investment. (Transglobal). No body was providing oversight over XXXXX. All of this was under the guise of XXXX representing XXXX and that these were XXXX Life Products. The Transglobal investments were not secure and most were made by XXXXX without XXXXs consent. All the money was lost.

Deposition testimony particularly from agent XXXXX as well as XXXX indicates that XXXXX’s reputation was not good and that the volume of business he was writing was also not good business. XXXX had significant lapses in 2002 and was in arrears in July of 2002 in the amount of $98,000. XXXXX who supervised XXXX was questioning method of payments and movement of funds and wanted to make certain policyholders were being protected. This was all surfacing while XXXX was churning XXXXX’s accounts and investing his money in unsuitable investment schemes. XXXXX should have been suspended immediately.

In addition money was being paid to XXXXX Life care of other companies. Policies were being sold where the premium was equal to 50 % of a client’s annual income; sales of 419 plans were being made when XXXX prohibited sales of these products. Checks were being made out from customers personally to XXXXX’s personal marketing assistant, and XXXX had a 76% lapse rate in one month. Clearly XXXX was engaged in activities that were contrary to the best practices XXXX would expect of any agent. The situation called for immediate termination. It became so severe that XXXX worried that XXXXX in a remote location would destroy evidence. A letter of suspension was actually written. Surprisingly and quite frankly quite shockingly, XXXX was permitted to stay on. There is a detailed corporate internal audit report dated May 19, 2003. It reflects numerous company rules violations and additional information concerning tax liens, vehicles being repossessed and $90,000 vehicles being purchased to replace the repossessed vehicle and disclosure that a former client had filed a civil action that XXXX had moved a customer’s funds from XXXXXX to a XXXX Securities a company that XXXX had an ownership interest in. XXXXX seemed to be satisfied with XXXX offering no comment on the civil action. XXXX was also involved in the proceedings involving a former XXXXX XXXX client. It is disturbing that XXXX would accept a no comment response. The sum and substance of the audit report should have called for XXXX to be suspended. Instead, a corrective action plan was entered into. The plan seems to minimize serious issues and portrays XXXXX as being reinvented and entering new markets where his potential is to earn $500,000. Mention is made of specifically churches, Fulton County Sheriffs in Ga for 22 million and Philadelphia for 30 million. It appears that XXXX was willing to look the other way on its own rules rather than lose the money that XXXX promised to produce. I understand that the Fulton County, Georgia/ XXXX deal suffered a similar fate as XXXXX. Also some type of discipline was recommended but it appears nothing was ever done in this respect. It appeared that it was intended to be no more than a slap on the wrist.

It was not until early 2004, when XXXXX was caught red handed misusing client’s funds that XXXXX resigned the next day citing his mistreatment as the reason.

I continue to read material that you are providing to me. At this juncture, I am offering you this letter reflecting my opinion on the matters you asked me to review. I have not yet reviewed the depositions of any XXXXX or XXXXX Life personnel and I would like to supplement my opinion after obtaining that information.

Thank you for the opportunity to be of service.


Very Truly Yours,



John J. O’Brien JD, CLU, CPCU

Captive Consulting -Risk Retention Groups

Risk Retention Groups in a Nut Shell
Your Guide to Understanding RRGS

Compliments of John J. O’Brien JD, CLU, CPCU

History of the Liability Risk Retention Act of 1986


To some legal scholars back in the nineteen sixties, what Professor Dean Prosser was to the field of Torts, Professor Dix Noel was to the field of Products Liability. Dix Noel taught Products Liability at the University of Tennessee College of Law. It was an impressive experience for this writer as a young man to be trained by Professor Noel from the foremost treatise (Noel on Product Liability) in an emerging field of law.

Three times a week Professor Noel at the highest level of “case book” method escorted us from the doctrine of caveat emptor through negligence to the emerging doctrine of strict liability. As product manufacturer’s liability expanded, privity of contract fell by the wayside. Strict Liability according to Professor Noel “...extends not only to manufacturers but to all suppliers of chattels, such as retailers and wholesalers. Liability runs to all users or consumers, with no need to prove either privity of contract or negligence.” Strict Products Liability Compared with No-Fault Automobile Accident Reparations, Dix W. Noel, 38 Tenn.L. Review.

Punitive damages as a way to punish manufacturers of defective products was a new concept. We students speculated if a cigarette could be considered a defective product and we were encouraged to consider both sides of the controversy including the pleasure the consumer derived from smoking - citing the popular advertising slogan of the times: “Winston Tastes Good. Like A Cigarette Should.”

