CSA
Summary
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REPORT BY THE STATE AUDITOR
OF CALIFORNIA
POOR MANAGEMENT PRACTICES AT THE
DEPARTMENT OF INSURANCE'S CONSERVATION
AND LIQUIDATION DIVISION WARRANT THE
DEPARTMENT'S CONTINUED CORRECTIVE ACTION
93113 MAY 1994
Poor Management Practices at the
Department of Insurance's Conservation
and Liquidation Division Warrant the
Department's Continued Corrective Action
93113Error! Reference source not found., May 1994 Error! Reference source not found.
California State Auditor
Bureau of State Audits
Table of Contents
Page
Summary S-1
Chapter
1 Introduction 1
2 The Division Has Not Developed a
Strategic Plan for the Conservation
and Liquidation of Conserved Insurers 9
3 Personnel Practices of the Division
Need Improvement 15
4 The Division Has Not Properly Managed
Its Consultant Contracts and Its
Contracts for Legal Services 35
5 The Division's Allocation of Costs Results
in Disproportionate Charges to
Conserved Insurers 43
6 Other Inappropriate Practices at the Division 49
7 Conclusions and Recommendations 55
Appendix Insurers in Conservation or Liquidation 61
Response to
the Audit Department of Insurance 65
California State Auditor's Comments
on the Response From the
Department of Insurance 75
Summary
Results in Brief The Conservation and Liquidation Division (division) of the
Department of Insurance is responsible for conserving and liquidating
16
insurance companies (insurers) that experience financial or other
problems or that are not authorized to transact insurance business in the
State of California. During conservation, an insurance company is
placed under court-ordered control to conserve the insurer's assets until
the insurer's status is determined. If the insurance commissioner
(commissioner) determines that it would be futile to rehabilitate the
insurer in conservation, he may apply to the court for an order to
liquidate the assets of the conserved insurer. Liquidation is a process
in which a conserved insurer's assets are converted to cash and applied
to the outstanding debt. After the division has liquidated a conserved
insurer's assets, the commissioner must apply for a court order to
distribute the liquidated insurer's assets to its policyholders, creditors,
and other groups in the order required by the California Insurance
Code. After final distribution of the assets takes place and the division
makes a declaration of that fact to the court, the closure of the insurer is
complete.
The purpose of this audit was to evaluate the effectiveness and
efficiency of the division's operations. Most of our review focused on
the operation of the division between 1991 and 1993. Our audit
revealed a series of improper decisions by former division managers,
which in several instances led to the expenditure of division funds on
questionable items. Our audit also disclosed lax procedures or no
established procedures for important aspects of the division's operation,
including identifying new employees to work in the division,
administering employees' salaries, controlling the amount of overtime
worked by division employees, and disposing of assets of liquidated
insurers. Our audit also addressed the division's need to better plan for
the essential responsibilities of the division by developing a strategic
plan focusing on the division's long-term goals, continuing its recently
adopted practice of developing an annual budget, and following
through on its intention to draft management plans specific to each of
the estates that the division supervises. A more specific discussion of
the conditions identified follows:
17
Forty-two of the 76 estates with court-ordered liquidations are still
not closed even though it has been from 3 to 15 years since the
court order. Among these 42 estates are 15 where the division
shares joint responsibility for conservation with another state.
Also, according to the commissioner, there are certain estates that
cannot be closed readily because of the nature of their outstanding
claims;
New procedures have been adopted by the division for the drafting
of an annual budget, and the division drafted a budget for 1994.
However, deficiencies still exist, such as the absence of budgeted
expenditures for consultant contract costs that will be directly
charged to conserved insurers, even though in 1993 these
expenditures amounted to $6.5 million;
The division's payroll grew rapidly between 1991 and 1993
(57 percent increase from 1991 to 1992 and 57 percent increase
from 1992 to 1993). The division's payroll growth can be
attributed to an increase in the salary rates of employees, employee
promotions, and an increase in the number of division employees.
