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A Quack in the china shop

By Carolyn T. Geer and Ashlea Ebeling

Originally appeared in Forbes magazine on October 20, 1997

DURING HIS EIGHT YEARS as a Republican state assemblyman from San Jose, Charles Quackenbush Quack, or Chuck, to friends was a backbencher, concerning himself with education and economic development. But this 6-foot-4 former U.S. Army captain was not content to remain a small fish. He set his sights on the elective post of California commissioner of insurance. California is one of only 12 states to elect its commissioner. In 1988 California voters passed Proposition 103, which made the job an elective post.

A backwater? Not for a politician. Not in California, where people almost live in their cars and where earthquakes happen. Californians pay nearly $60 billion in insurance premiums every year and don't much like insurance companies. There's political capital in bashing them and promising to hold rates down.

Quackenbush, 43, raised $3.5 million for his successful 1994 run. Two-thirds of his money came from insurance people. The industry must have believed Quackenbush's assurances that he was a free enterprise man who would not exploit the potential of office for demagoguery. Having suffered through four years of regulation by the ambitious but bungling liberal Democrat John Garamendi, insurance people hoped for better things from a Republican. Garamendi seized Executive Life Insurance Co. in 1991 to "protect" policyholders and ended up turning its valuable portfolio of junk bonds over to financier Leon Black at firesale prices (Forbes, Mar. 14, 1994).

Quackenbush knew a fair amount about politics. He knew next to nothing about insurance.

After Quackenbush won the commissioner's job, he appointed James Woods, the managing partner in law firm LeBoeuf, Lamb, Greene & MacRae's San Francisco office, to head his transition advisory team. LeBoeuf and the insurance clients it lobbies for in California have contributed at least $800,000 to Quackenbush and his committees since 1994.

Nature soon handed him an opportunity to grab the headlines. The year he was elected, California was rocked by the Northridge quake, which caused $12.5 billion of insured losses. Badly shaken, most insurance companies stopped writing new homeowners policies because California law required them to offer earthquake coverage as well.

In July 1995, six months after taking office, Quackenbush announced his solution: He'd create a government-run, privately funded insurance pool, the California Earthquake Authority, to shoulder earthquake risk. He gave himself a seat on the three-person board and named his deputy insurance commissioner and former campaign head Gregory Butler, 31, chief executive. Butler was as new to insurance as his boss.

The state's largest property insurers, State Farm, Allstate and Farmers, agreed to participate in the pool in return for getting the right to write homeowners policies without the earthquake coverage. Customers buying earthquake insurance would get policies backed by the pool.

The California Earthquake Authority was a win-win, Quack crowed."We restored the homeowners' marketplace; everybody has access to an earthquake policy if they want it," he says. "It's been a smashing success."

For whom? CEA policies are at least twice as expensive and, in some areas, even four to five times what Californians had been paying for more comprehensive earthquake coverage. If CEA gets hit with too many claims, policyholders will be reassessed and their claims reduced.

With rates this high, the new California Earthquake Authority policies are selling slowly. A knowledgeable source says only half as many policies are being sold as originally projected.

Naturally, rates would have risen after the Northridge disaster, but bureaucratic bungling by Quackenbush and his aides almost certainly put them higher than they would have been had companies been permitted to charge market rates. This summer the state's chief geologist found that the CEA had overestimated the likelihood of quakes along three northern California faults. Following the report, Quackenbush agreed to slash rates an average 11%.

The CEA may not have done much for consumers of earthquake insurance, but it has done a lot of good to Quackenbush supporters.

E.W. Blanch Co., the lead broker picked to coordinate the purchase of reinsurance for the pool, grossed $5.5 million of the $11 million in brokers' fees. Blanch and its employees have contributed at least $14,000 to Quackenbush committees.

There is evidence that Quackenbush and his brokers could have driven a better bargain. The plan provided that in the event of an earthquake the first $4 billion of losses would be covered by contributions from participating insurance companies and premiums collected from policyholders. Reinsurance would absorb losses from $4 billion to $6 billion. Over that, the next $1 billion would be covered by a line of credit, to be repaid with proceeds from a bond offering. An additional $1.5 billion of risk would be underwritten in the capital markets. Of further losses, $2 billion would be paid by the participating insurance companies.