Years spent in the insurance and law fields have helped me understand how the breakdown of product liability tort law we learned in law school led to the insurance availability crisis of the mid nineteen seventies. Because their products were no longer sheltered by the protection of caveat emptor and because states were adopting uniform statutes imposing strict liability, product manufacturers were becoming anathema to the commercial insurance industry.

The insurance industry responded to the product liability risk crises by increasing rates, not renewing coverage, and avoiding policyholders that sold products the underwriters considered hazardous. These actions created a product liability insurance crises. During this same period the states of Vermont, Colorado, Virginia and Tennessee enacted captive insurance laws and suggested that industry employ alternative risk transfer strategies as a solution to the insurance crises. Manufacturers began forming captive insurance companies in theses domiciles as well as in the off shore captive insurance domiciles of Bermuda and the Caymans.

A beleaguered industry also brought its predicament to the attention of President Carter and Congress. In 1976, the United States Department of Commerce established a federal interagency task force on product liability to determine why insurance coverage for defective products had constricted.

Years earlier the McCarran Ferguson Act had established a dual insurance regulatory structure where the federal government would, on a case by case basis, allow the states to regulate insurance unless the federal government decided differently. Essentially, the states were granted the right to regulate at the pleasure of Congress

In 1976, the 96th Congress House Committee on Energy and Commerce conducted hearings on the “product liability crises.” I was not able to determine if Dix Noel testified but if he did, he would have provided a keen insight into the evolution of the liability of products. Ultimately three causes of the product liability crises were identified:

1. questionable insurance company rate making and reserving practices;

2. unsafe products; and

3. uncertainties in the tort litigation system.



Congress then enacted and President Reagan signed into law the Product Liability Risk Retention Act of 1981 (LRRA). Simultaneously, it seemed, insurers experienced an unexpected recovery linked to favorable investment returns. During periods of high investment returns, insurance that might otherwise be unavailable or unaffordable tends to be obtainable at a reasonable price. This phenomenon has caused several insurance experts to argue that the most influential criteria for whether there is a soft or hard market (the so-called cyclical nature of the insurance marketplace) are investment returns. Insurance reserving allows insurance companies to hold loss payments for long periods at high returns prior to loss payment. A high rate of investment return on reserves can convert what would be a bad book of business from a loss ratio perspective into a profitable book of business from an investment return perspective. This apparently is what transpired in the early eighties thus enabling the industry to be more receptive to receiving premiums to place product liability risk.

The product liability insurance cycle had shifted before the Product Liability Risk Retention Act of 1981 was used by groups seeking alternative vehicles to insure their risks. Meanwhile, however, the insurance availability pendulum was swinging towards other types of casualty insurance such as environmental and errors and omissions coverage. Congress reacted to this new need in 1986 by broadening the 1981 Act significantly to enable purchasing and risk retention groups to offer not only product liability coverage but also all types of liability insurance arising out of the operation of business, professional practices as well as out of the operation of state or local government.

The Liability Risk Retention Act of 1986 provides for the creation of risk retention groups as well as purchasing groups to enable industry, groups and state and local government to address the liability insurance crises. Although the concept of risk retention and purchasing groups was devised by the federal government, the federal government does not regulated risk retention and purchasing groups. Instead, regulation pursuant to the McCarron Ferguson Act is left with the states and particularly for risk retention groups, with the state where the risk retention group is domiciled and licensed. Clear mandates as to formation criteria and regulation are provided for in the federal act.


What are Risk Retention and Purchasing Groups?


A risk retention group is a liability insurance company that is owned by its members all of whom are members of the same industry and face similar exposures. Essentially, it is a group captive. The federal statute permits a group to domicile the risk retention company in one state and engage in the business of insurance in all states subject to certain restrictions. Under the McCarran Ferguson Act, regulation of insurance is handled by the individual states and specifically the insurance commissioners of those states. That is the case so long as the federal government does not elect to preempt that state oversight. Through the Liability Risk Retention Act of 1986, Congress did preempt state regulation and therefore the federal act takes precedence over state insurance laws and regulations generally. The provisions of the 1986 Act set forth a lengthy description of what makes up a risk retention group which I paraphrase here.