The salary rates of division employees outpaced the salary rates of
comparable positions in the insurance industry and in the public
sector. Between 1991 and 1993, the promotion of division
employees whose salaries increased an average 29 percent also
outpaced the rate of employee promotions in the insurance industry,
which averaged 1 percent during the same period. The division
also added a net total of 50 employees to its work force between
1991 and 1993;
Information provided to us by the division on the amount of insurer
assets distributed by the division from 1991 to 1993 that, according
to the division, are an indicator of the division's workload, showed
a significant increase in assets distributed from 1991 to 1992 and a
slight increase from 1992 to 1993;
Between 1991 and 1993, the division's payments for overtime
increased by more than 400 percent, which the division attributed to
an increase in the number of insurer conservations, estate closures,
and insurer insolvencies, and efforts to implement better controls
over division operations. In January 1992, the division dropped its
requirement that division employees obtain prior approval in
writing before working overtime. During 1989 and 1990, the
division's exempt employees were allowed to accumulate
compensatory time off (CTO) for overtime that they worked even
though the division had in place a requirement prohibiting this
practice. Between 1990 and 1993, although the division's policy
18
prohibited the payment to exempt employees for overtime worked,
the division paid more than $119,000 to such employees who had
accumulated CTO;
In June 1993, two former managers of the division paid
approximately $72,000 in net severance payments to 26 employees,
even though these employees never severed their employment with
the division. In November 1993, the division informed all of these
employees that the payment they received was improper and
requested that the employees pay back the division, and about
$9,000 of the $72,000 has been repaid thus far;
According to our interviews with division employees, vacant
positions within the division were advertised primarily by word of
mouth, and most of the employees who were hired formerly worked
for failed insurance companies;
Our review of 31 contracts revealed that for 4 of the contracts, the
division did not have written agreements with its consultants.
Also, the division did not always attempt to obtain competition
before it awarded contracts, and it did not always write all the
essential provisions into its contracts. In addition, the division's
process for reviewing invoices was flawed, leading to questionable
payments to its consultants, such as three payments totaling
$34,000 that were made twice for the same work, and
reimbursements to consultants for questionable items, such as the
expense of a hotel health club and long-distance calls not related to
division business;
Our review of 66 expenditures that the division allocated to the
conserved companies identified several instances of erroneous
allocations, such as $75,000 of expenditures that were allocated to a
single month that the division should have distributed over several
months. Also, in 1992 and 1993, the division allocated $181,000
of its costs of servicing conserved insurers with few assets to estates
that had more assets. The $181,000 has since been paid back by
the Department of Insurance. In July 1993, the division began
allocating its costs of rendering services to all the insurers it
manages regardless of whether the insurers have assets; however,
because the division does not have the funds to cover ongoing costs
of managing insurers with few assets, the insurers having more
assets are still bearing a disproportionate share of the division's
costs;
19
In 1992 and 1993, the division allowed its employees and
consultants, as well as their friends and families, to purchase the
assets of liquidated insurers, posing a conflict of interest. In 1991,
the division retained three oil paintings worth about $35,000 at the
division's offices instead of disposing of them through a public sale.
As of March 1994, these paintings were still not sold; and
In three of the four claims that we reviewed, the division did not
process the claims promptly, taking over two years to process them.
Corrective Action The department has taken steps to address most of the weaknesses
Taken by the discussed in this report. In October 1993, the department terminated
the employment of the general manager of the division and demoted the
Division
division chief to a position elsewhere in the department. Also, in the
past 12 months the division has been reorganized and hired a new chief
executive officer. Additionally, the division has adopted new
procedures covering the division's essential activities, including
compensating division employees; selecting, managing, and paying
outside consultants and law firms; disposing of the assets of liquidated
insurers; and creating an operating budget for the division each year.
Also, in March 1994, the division adopted new accounting procedures
that were drafted especially for the division by a public accounting
firm.
The department has more to do to remedy the shortcomings of the
division, however. An area of primary importance is for the division
to create a strategic plan that will enable it to better prioritize its
workload into the foreseeable future. The division also needs to focus
on developing individual management plans for each of the open and
active estates under its care.
Recommendations To ensure that the new policies established by the division operate as
intended and are adhered to by the division, the department must
improve its oversight of the division's activities. Currently, the
division's activities are overseen by the courts, by executive
management of the department, and through regular reviews by the
Department of Finance. We recommend that the Bureau of State
Audits or another independent auditor conduct a followup review of the
division's operations in one year. For a complete list of our
recommendations, see Chapter 7, page 56.
