Study: California Workers’ Comp Insurer Needs Significant Reforms

December 11, 2007

California’s State Compensation Insurance Fund “has weak corporate governance, inadequate internal controls in various areas and a general inability to plan for the long-term,” according to an operational review report released by the state Department of Insurance.

Following up on its audit of the state workers’ compensation insurer completed in October, Insurance Commissioner Steve Poizner said the report “revealed what we expected — serious structural and operational issues.”

Last spring, Poizner ordered a operational review and fiinancial examination of SCIF following the firings of the insurer’s former President James Tudor and vice president in charge of group programs Renee Koren over questions of unethical practices. Since then, SCIF has completed its own internal audit, as well as hired a new president, Janet Frank, who came to the California organization from CNA Financial.

The current CDI report reviewed:
•Governance and management practices, which encompasses the governance structure over management positions, a review of the organization’s risk management activities and an assessment of the internal audit function and human resources function;
•Group association programs, including a general review of group association program components, group interviews conducted by SCIF investigators, and independently analyzed data provided by associations;
•Information technology (IT), including an assessment of general controls of SCIF’s IT environment;
•District offices and claims processing centers, including an initial operational review of four district offices and three claims processing centers; and
•Business services, including a limited review of the business applications unit and purchasing/ transportation/ supply unit, which focuses on the IT vendor process and fleet car management.

In particular, the reported noted “serious concerns” regarding the structural and organization problems, including:
•SCIF’s board of directors lacks sufficient resources to provide the oversight necessary for an insurer of State Fund’s size and complexity;
•Management structure is inadequate and lacks several key positions including chief financial officer, chief operating officer, chief information officer and chief investment officer;
•Potential conflicts of interest with two past members of the board — SCIF paid in excess of $500 million in group association administration fees from 1997 through January 2007. Of that amount, more than $140 million was paid to an entity controlled by a person who was a board member form 2003 through 2006. In addition, more than $125 million was paid to associations with whom another member of the board from 2004 through 2006 had a business affiliation. Group administrative fees paid to associations were incorrectly classified as legal and auditing fees in SCIF’s financial statements. That classification was misleading to users of the financial statements; and
•Lack of controls over material expenditures and IT systems.

The audit also reported other concerns, such as SCIF:
•Paid $19.5 million in penalties from January 2007 to July 2007 due to late payments on medical bills and indemnity bills;
•Maintains a significant reliance on IT vendors. SCIF has approximately 200 outside IT consultants, at a cost of approximately $321 million since 2004;
•IT internal control deficiencies were noted in IT governance, logical security and computer operations;
•Allowed inappropriate access of lower level employees into IT systems, such as the organization’s Oracle payments system;
•Paid invoices without a purchase order or contract;
•There are more than 2,000 fleet vehicles for a total of 8,000 employees. Despite the significant cost of acquisition and maintenance of this vehicle fleet, SCIF has not performed an audit of fleet management since 2003;
•Has not performed adequate background checks on IT vendors to ensure the legitimacy of the vendor. During the examination, background research was performed on certain SCIF vendors, which revealed that one vendor, while working as an insurance lobbyist, was convicted of a felony in 1993;
•SCIF engaged in inappropriate business practices that allowed additional expenditures to be made to vendors which were outside of the board approved budgetary process. That allowed SCIF to purchase goods or services, and make charitable contributions, which were neither known nor approved by the board;
•Has no established procedure to ensure that company-issued equipment, property or records are returned upon an employee’s termination or resignation. Due to those lack of controls, terminated employees may still have access to SCIF systems; and
•Oversight of the group administration fees was severely inadequate. In some cases, little to no safety services, or any other services, were provided to the members of the associations being paid these administrative fees. Although the standard contracts authorized SCIF to audit the use of these fees, no audits were ever performed. Further, despite the magnitude of these expenses, these agreements did not require Board approval

Poizner said it is important to note that despite the critical report findings, SCIF already has taken, or has committed to take, corrective action on several of the items uncovered during the examination.

“We have identified important issues, communicated our recommendations, and we expect that the State Fund will continue to work to make necessary reforms,” he said. “As SCIF’s regulator, I will continue to monitor their activities and work with them. Given SCIF’s size, its fiscal health is integral to ensuring a healthy and competitive workers compensation marketplace.”

President Frank echoed those sentiments, saying, the report “will serve as a clear roadmap as we continue our work to bring efficiency, transparency and accountability to State Fund’s operations.”

“We appreciate the California Department of Insurance’s review of State Fund operations and welcome their comments and recommendations,” Frank said. “Thanks in large part to the leadership and tenacity of our board of directors, change has been underway at State Fund for more than a year. In fact State Fund has already accomplished or begun to implement most of the recommendations in CDI’s report,” she said in a statement.

“Although State Fund has undergone transformative change, it is clear we must remain committed to this path,” she continued. “We recognize there have been problems, but are pleased to have turned a significant corner on this difficult period as we move forward and continue to fulfill our important mission in California’s insurance market.”

SCIF Board Chair Jeanne Cain said her organization agreed with CDI’s review and recommended course of action. “We have been moving in this direction for quite some time and will remain committed to doing so until the job is done.”

However, she noted SCIF would need to enact legislation to fulfill some of the recommendations, such as adding new exempt management positions and increasing the size of the Board. State Fund attempted to pass legislation in 2007 related to structural reforms but was unsuccessful. The group is expected to introduce legislation again in 2008 to address the reforms.

In addition to the audit performed by the Department of Insurance, the SCIF’s board also initiated an independent investigation last year to review the Group Association Programs and related internal controls among other internal operations. The internal investigation continues and a referral was made to the California Highway Patrol (CHP). Those two entities have joined with the DOI to coordinate efforts in the investigation of potential criminal misconduct by former employees.

To view the full operational review, visit

Sources: CDI, SCIF

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