The Act defines a risk retention group as a group:


1. whose primary activity consists of assuming the liability risks of its members and spreading that risk amongst its members and is organized for that purpose;

2. that is organized and authorized to do business in and by one state (there is a provision to allow an existing chartered Bermuda or Cayman company to do business under certain conditions);


3. that does not exclude members solely to provide a competitive advantage to the group;


4. that has as its owners only insured members;


5. whose owners are engaged in similar business or related with respect to the liability to which they are exposed;


6. whose insurance activities are limited to liability insurance or reinsurance for assuming and spreading the risk of members; and


7. whose name includes the phrase “Risk Retention Group”.


The Act provides two options for structuring the ownership of a risk retention group. The first option limits ownership directly by the members of the risk retention group. The second option provides for ownership by a sole owner that is an organization which has as its members only persons who comprise the membership of the risk retention group and who are provided insurance by the risk retention group. Accordingly, an association can actually be the owner of the risk retention group. Insurance departments will look for an association that has been in existence for at least a year and do not look very kindly on associations that are formed solely for the purpose of owning the risk retention group. In fact overall, regulators will be on the lookout for entrepreneurial motivations behind the formation of risk retention groups and will also check to see if there is an availability or affordability problem in the commercial market. One application I attempted to lead through South Carolina in the early days of the captive program here was cut short by our regulator because it was viewed as an attempt by entrepreneurs to position themselves in an emerging market. We were dismissed with the appropriate application of Southern charm and compliments:

“I applaud the business savvy and foresight of your client. However, this is
simply too far outside the parameters of our captive program to go forward
with at this time. I’m sorry for taking so long to get a decision on this but I
wanted to give it every chance for consideration.”


Purchasing Groups

The Liability Risk Retention Act in addition to providing for the formation of risk retention groups also contains provisions that apply solely to the formation of purchasing groups. There are differences between risk retention groups and purchasing groups.

A purchasing group is comprised of insurance buyers who band together, frequently on a national basis, to purchase their liability insurance coverage from an insurance company or from a risk retention group. Congress by creating the purchasing group concept was endowing industry with the benefits of association and group purchasing power in the face of unkind treatment by the insurance industry. As the name implies, the purchasing group serves as an insurance purchasing vehicle for its members. A purchasing group may also form a risk retention group to buy down a large self insured retention for example. A key difference between a risk retention group and a purchasing group is that participants in a risk retention group are required to capitalize the risk retention group but the purchasing group does not have to be capitalized because the purchasing group does not itself take on risks. Purchasing groups purchase insurance from an insurer that issues the policies and takes the risk. As insurers, unlike purchasing groups, risk retention groups issue policies on their members and bear risk. Purchasing groups obviously are not regulated to the same degree as are risk retention groups. Purchasing groups purchase insurance from insurance companies that are already capitalized and subject to insurance company regulation. Another difference is that almost all risk retention groups purchase reinsurance while purchasing groups do not.

The broad exemptions from state regulation available to risk retention groups are not available to purchasing groups. Instead the Act exempts them only from specified state laws, rules and regulations and all other requirements not mentioned are not preempted. State laws that are preempted are primarily in the nature of fictitious group and countersignature requirements.


Purchasing groups have served an important purpose in permitting commercial insurance consumers to obtain better control over their liability insurance programs. They provide their members with tailor made coverage, broader coverage terms, dividends and reduced premiums through the employment of large group purchasing power. In both purchasing groups and risk retention groups, the members/owners have to be from the same homogenous industry. Purchasing Groups when employed by savvy insurance professionals provide an excellent risk transfer vehicle but the methods of how purchasing groups are so employed would be the subject of another “in a nutshell” paper. I have centered this paper on the formation, licensing and management of risk retention groups. They are subject to many more requirements and are much more complicated from an organizational and operational perspective than are purchasing groups.


Regulation of Risk Retention Groups

A risk retention group obtains its license from one state. It is said to be domiciled in that state. It is licensed through the action of the state insurance commissioner and its operations are governed by that state insurance commissioner. Those operations could extend into fifty states. Understandably, this is a much different situation than a standard insurance company or for that matter a traditional captive where each state has some control over the licensing and business operations of the entity when business is written in that state. Many states particularly those states that are not themselves active captive domiciles are uncomfortable with this regulatory situation.

The National Association of Insurance Commissioners (NAIC) is an advisory group of the states insurance commissioners. It is a voluntary association of heads of insurance departments from each state, the District of Columbia, and five U.S. territories. It does not have authority to make law or to enforce law. It does however draft and recommend model insurance acts for adoption by the states and these are usually adopted as law by the individual states.