Agency With few exceptions, the Department of Insurance concurs with the
Comments conclusions and recommendations in our report.
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Chapter 1 Introduction
The authority for the Conservation and Liquidation Division (division)
within the Department of Insurance (department) dates back to 1935,
when the Legislature enacted Article 14 of the California Insurance
Code. The division is responsible for conserving and liquidating
insurance companies (insurers) that experience financial or other
problems or that are not authorized to transact insurance business in the
State of California. Section 1011 of the California Insurance Code
authorizes the insurance commissioner (commissioner) to file for a
court order to take possession of the assets of an insurer that is
experiencing financial or other problems or that is an unlicensed insurer
and, with the court order, conserve the insurer's assets.
During conservation, the insurance company is placed under
court-ordered regulatory control to conserve the insurer's assets until
the insurer's status is determined. If the commissioner determines that
it would be futile to rehabilitate the insurer in conservation (conserved
insurer), he may apply to the court for an order to liquidate the assets of
the conserved insurer. Liquidation is a process in which a conserved
insurer's assets are converted to cash and applied toward its outstanding
debt.
After the division has liquidated a conserved insurer's assets (liquidated
insurer), the commissioner must apply for a court order to distribute the
liquidated insurer's assets to its policyholders, creditors, and other
interested parties in the order required by the California Insurance
Code. The final distribution of assets and declaration to the court of
that fact serves as closure of that insurer. Figure 1 shows the number
of insurers conserved, closed, and being actively managed by the
division during each year from 1989 through 1993.
Figure 1 Number of Insurers Conserved, Closed, and
Being Managed by the Conservation
and Liquidation Division
21
120
103
100 95
91
79 78
80
Insurers conserved
60 Conserved insurers closed
Conserved insurers still active
40
21
20
12 4 7 8 8 10 6 9 N t o h c o e c t u e d : r i e v d i O s i f f o o 1 n r 0 ; 1 3 a 7 f in i o n s t a h u l e r e d rs r is s t b , r u i 7 b t 6 u t t h a io e re n c m o o f u a r a n t s a s s g h e e a t d s v e b y yet
1 to designate them closed; and 5 others,
0 including 2 with 5 related companies, are
managed by special deputy commissioners.
1989 1990 1991 1992 1993
As of January 1994, the division has conserved or is liquidating the
assets of 76 failed and unlicensed insurers. These insurers' assets total
approximately $415 million. The total amount of assets of insurers in
conservation or liquidation managed by the division from calendar
years 1989 through 1993 is shown in Figure 2 below.
Figure 2 Total Assets in Conservation or Liquidation
1989 to 1993
(In Millions)
$700 $682
$644
$600
$509
$500 $482
$415
$400
$300
$200
$100
$0
1989 1990 1991 1992 1993
Of the 76 insurers in conservation or liquidation, 70 are being managed
within the division, and 6 are being managed by division employees at
the insurer's location. In addition to the 76 insurers being managed
during conservation or liquidation by the division, the commissioner is
responsible for conserving 5 other insurers that are managed by special
22
deputy commissioners appointed by the commissioner. According to
the department, these 5 insurers are managed outside the division's
control because of their size and complexity. The externally managed
conservations include Executive Life Insurance Company and First
Capital Life Insurance Company, both of which were conserved in
1991. These 5 insurers had assets totaling approximately $10.2 billion
as of December 1992.
The division's responsibilities in managing conserved and liquidated
insurers primarily consist of reviewing claims not covered by insurance
guarantee funds; determining amounts owed to the claimants; and
taking action to identify, marshal, and manage the assets of insurers in
conservation to maximize the return to policyholders and general
creditors should a liquidation of assets become necessary.
Many policyholders of licensed insurers in conservation or liquidation
are covered by a state insurance guarantee fund. In California, the
California Insurance Guarantee Association, the California Life
Insurance Guarantee Association, and the Robbins-Seastrand Health
Insurance Guarantee Association process and pay covered claims of
insolvent property and casualty, life, and health insurers who are
members of these associations.
