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Quackenbush probe to look at Lloyd's ties

Questions raised over reimbursement

Business Insurance, February 26, 2001

SACRAMENTO, Calif.-Lawmakers auditing the California Department of Insurance's activities under former Commissioner Chuck Quackenbush also plan to investigate new allegations that his staff concealed money received from Lloyd's of London to defend the insurer from lawsuits brought by investors and other regulators.

A hearing by the Joint Legislative Audit Committee is scheduled to begin today in Sacramento. The hearing is part of an audit process that, among other things, will look into the allegation that monies from the state's Conservation and Liquidation Office were used to fund activities undertaken on behalf of Lloyd's, said Richard Steffen, staff director for the state Senate Insurance Committee.

Mr. Steffen said the Senate Insurance Committee first learned of such alleged irregularities last year, at about the time it was conducting hearings on other matters related to the tenure of Mr. Quackenbush, who resigned from his post last year. In addition to the joint panel, the FBI and state Attorney General Bill Lockyer also are now investigating Mr. Quackenbush's administration.

The Los Angeles Times last week reported that Mr. Quackenbush's senior staff, against the advice of one of their own attorneys, allegedly produced a phony invoice to hide $400,000 in legal fees the department incurred while working on behalf of Lloyd's during the mid-1990s. During that period, securities regulators from California and other states, as well as Lloyd's names, were suing Lloyd's for alleged fraud and securities violations.

The Insurance Department under Mr. Quackenbush joined legal efforts to fight such a lawsuit that was filed in 1996 by the California Department of Corporations. In doing so, the department incurred legal bills by hiring outside law firms for the job.

The Times' report alleges that, at first, money borrowed from the assets of insurers in conservation was used to pay the legal bills. But Insurance Department officials later turned to Lloyd's for payment, according to the Times' report, which was based on Insurance Department internal memos.

An attorney representing Lloyd's was concerned that an invoice to pay for the department's efforts would arouse the suspicion of auditors. The attorney representing Lloyd's dictated the wording of an Insurance Department invoice that went to Lloyd's so that it appeared as a billing for ``educational briefings,'' according to the Times' report.

A spokesman for Lloyd's disputed the Times' reporting and said a court would dismiss the internal Insurance Department correspondence on which the newspaper's report was based as hearsay.

In a prepared statement, Lloyd's said it did not reimburse the Insurance Department for legal expenses. Monies it paid to the department were for reimbursement of the costs associated with the department's monitoring of the insurer's operations, as required by law. Furthermore, any reclassifying of monies received from Lloyd's is an internal Insurance Department issue, the statement said.

``Lloyd's reimbursed the California Department of Insurance for expenses incurred during work to monitor Lloyd's and gain a greater understanding of its complex financial structure,'' the statement said. ``Lloyd's, in common with all other major insurers trading in the U.S., makes similar reimbursements to regulators in other states and continues to do so.''

But one critic of Lloyd's disputes that statement.

Jeffrey Peterson, executive director of the Rancho Santa Fe, Calif.-based American Names Assn. contends that as, a non-admitted insurer, Lloyd's would have no reason to pay for Insurance Department auditing and monitoring. The American Names Assn. participated in suing Lloyd's in the mid-1990s.

Non-admitted insurers are not directly regulated by state insurance departments. Lloyd's is a non-admitted insurer in all states but Illinois, Kentucky and New York, where it is licensed.

A spokesman for the Insurance Department said the department does not conduct individual audits of Lloyd's, but it has participated in exams conducted by the National Assn. of Insurance Commissioners.

He could only verify that the Insurance Department maintained this practice for the past six years, however. Any bills for such exams would be submitted by the NAIC, not the Insurance Department, the spokesman said.

Mr. Quackenbush during the 1990s was a member of the NAIC's Surplus Lines Task Force. California is the nation's largest surplus lines insurance market, generating more than $1.52 billion in non-admitted premiums in 1999.

Allegations that Lloyd's paid for the Insurance Department's legal representation come as no surprise, said Bill McDonald, enforcement director for the California Department of Corporations. Mr. McDonald led his department's 1996 lawsuit against Lloyd's that charged Lloyd's fraudulently sold securities by recruiting names to invest in syndicates that Lloyd's knew could expect massive pollution and asbestos losses.

The Insurance Department, in response, then sued to block the Department of Corporations' suit, claiming that the department did not have jurisdiction in the matter, as Lloyd's is an insurer. The pleadings contained in the Insurance Department's complaint made Mr. Quackenbush's team appear to be ``carrying water for Lloyd's,'' Mr. McDonald said.

``We were flabbergasted that one state agency was suing another,'' he said. ``It was crazy. Every argument they made was an argument on behalf of Lloyd's. They were acting as outside counsel.''

In defense of the Insurance Department, Mr. McDonald said he thinks it genuinely believed that allowing securities regulators to prevail would have a negative impact on insurance solvency issues.

It was common at that time for securities regulators in several states to fight with insurance commissioners over jurisdiction in similar cases involving Lloyd's, Mr. McDonald said. But Mr. McDonald said that as far as he knows, no other state insurance commissioner filed a lawsuit against the security regulators of his or her own state.

The Department of Corporations eventually settled with Lloyd's after its lawsuit was dismissed on a technicality.

A spokeswoman for Mr. Lockyer, California's attorney general, said law enforcement officials will not comment on whether their ongoing investigation includes a review of monies paid to the Insurance Department by Lloyd's.

But the Joint Legislative Audit Committee routinely works closely with the state attorney general's office, providing it with audit findings, Mr. Steffen said. ``They are going to look at all the money and where it has gone,'' he said. ``It's a huge net. They will catch everything.''

The Insurance Department declined to comment on the case. But Mr. Quackenbush's successor, Insurance Commissioner Harry Low, requested last fall that legislators order such an audit, Mr. Steffen said. ``He found some funny bookkeeping when he took over.''

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