The NAIC does not take a position as to the legality or utility of different state approaches to interpreting the Liability Risk Retention Act of 1986. It does however provide advice for its members on regulating risk retention groups and purchasing groups primarily through an NAIC publication know as the Risk Retention and Purchasing Group Handbook.

The position of the NAIC is that once the risk retention group has obtained its license, it may operate in all states without the necessity of a license in each state and is regulated almost exclusively by the domicile state’s insurance department. Non-domicile states require risk retention groups to comply with the following laws or requirements:

1. unfair claims settlements laws;

2. laws requiring the payment of premiums and taxes on a non-discriminatory basis;

3. laws requiring the participation in a residual market mechanism for liability
insurance;

4. laws requiring the risk retention group to designate the insurance commissioner as its agent for service of process;

5. laws against deceptive, false or fraudulent acts or practices; and

6. laws requiring the policies issued by the risk retention group to contain notices
that the company may not be subject to all state laws and that the guaranty fund
protection act does not apply.

In addition non-domiciliary commissioners are granted authority to monitor the financial solvency of risk retention groups and to examine them under certain conditions. They can:

1. require the risk retention group to submit to an examination in coordination with the
domiciliary commissioner to determine the risk retention group’s financial condition
if the domiciliary commissioner has not begun or has refused to initiate an
examination of the risk retention group;

2. require the risk retention group to comply with a legitimate court order issued in a voluntary dissolution proceeding; and

3. require the risk retention group to comply with an injunction issued by a court of competent jurisdiction alleging that the risk retention group is in hazardous financial condition.


Risk retention groups as a rule are domiciled in states that have captive statutes and they are characteristically formed as captives. The captive statute will set forth the capital and surplus requirement which is generally lower than would be required by non captive states where risk retention groups may also be formed. Also these captive states have sometimes allowed a risk retention group to build capital from its members over a certain period of time after a license has been issued or to capitalize with a letter of credit. As a result of these and other advantages, the majority of risk retention groups have domiciled in six states- Arizona, the District of Columbia, Hawaii, Nevada, South Carolina, and Vermont. A captive could be licensed in a state that allows them to be chartered as a captive insurer even though no business is written in that state and all the business is written in another state.

As of June 30, 2004, the breakdown of active domiciled risk retention groups was Vermont 63, South Carolina 36, Hawaii 17, District of Columbia 12, Nevada 8 and Arizona 6. These numbers are always increasing. The 19th annual survey of risk retention groups conducted by the Risk Retention Reporter revealed that 25 risk retention groups were formed in the first nine months of 2006 compared with 21 for the same period in 2005. Most of these were healthcare captives. Total premium written in risk retention groups has risen to $2.7 billion.


The Licensing Process for Risk Retention Groups

Because most risk retention groups are formed as captives, one of the first considerations in forming a captive is domicile selection. Captives may only be formed in states or jurisdictions where captive legislation has been enacted. Risk retention groups may only be formed in states of the United States or the District of Columbia. Although thirty three states now have some type of captive laws on the books, only a handful of those states have a dedicated alternative risk staff, an active captive formation history and an industry infrastructure in place to assist with the licensing and management of a risk retention group. Different domiciles are more receptive to risk retention groups than others and. Different domiciles also have higher degrees of receptiveness for some groups compared to others. Risk retention groups are formed by groups ranging from independent truckers to brain surgeons. The experience of captive domiciles may lead a captive domicile to shy away from particular groups for example “wheels” in a domicile that has experienced insolvencies with trucking risk retention groups. Most captive insurance consultants worthy of the name are aware of the receptivity of each captive domicile to particular types of risk retention groups and can assist in the domicile selection process as part of the services they offer.

In those domiciles that are actively forming captives, there has evolved a fairly uniform pre-application procedure which I call the “getting to know you, getting to know all about you stage.” Here for example is how the procedure works in South Carolina. The proposed captive manager, attorney or consultant will first contact the insurance department to alert them to a pending application and to arrange a face to face meeting with the alternative risk regulatory group and the principals of the proposed captive. Before the meeting takes place a brief written synopsis of the proposed captive is prepared and submitted to the insurance department. This written synopsis will include at least:

1. the name of the South Carolina captive manager (required);

2. South Carolina legal counsel (if selected);

3. a brief, but complete, business plan;

4. names of principals;

5. information on the parent company or names of group members for risk retention groups;

6. retention levels;

7. reinsurance proposed;

8. capitalization ; and

9. estimated annual premium.