The operations of the division are funded through the assets of the
conserved and liquidated insurers. For calendar years 1992 and 1993,
the total operating expenses of the division were approximately
$14.6 million and $14 million, respectively.
Historically, the division has interpreted the code and long-standing
case law as exempting it from budgetary oversight by the Department
of Finance, expenditure and financial statement oversight by the State
Controller's Office, contracting and purchasing oversight by the
Department of General Services, and personnel practices, salary
administration, and travel policy oversight by the Department of
Personnel Administration and State Personnel Board.
23
According to the department, oversight of the division's operations is
provided through three independent sources: the internal management
of the department, superior courts and judges (where conservation and
liquidation matters are reviewed), and the audits conducted by the
Department of Finance.
The Division's Before its recent reorganization, the division was organized into seven
Organization and units: (1) administration and special projects; (2) property and
casualty claims; (3) life, health, and surety claims; (4) special
Staffing
receiverships; (5) management information systems; (6) accounting and
finance; and (7) reinsurance. Each of these units was headed by a
manager who was a non-civil service employee, or "at-will" employee.
"At-will" employees are non-civil service employees whose
employment the division may terminate at any time, with or without
cause. These managers reported to the general manager, who also was
an at-will employee. The general manager in turn reported to the
division chief, who was a civil service employee. The division also
had an assistant chief, who was a civil service employee. In
September 1993, the chief of the enforcement division terminated the
employment of the general manager, and in October 1993, he
transferred the division chief to the department's Financial Surveillance
Division.
In November 1993, the department reorganized the structure of the
division into three bureaus under the proposed direction of a chief
executive officer (CEO): the estate trust bureau, the financial bureau,
and the operations bureau. The estate trust bureau will be staffed with
an estate trust officer, who will oversee five estate trust managers to
manage all conserved and liquidated insurers. The financial bureau
will be staffed with a chief financial officer, who will oversee the data
processing, accounting, investments, and reinsurance units. The
division is evaluating the time line for hiring an administrative officer
for the operations bureau, who will oversee the administration, claims,
and human resources units. All of these positions are or will be staffed
by at-will employees.
According to the commissioner, the division employs a non-civil
service work force because, under that arrangement, staff may be added
or decreased based on the flow of the work, which is more complicated
and often impossible to do with a civil service staff. The
commissioner stated that it is impractical to predict the annual number
of insurer insolvencies or fraudulent activity that will result in
conservation actions managed by the division. The commissioner also
stated that by employing at-will employees, the division can hire highly
trained and experienced personnel as needed at competitive market
24
salaries and that the existing employees available at conserved insurers
are operating as private employees, not civil servants. Figure 3 shows
the current organization structure of the division.
Figure 3 Conservation and Liquidation Division
Organization Structure
In January 1994, the division had 5 civil service employees and 91
at-will employees. The division has since laid off 9 at-will employees
during January and February 1994. According to the department's
chief of the enforcement division, who has oversight responsibilities for
the division, the work force was reduced because of the efficiency
gained from newly developed accounting policies and procedures,
consolidation of the division's claims units, and abolishment of the
division's special receivership unit. As of April 1, 1994, the division
25
employs 5 civil service employees and 85 at-will employees. In
March 1994, the division hired a CEO and in April 1994, it hired a
chief financial officer and an estate trust officer.
In addition to the division's work force, the division also engages the
services of Department of Justice attorneys, private consultants, and
private legal counsel for assistance in the conservation and liquidation
of conserved insurers.
Scope and The purpose of this audit was to evaluate the effectiveness and
Methodology efficiency of the division's operations. In conducting this audit, we
reviewed pertinent laws, regulations, and policies and we interviewed
personnel of the division and other department representatives. We also
met with consultants who had been retained to develop the division's
accounting policies and procedures and discussed specific
compensation information gathered during the course of the audit with
the compensation consultants engaged by the division.
To evaluate the division's personnel practices, we reviewed the salaries
paid to at-will employees at the division for calendar years 1991
through 1993 to determine their reasonableness. We also reviewed the
compensation study conducted recently by Ernst & Young and
interviewed its staff to determine the reasonableness of the study's
methodology and the recommended salaries for all positions staffed by
at-will employees. Furthermore, we reviewed the current and past
practices used by the division to establish salaries, merit and
promotional raises, compensation for overtime, and severance
payments to its at-will employees. Finally, we determined the current
and past practices used by the division in hiring at-will employees.