Before the legislature would approve his earthquake insurance plan, Quackenbush had to line up reinsurers willing to participate. Armed with $500,000 of taxpayer money, he set out on a nine-day road show of 50 meetings in five countries. Reinsurers were skittish about committing capital to quake-prone California. Not wanting to return home empty-handed, Quackenbush made them a handsome offer. To get $2 billion in reinsurance, the California Earthquake Authority would pay them $280 million per year for two years, an annual premium rate of more than 14%.

Odds are the reinsurers will have an earthquake claim only once every 33 years, yet they are getting paid as if a loss were expected every 7 years. Odds of a total loss for the reinsurers are one every 55 years. "There could always be a huge quake tomorrow," allows actuary and former Texas insurance commissioner J. Robert Hunter, "but there's no question that it was a very bad deal [for the CEA]."

Spotting a good thing, Warren Buffett's Berkshire Hathaway offered to reinsure the $1.5 billion of risk originally slated for the capital markets. His company gets $160 million per year for four years, a premium rate of almost 11% per year.Its expected annual loss over time is barely 1%. "Berkshire got a pretty sweet deal," says Mark Broido, marketing director of a Silicon Valley catastrophe risk management firm.

You can't blame Berkshire for grabbing the deal. You can wonder at a situation that lets a neophyte like Quackenbush dabble in anything as esoteric as reinsurance.

Lloyd's of London syndicates got to underwrite $150 million of the CEA reinsurance. But Lloyd's has another reason to be grateful to Quackenbush. He helped squash a lawsuit by California securities regulators against Lloyd's and his pals at LeBoeuf. Lloyd's is one of LeBoeuf's biggest clients.

Then he took the lead to help dismiss similar cases arising out of Lloyd's near failure last year in a dozen states. He moved to stop three private securities fraud cases filed against Lloyd's by individuals, known as Names, who accepted unlimited liability in backing Lloyd's insurance policies. Quackenbush claims he was only trying to protect policyholders.

If he's been good to his friends, Quack has been rough on a lot of other people. Last year his insurance department conducted a routine solvency audit of San Diego-based Golden Eagle Insurance Co., a $1 billion-plus (assets) workers' compensation insurer. Quackenbush proclaimed the insurer underreserved by about $150 million. John Mabee, Golden Eagle's owner, argued loudly and publicly that Quackenbush was wrong. Quackenbush maintains that Mabee's numbers were bogus and that Mabee had taken unsecured loans from the company.

Quackenbush refused to give Mabee a court hearing, claiming the law didn't require it. In January, Mabee agreed to up his reserves as ordered but vowed to fight on for a hearing. Days later 20 police and insurance department staff swooped down on Golden Eagle's headquarters and took over the company.

Before the affair was over, New York-based American International Group (AIG), the big multinational insurer run by Maurice (Hank) Greenberg, got a dose of what happens if you aren't on Quack's side.

Moments after Quackenbush seized Golden Eagle, he announced its sale to a consortium. Quackenbush says he wanted to avoid a run on the company, but competitors argued they'd been shut out. Quackenbush backtracked and held a bidding contest. In April he proclaimed AIG the winner; a contract was signed.

But AIG didn't get the prize. Liberty Mutual Insurance Co. of Boston, represented by LeBoeuf, overbid AIG. AIG launched an aggressive marketing campaign, with full-page newspaper ads and statewide mailings to insurance salesmen stating that it was appealing the decision.

Quackenbush retaliated by threatening to investigate AIG's practices in the state. Liz Figueroa, head of the California Assembly's insurance committee, accused the commissioner of trying to "exact vengeance" on AIG. She wrote: "It seems to me that you are sending a loud message to the industry Do not disagree with me, or face the consequences.'"

At any rate, Liberty, not AIG, got the seized company. It may be coincidental or it may not, but AIG gave Quackenbush committees just $15,000. Liberty Mutual gave $65,000. Quackenbush says he does not play favorites; he has fined contributors and noncontributors alike.

In April Quackenbush agreed to pay a $50,000 fine for negligent campaign reporting including underreporting more than $100,000 in contributions from insurance sources.

The moral of this story is a familiar one: The free market is better at setting rates and prices, better in the end at giving people a fair deal than government can ever be, no matter whether that government is run by Democrats or by Republicans.

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