After the material submitted is reviewed by the designated alternative risk regulator, the face to face meeting takes place. In South Carolina, it could have as many as five participants from the insurance department. The captive manager should always attend and as many of the principals as practical are encouraged to attend. In the case of risk retention groups since the owners are the insured and the insured the owners, the principals would be drawn from the proposed insureds. These meetings generally last about two hours and there is often a lively exchange of questions and answers leading up to an understanding on the part of the risk retention groups principals of the regulatory process and the regulatory environment and an understanding on the part of the regulators of the corporate structure and business plan of the proposed risk retention group. Uniformly, in all captive domiciles these introductory meetings turn out to be beneficial to groups wishing to form a risk retention group. Alternative risk regulators typically will be anxious to see the group succeed and have valuable information and suggestions that they will freely provide at this meeting. It is an important step in the risk retention group formation process and the first opportunity to meet the regulators who will be interacting with the risk retention group on a regular basis for many years after the group is licensed.
.
Shortly after this initial meeting or sometimes actually at the meeting itself, the insurance department will ask the captive manager or consultant to submit a petition for a Certificate of General Good. This generally indicates that the captive has found favor with the insurance department. The petition itself is prepared by the consultant or captive manager and contains boilerplate language describing why the formation of the risk retention group will answer a need and provide a benefit and contribute to the overall good. The Certificate of General Good will enable the attorney to incorporate the company or establish it as a limited liability insurance company. It is filed along with the articles of incorporation at the office of the Secretary of State. Without it, the Secretary of State will not allow the risk retention group to incorporate.

The Certificate of General Good is incorporated into the complete application which is submitted as soon thereafter as practical. Following the theory that it is judicious to strike while the iron is hot, it is always an advantage to have the application completed and ready to submit even before the “getting to know you, getting to know all about you stage “meeting. Most insurance department web sites including South Carolina’s contain the states entire official captive insurance company application form.

Generally, the business plan of the risk retention group will contain all of the information required to answer the specific questions asked on the application form. That the answers to all questions asked can be pulled from the business plan is a measurement of the thoroughness of the business plan. The business plan of the risk retention group will typically provide an overview of how the risk retention group will operate and be governed. It will describe the coverage it will write and the homogenous group that the insurance policies will be issued to and in what amounts and also what amounts will be reinsured and who will be the reinsurers. Ideally, the business plan will describe and provide a copy of the insurance policy and historic loss data, ongoing loss data, a rating plan including rates and a classification system. A thorough business plan will provide a description of the data processing system utilized for underwriting, policy issuance, claims and accounting. A copy of the insurance policy to be issued by the risk retention group will be included because the regulators will be looking for the language required by the federal act in the size type then required. It began as a 10-point type and has now gone to 12-point type. The notice says:

“NOTICE: This policy is issued by your risk retention group. Your risk retention group may not be subject to all of the insurance laws and regulations of your State. State insurance insolvency guaranty funds are not available for your risk retention group.”

The initial funding of the risk retention group will be described in detail. Often the initial funding for a risk retention group is provided in the form of a surplus note or letters of credit that are repaid with the approval of the insurance commissioner over the first several years of the risk retention groups operation. Usually each new insured will pay part of his premium towards the capital of the risk retention group. This investment and the offering to make the investment in a risk retention group are exempt from federal securities laws as well as state “Blue Sky” laws. Information on the members of the group will be viewed carefully. The domiciliary state has the power to determine if the risk retention group qualifies as a risk retention group under the federal act. There is no federal administrative body available to review the decision of the state regulator.

The business plan will contain biographical affidavits and resumes on key service providers of the risk retention group who could include all officers, accounting, underwriter and claims manager. Similar information will be provided on outside service providers like a CPA, attorney, actuary, coverage counsel and insurance broker.

A captive structure chart should be provided. Program objectives should be outlined remembering the purpose of the Liability Risk Retention Act is to create a vehicle for providing insurance where insurance is not available or affordable. The actuarial feasibility study will be attached. Attachments to the application would include:

1. the underwriting manual;

2. captive manager staff resumes;

3. captive structure chart;

4. historic underwriting results;

5. reinsurance treatise;

6. expected underwriting results;

7. pro forma financial statements and projections;

8. actuarial opinion regarding the determination of minimum premium and
participation levels required to commence operations and to prevent a
hazardous financial condition;

9. the states in which the risk retention group intends to operate; and

10. marketing materials.