To determine the appropriateness of the expenditures incurred by the
division for employee severance and overtime pay, we reviewed
records and interviewed staff at the division. To determine the
propriety of selling the assets of liquidated insurers to division
employees, we reviewed the department's investigative report and
records on the sales.
To evaluate the propriety of the division's expenditures for consultant
services, we examined the division's practices for selecting consultants
and determined how contracts were awarded. We also reviewed a
sample of consultant contracts and billings to assess the reasonableness
and propriety for each consultant payment. In addition, we reviewed
the division's controls to prevent conflicts of interest in its hiring
practices and awarding of consulting contracts.
26
To assess how the division estimates and controls its income and
expenses, we examined the methodology used by the division in
establishing its budget and reviewed how the budget is monitored. We
also assessed the division's method of allocating its direct and indirect
costs to the insurers in conservation and liquidation.
To determine whether the division is effectively managing the assets of
conserved and liquidated insurers, we reviewed some of the division's
status reports for the conservation and liquidation of the insurers under
its management. We also reviewed the division's processing of claims
under its control and the management of reinsurance receivables.
To determine if the division has implemented corrective actions for
previously identified control weaknesses, we interviewed staff and
determined the status of the corrective actions taken.
Finally, we assessed key management controls used by one of five
conserved insurers managed outside the division's control. We
determined the practices and management controls used by the special
deputy commissioner of First Capital Life Insurance Company in
conserving the insurer. From our limited review, we did not find any
major deficiencies in the conservation of this insurer.
27
Blank page inserted for reproduction purposes only
Chapter 2 The Division Has Not Developed a
Strategic Plan for the Conservation
and Liquidation of Conserved Insurers
Chapter According to the California Insurance Code, the Conservation and
Summary Liquidation Division (division) is responsible for managing the
property and investments of the insurers it conserves. In addition, the
division is responsible for recovering all assets belonging to the
conserved insurers and managing these assets so as to maximize the
return to policyholders, creditors, and others having an interest in these
insurers in the event that the assets are distributed following
liquidation. Because of the division's responsibilities, its primary
goals should be to maximize asset recoveries; maximize the
productivity and cost-effectiveness of its operations; and manage the
assets under its control to ensure a maximum return to policyholders,
creditors, and other interested parties.
In an attempt to determine the division's goals and objectives, we
reviewed the latest Annual Report of the Commissioner and the
division's Performance Management Program Manual. Neither of
these documents contained a discussion of the division's goals. In a
March 1994 letter to the Department of Finance, the commissioner said
that goals had not been developed, but would be by mid-April 1994.
Additionally, in April 1994, the chief of the enforcement division told
us that one of the first assignments of the division's new CEO is to
develop written goals.
Because the division does not have goals, it is unable to develop
objectives to reach its goals. In fact, we found that the division has not
developed a meaningful annual budget and has not developed closure
plans for the conserved insurers it manages. As a result, the division
cannot ensure that it is effectively managing the conserved insurers
under its care.
28
The Division Did The division does not have management plans to close many of the
Not Establish conserved and liquidated insurers under its management. Specifically,
the division often does not have any management plans specifying
Management
goals and milestones for managing the 76 conserved insurers under its
Plans To Close
control. Without management plans projecting the necessary work to
Any of the
be done in conserving and liquidating the conserved insurers, the
Conserved or division cannot effectively determine its staffing requirements. Of 76
Liquidated conserved insurers, 42 still had not been closed and their assets had not
Insurers been distributed three years after the orders to liquidate the conserved
insurers were approved by the court. Furthermore, for two of these
estates, court-approved liquidation orders dated back more than 15
years, with the earliest court order approved in 1965.
Among these 42 insurers are 15 ancillary insurers. An ancillary
insurer is an insurer that is incorporated in a state other than California.