The term “feasibility study” is a widely used term in the captive insurance industry. Sometimes it is used interchangeably with the term “business plan”. In the strictest and most correct sense, the feasibility study is that study prepared by a professional actuary that provides evidence of the expected costs and benefits of the captive, expected underwriting losses even under a worse case scenario as well as expected return on investment. It will demonstrate to the investors as well as the regulators (as well as can be expected by a document that is prepared as an attempt to predict the future with accuracy) that a risk retention group will be a financial success. While in a pure captive, the feasibility study may not be required, for a risk retention group it cannot be overlooked and the regulators will expect to see it and it is required under the NAIC Model Act.


Organizational Steps and Management after Formation and Licensing

The domiciliary state will issue a license to the risk retention group if the regulators are happy with the application material submitted by the group. Sometimes, this license is written subject to certain conditions. One constant condition is that no business can be written until the risk retention group is capitalized.

It is necessary that the risk retention group have an organizational meeting of the shareholders and board of directors. The requirements for these meetings vary as to where the meetings should be held and who should attend. There usually is a requirement that the risk retention group have at least one director who is a resident of the domicile. This role is typically played by the captive manager and the captive manager after stewarding the application for license through his state’s insurance department now becomes the bedrock for future compliance and regulatory reporting of the risk retention group.



Actions that are taken at the organization meetings of directors and board of directors include:

1. ratification of the actions of the incorporators;

2. designation of financial institution for holding capital and investments;

3. appointment of officers;

4. issuance of shares certificates;

5. acceptance of corporate governance policy;

6. acceptance of the form of stock certificate;

7. adoption of a conflict of interest policy with parties signing it and disclosing
Any potential conflicts of interest;

8. adoption of check writing policies;

9. appointment of auditor;

10. appointment of attorney;

11. adoption of investment policy;

12. appointment of captive manager;

13. acceptance of the form of insurance policy;

14. signing of any other service provider contracts;

15. opening bank and investment accounts;

16. reviewing and accepting reinsurance treatise;

17. accepting corporate seal; and

18. accepting form of subscription agreement.

This meeting customarily takes place in the offices of the captive manager in the domiciliary state. There usually is a requirement that the meeting take place in that state as well as for subsequent shareholders and board of directors meeting. It is strongly recommended that the organizational and operational functions of the risk retention group be carried out under the oversight and tutelage of a qualified captive manager. Granted it is not rocket science but a risk retention group is in reality an insurance company and insurance is only considered “simple” by those who are trained and nurtured in the field. To all others, it is rocket science.

Although the regulation of traditional captives by a state might be limited, regulation of risk retention groups tends to be a bit more stringent. The risk retention group will be subject to an organizational examination sometimes during the first ninety days of its existence. In addition the risk retention group is subject to the same requirements of the domiciliary state that apply to any captive including providing a copy of the annual statement certified by an independent public accountant and an annual actuarial opinion on the adequacy of loss reserves.

Risk retention groups are required to apply for an NAIC company number or code. The form is available at www.naic.org. A certified copy of the state license must be provided in order to obtain the company code. Subsequently, the risk retention group must also file annual and quarterly financial statements with the NAIC and are subject to accreditation standards. Risk retention groups must also file quarterly statements with the states where they are registered and with the domiciliary state. The National Association of Insurance Commissioners establishes the format for the annual and quarterly statements. For property and casualty companies, the annual statement has a yellow cover and is popularly know in the industry as the “Yellow Peril.”

The owners of successful risk retention groups embrace the oversight by the domiciliary state. Attitude as in most endeavors is important in the operation of a risk retention group. Attention to detail and establishment of corporate governance standards will go a long way to ensure the success of a risk retention group. The federal preemption of separate state regulation is a valuable commodity. It will enable a group after it receives a license to have almost instant access to market and be free from the red tape of individual state regulation. It is a privilege that is best employed in a reasonable fashion with careful attention to the filing requirements, fee requirements and tax requirements of each state. This corporate good behavior is a small price to pay for the rights granted by the Liability Risk Retention Act.


Registration Process and Annual Filings / the Non Domiciliary States

After a license is granted by the domiciliary state, the risk retention group must register in all states where it expects to do business. These filings are usually carried out by the risk retention group’s captive manager. The manager handles these filings on forms provided by the states. The forms are filed along with the required filing fees. The filing fees vary from state to state ranging from no fee to several hundred dollars and from just an initial fee to an initial fee and annual fees after that.

After a state filing, the risk retention group will receive a response from the particular state that acknowledges that a group has been registered and reminding the group to pay taxes on the business that is written in that state. If a state objects or raises roadblocks to the operation of the risk retention group in the state, then the risk retention group or its counsel or even the National Risk Retention Association (if requested and if appropriate) will respond to the situation and a decision can be made as to whether to proceed to write business in that state or not. Risk retention groups have been known to ignore individual filing state’s unreasonable mandates and simply write business relying upon the authority of the federal preemption of such state mandates

Overreaching of the non domiciliary states generally takes place in three areas:

1. improper assessment of fees;

2. impermissible requests for informational; and

3. making operation in a state contingent upon regulatory review and approval.


The existence of a significant number of court cases around the country since the enactment of the LRRA demonstrates that several states did not accept the federal preemption readily and saw it as a threat to their desire to have the last say when it comes to providing insurance consumer protection. However, the case law or decisions reached by the judges in those cases from around the country have generally upheld the preemptive nature of the Liability Risk Retention Act.

Only a few states today raise such roadblocks and it is suggested that this area is an evolving situation because some states question the effectiveness of particular domiciliary states regulation. As the NAIC addresses the problem and establish a uniform level of oversight by the various leading captive jurisdictions, this questioning or rather objection by a few states should dissipate. This area is briefly addressed below in the reference to the report of the Government Accountability Office.

The risk retention group in response to a state filing will by and large receive an acceptance of the filing by a letter from the state’s insurance department saying that the state has added the group to the list of groups registered in the state to do business. This letter will then alert the risk retention group to the annual filing requirements and notice requirements of that states insurance laws relating to risk retention groups and that states guaranty funds and point out that the risk retention group must file an annual premium tax return and then disclose the rate of the annual tax. The letter might also point out the states agent’s licensing requirements and that any person, firm, association or corporation who acts in any manner in soliciting, negotiating or procuring liability insurance must hold the appropriate license.

The annual filing requirements for foreign registered risk retention groups consists of the annual statement, statement of actuarial opinion of loss reserves, report of examination, management discussion and analysis, CPA audit report, designees for service of process, plan of operation or feasibility study if there have been changes or amendments from the original. Each risk retention group should address these individual requirements with their own captive manager and counsel.


The Report of the Government Accountability Office

At the request of the chairman of the Committee of Financial Services of the U.S. House of Representatives, the United States Government Accountability Office conducted a study of the regulation of risk retention groups. On August 15, 2005 the Government Accountability Office filed its report consisting of over 100 pages. That report and testimony leading up to it are available through the GAO’s Web site. (http://www.gao.gov/) In short, the report concluded that risk retention groups have had a small but important effect on increasing the availability and affordability of commercial insurance for certain groups. Risk retention groups roughly have accounted for 2 billion or over 1% of all commercial liability insurance. There has been a deluge of risk retention groups formed in recent years and this trend will continue according to the report. Physicians and medical groups are forming risk retention groups at an increasing rate and seem to be forming these groups regardless of the soft or hard market for commercial insurance. Physicians in Pennsylvania in 2003 saw the availability of commercial insurance disappear with the withdrawal of St. Paul Insurance Company so advocates of formation of risk retention groups to physicians are finding receptive ears to the concept that a soft market might be a good time to form a risk retention group so that the physician’s med mal program will be freed from reliance on the unpredictable commercial market.

The overall conclusion of the Government Accountability Office was that common regulatory standards were needed amongst the states and greater protections are needed. According to the report, the LRRA’s partial preemption of state insurance laws has resulted in a regulatory scene characterized by widely divergent state standards. Some states charter risk retention groups as captive insurance companies and captives operate with fewer restrictions than do traditional insurers. The report stated that most risk retention groups are domiciled in six states and those states make no secret of their desire to attract captives to their states as part of an economic development strategy. Most new risk retention groups tend to make their way to a newly emerging state captive domicile. The report suggested that this desire to be a successful captive domicile may result in a captive domicile lessening its regulatory standards.

Additionally, because most risk retention groups are captives, they are not subject to the same uniform baseline standards for solvency regulation as traditional insurers are. State requirements in important areas such as financial reporting also vary. Regulators may have difficulty assessing the financial condition of risk retention groups operating in their state because not all risk retention groups use the same accounting principles.