According to Section 1064.3 of the California Insurance Code, when an
ancillary insurer having operations in California is conserved, the court
generally appoints the commissioner as the ancillary receiver. The
Code further states that, once appointed as ancillary receiver, the
commissioner has the sole right to recover the ancillary insurer's assets
located in California, liquidate and pay certain priority claims that have
been established and allowed by the ancillary court, and pay necessary
expenses of such proceedings. All remaining assets are then required
to be promptly transferred to the receiver located in the ancillary
insurer's state of incorporation.
In addition, according to the division, there are some estates with
long-tailed liabilities which could be an obstacle to closing an estate.
According to the commissioner, some of the conserved insurers that
have been in conservation for more than 15 years could remain in
conservation even longer because of long-tail liabilities and complex
litigation. Long-tail liabilities are those that are not readily
determinable because the amounts owed to claimants are related to
ongoing medical conditions or other conditions that have not yet
surfaced. A table detailing the 76 insurers, their states of domicile,
and the date of their conservation and liquidation, if any, is provided in
the Appendix.
The division has not established management plans for many of these
conserved or liquidated insurers. According to a special deputy
commissioner appointed by the commissioner to oversee the affairs of
two conserved insurers, the division could reasonably determine within
a few weeks whether a conserved insurer could be rehabilitated.
29
Further, when the division determines that a conserved insurer cannot
be rehabilitated, the division should proceed to liquidate the assets and
close the insurer.
In a March 1994 response to a Department of Finance recommendation
concerning the issue of better planning for the management of
conserved insurers, the commissioner indicated that the division had
completed status reports on all special receiverships and would begin
reviewing the remaining estates as soon as the estate trust managers
were hired.
We acknowledge that the division has completed status reports for
some of the insurers it manages; however, in our view, these status
reports do not sufficiently set forth a plan of action for each estate.
These reports do not establish milestones toward the closure of the
insurers or target dates by which key actions must occur. For example,
the division prepared a status report for one insurer that described the
history of the insurer's problems leading to the conservation order.
However, no key actions or related target dates were identified to
estimate when closure of the insurer would occur. We confirmed that
the estate trust managers were hired as of April 15, 1994, and according
to the department's chief of the enforcement division, these managers
would be responsible for reviewing all the conserved and liquidated
insurers by June 1, 1994.
Section 1016 of the California Insurance Code states that if the
commissioner determines that rehabilitating the conserved insurer
would be futile, he may apply to the court for an order to liquidate the
assets of the insurer and finalize the business of the insurer. Further,
Section 1064.2(c) of the California Insurance Code requires the
commissioner, as liquidator of the insurer, to immediately take such
steps as are necessary to liquidate the assets of the insurer.
Without management plans, the division cannot be sure it effectively
and efficiently manages the assets of the conserved and liquidated
insurers and cannot ensure that it is maximizing the assets of liquidated
insurers and distributing the assets at the earliest possible time without
further draining the resources of the entity.
30
The Division
In its December 1992 management letter on the review of the internal
Does Not Have a
control structure of the division, the Department of Finance informed
Meaningful the commissioner that it found that the division had neither an annual
Budget for Its budget for its operations nor written policies and procedures to be used
in preparing a budget. According to the division's accounting
Operations
manager, the division had not prepared annual budgets for the division
before 1994.
The division has developed an annual budget for 1994, but it identifies
budgeted expenditures only for the division's at-will personnel and
some indirect costs and does not identify other direct costs, such as the
costs of hiring consultants for the division or for specific conserved or
liquidated insurers. In 1992 and 1993, the total fees paid for
consultant services were approximately $4.5 million and $6.5 million,
respectively. The total operating expenses, including the direct costs
for the division in 1992 and 1993, were approximately $14.6 million
and $14 million, respectively.
The accounting manager indicated that she prepared the 1994 budget.
To determine personnel and personnel-related indirect costs for 1994,
she took the division's personnel salaries at the time she was preparing
the budget and added 35 percent for employee benefits to arrive at the
division's 1994 personnel expenses. Further, for other indirect costs,
she used the 1993 figures. However, we found that the division gave
no consideration to the level of conservation or liquidation activities,
workload, or the asset base in developing the budget. The division
also did not estimate the costs of the contracts that it awarded for
consultant services and therefore did not budget for the cost of these
contracts. Finally, we question the division's ability to budget
meaningfully for its operations when it does not have any management
plans for the conserved and liquidated insurers.
According to the department's chief of the enforcement division, by
July 1994, the division intends to develop an annual budget that will
include all direct costs. In addition, the division hired an accounting
firm in October 1993 to formulate accounting policies and procedures
for the division. Among the accounting policies and procedures
prepared by this consultant are procedures to develop an annual budget.
Our review of the newly developed policies and procedures for annual
budgeting, however, revealed several deficiencies. Specifically, the
new policies and procedures do not explicitly address budgeting the
expenses of consultants engaged by the division that are ultimately
charged to the conserved and liquidated insurers directly, such as fees
for attorneys and other professionals. Furthermore, the policies and
procedures do not address developing the budget based on activity
31
measures, such as level of conservation and liquidation activities,
workload, income, or size of the asset base managed by the division.
Section 1035 of the California Insurance Code states that, among other
things, the commissioner shall establish the compensation of personnel
and the costs of taking possession of, conserving, conducting,
liquidating, disposing of, or otherwise dealing with the business and
property of insurers, subject to the approval of the court. Further,
Section 13403(a) of the California Government Code requires the
establishment of a system of authorization and recordkeeping adequate
to provide effective accounting control over assets, liabilities, revenues,
and expenditures.
Without a meaningful annual budget, the division cannot effectively
monitor its total operating costs. Further, without an appropriate
budget, the division does not have a mechanism to evaluate the volume
and effectiveness of its spending, nor do managers within the division
have an incentive to keep costs to a minimum. Therefore, the division
cannot ensure that it is protecting the assets of the conserved and
liquidated insurers while maximizing the return of assets to the
policyholders and general creditors of these conserved and liquidated
insurers.
32
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Chapter 3 Personnel Practices of the Division
Need Improvement
Chapter The California Insurance Code gives the insurance commissioner
Summary (commissioner) the power to hire and compensate special deputy
commissioners, clerks, and assistants and vest them with the power to
take possession of insurers operating in a hazardous manner within the
State, conduct their businesses, conserve or liquidate their assets, and
otherwise dispose of or deal with the businesses or properties of such
insurers. The compensation to pay these special deputy
commissioners, clerks, and assistants, along with all expenses incurred
by them in performing these activities, is fixed by the commissioner,
subject to approval by the courts, and paid out of the assets of the
conserved insurers under the control of the Conservation and
Liquidation Division (division). However, despite having some
formalized policies and procedures relating to its personnel practices,
the division used questionable practices in the hiring of division
employees and in granting merit increases and promotions.
In addition, shortcomings in the division's oversight and control of
overtime contributed to a 418 percent increase in the compensation
paid for overtime from 1991 to 1993. Furthermore, the division's
management failed to adhere to its own policies when it paid exempt
employees more than $119,000 for compensatory time off (CTO) that
exempt employees had accrued between 1990 and 1993. An exempt
employee is an employee working in an administrative, executive, or
professional capacity who, under both state and federal law, is exempt
from overtime provisions. Finally, the former division managers
improperly authorized the payment of approximately $90,000 in
severance payments to division employees who had not severed their
employment with the division.
33
The division has taken a variety of corrective actions to address these
problems, including transferring the former division chief to a position
elsewhere in the department and removing the former general manager,
but additional corrective action is necessary.
The Division's As shown in Figure 4, the amount that the division has spent on
Payroll employee salaries, exclusive of overtime payments, has increased
dramatically from 1991 to 1993. Specifically, payroll expenses for
Expenditures
salaries increased from $1,250,000 in 1991 to $1,960,000 in 1992
Grew at a Rapid
(56.7 percent) and from $1,960,000 in 1992 to $3,080,000 in 1993
Rate From 1991
(57.3 percent). This growth in salary expenses can be explained by
to 1993 three factors: an increase in the base salary rates paid to division
employees, a significant number of promotions for division employees,
and an increase in the division's work force.
Figure 4 Conservation and Liquidation Division
Payroll Expenditures
1991 to 1993
First, the base salary rates paid to division employees have increased.