Because the LRRA does not specify characteristics of ownership or control, or establish governance safeguards, risk retention groups can be operated in ways that do not consistently protect the best interest of their insureds. For example, the LRRA does not explicitly require that the insureds contribute capital to the risk retention group or recognize that outside firms typically manage risk retention groups. Some regulators believe that members without “skin in the game” will have less interest in the success and operation of their risk retention group and that risk retention groups would be chartered for purposes other than self-insurance, such as making profits for entrepreneurs who form and finance a risk retention group.

The distaste regulators display for the entrepreneur who promotes the formation of a risk retention group is somewhat disturbing. It presents a dilemma to promoters of much needed risk retention group. For example physician groups can truly benefit from forming and belonging to a risk retention group but corralling the physicians, because of their busy schedules and their dedication to their medical practices, has been described by one expert “as trying to herd cats on ice.” In most cases, it will take an entrepreneur such as a broker or consultant to the medical profession to orchestrate the formation and management of a physician’s risk retention group. This person cannot be an owner since he will not be an insured. Obviously, that entrepreneur wants to be compensated and also to protect his own position and investment.

The LRRA provides no governance protections to counteract potential conflicts of interests between insureds and management companies. The report suggests that sometimes management companies have promoted their own interest at the expense of the insureds. Risk retention groups the report suggests could benefit by corporate governance standards that would establish the insured’s authority over management. In fact this is an issue that risk retention groups have themselves struggled with so input and even reasonable regulatory guidelines would probably be viewed with favor by the industry.

The report suggests that non- captive domicile states feel that there has been a lessening of regulatory standards in the six states that license risk retention groups. A combination of single state regulation, growth in new domiciles, and wide variance in regulatory practices has increased the potential that risk retention groups would face greater solvency risks. As a result, the Government Accountability Office believes risk retention groups would benefit from uniform, baseline regulatory standards.

The manner in which other states view the regulatory posture of a domiciliary state is important because the insurance departments themselves are subject to examination by the NAIC periodically and must be accredited by the NAIC. If they fail in obtaining accreditation, they could lose their right to license risk retention groups altogether.


WHAT LIES AHEAD

Risk retention groups are a creation of Congress to solve an insurance availability and affordability crises. Since insurance is cyclical, it would appear that risk retention groups will continue to have a purpose. History has demonstrated the popularity of risk retention groups and risk retention groups have been successful in giving commercial insurance consumers control over their insurance costs. To the commercial insurance consumer, a risk retention group has many advantages including:

· Avoidance of multiple state filing and licensing requirements
· Member control over risks and litigation management
· Stable market established for coverage and rates
· Elimination of market residuals
· Exemption from countersignature laws for agents and brokers
· No expense for fronting fees
· Services unbundled
· Access to the reinsurance markets


As well as disadvantages:

· Risks are limited to liability insurance
· Not permitted to write outside business
· No guaranty fund availability for members
· Might not be able to comply with proof of financial responsibility laws

It appears that the regulation of insurance is taking a federal turn. The LRRA creates an attractive formula for a system of dual regulation. Congress passes the law, creates some rules and then passes off the ongoing regulation to the states. Congress is seriously considering expanding the LRRA to allow property insurance to be written in risk retention groups. It would make sense that it would not be expanded if the state system of regulation was in disrepair. The state system is not ready for the junk heap but it does need some repairs. Continuing efforts by the NAIC will ensure that uniform high standards of regulation of risk retention groups will be established to prevent insolvencies. It seems logical that Congress will keep the existing procedure for regulating risk retention groups after some needed adjustments are made. There will be development of more uniform and appropriate regulation of risk retention groups along with standardized accounting requirements. Thereafter, the numbers of well run and well regulated risk retention groups will continue to grow and continue to write a larger and larger percentage of the commercial insurance market.

Individual states will find a happy balance between economic development and sound insurance regulation interests. The efforts of The NAIC will result in providing a surer foundation to support the growth of premium volume brought about through new business in existing groups, the ever increasing formation of new groups and the expansion of product lines of risk retention groups which could then lead to the eventual elimination of the above named disadvantages of risk retention groups. Court cases will ultimately determine where the regulatory power resides. It is an emerging and interesting although complicated field of alternative risk finance and law. It is a subject that a forward thinking college professor or law school professor in the tradition of Professor Dix Noel could easily embrace.


April 6, 2007
Charleston, South Carolina



John J. O’Brien JD, CLU, CPCU
A Professional Corporation
Captive Insurance Consulting, Insurance Law and Expert Services
The Garden House
12 Franklin Street
Charleston South Carolina 29401
18437372738

lionsthree@aol.com