We performed an analysis of all at-will employees who had worked for
the division during the 1991, 1992, and 1993 calendar years. We
excluded any employees who had received promotions, were
transferred among work units, or went from a "junior" job title to a
"senior" job title during this period. According to our analysis, the
base salaries of at-will employees increased by approximately 9.5
34
snoilliM
nI
$3.50
$3.08
$3.00
$2.50
$1.96
$2.00
$1.50
$1.25
$1.00
$0.50
$0.00
1991 1992 1993
percent from 1991 to 1992 and an additional 2.6 percent from 1992 to
1993 for an overall two-year increase of approximately 12 percent. It
is important to note that, since November 1993, the division has been
35
under a hiring freeze with the exception of the hiring of a new chief
executive officer in March 1994 and a chief financial officer to take
effect as of May 1, 1994.
To determine if the increases in the division's base salary rates were
reasonable compared to those in other industries, we obtained statistics
from the American Compensation Association representing base salary
increases in the insurance industry in the western United States and in
U.S. financial institutions for calendar years 1992 and 1993. We also
obtained base salary data from the California Department of Personnel
Administration for selected California civil service groups for calendar
years 1992 and 1993. As shown in Figure 5, the division outpaced the
base salary increases in both the private and public sectors in 1992
while lagging behind the private sector for increases in base salary rates
in 1993.
Figure 5 Comparison of Base Salary Percentage Increases
The second factor explaining the increase in the amount the division
has spent on salaries is the size and number of pay increases related to
promotions granted to its employees between the 1991 and 1993
calendar years. Our analysis of 24 at-will employees who worked for
the division during the period from 1991 to 1993 and received
promotions showed that, overall, the salaries of these employees
increased 29.26 percent over those two years as a result of promotions.
Salaries of promoted employees increased more than 22 percent in
36
segatnecreP
14
12.27
12
10 9.46 9.8 9.45
Conservation and Liquidation
Division
8
Western U.S. insurance industry
6 U.S. financial industry
5.05
4.70 4.75 4.75
CA civil service work force
4
2.57
2
0 0 0
0
1992 1993 Totals
1992 and an additional 5.7 percent in 1993. Expressed as a percentage
of the employee's base salary, promotions received in 1992 ranged
from a low of 3.16 percent to a high of more than 70 percent. During
1993, promotions ranged from 4 percent to more than 23 percent. In
contrast, pay increases related to promotions expressed as a percentage
of total base salaries for the insurance industry were 1 percent for 1992
and 0.9 percent for 1993. Figure 6 shows the percentage of salary
increases for the 24 promoted employees from 1991 to 1993 and the
number of employees receiving the respective percentage of salary
increases.
Figure 6 Conservation and Liquidation Division
Percentage of Salary Increase
for Promoted Employees
1991-1993
Percentage of Salary Increase
For example, in 1992, an office clerk in accounting paid at a base salary
of $2,025 per month was promoted to a cash management specialist
position, which pays a base salary of $3,000 per month, an increase of
more than 48 percent. In another example for 1992, an administrative
assistant paid a base salary of $2,875 per month was promoted to
manager of special receiverships at a base salary of $4,800 per month,
an increase of approximately 67 percent.
37
seeyolpmE
fo
rebmuN
6
6
Note: Of 24 employees who received promotions, 23
5 are shown below. The only employee not shown was
5 promoted and then demoted during the same year.
4
4
3
3
2 2
2
1
1
0
0-10% 11-20% 21-30% 31-40% 41-50% 51-60% >61%
s
The last factor contributing to the increase in the division's salary
expense over the last two years is the net increase in the division's work
force during that period. From 1991 to 1993, the division hired 78
at-will employees (57 permanent and 21 temporary) and terminated 28
(20 permanent and 8 temporary), for a net increase of 50 (37 permanent
and 13 temporary). The division's hiring trend for 1990 through 1993
is shown in Figure 7. The largest single-year increase occurred in
1992, when the division added a net total of 31 employees to its work
force (24 permanent and 7 temporary). In contrast, in the 14 years
before 1991, the division hired a net total of only 36 employees. The
administration manager cautioned that the hiring statistics supplied to
us by the division for the years before 1991 may not be exact. She
believes that the division lacks some historic personnel data.
Figure 7 Conservation and Liquidation Division
Number of At-Will Employees
1990-1993
Overtime payments have increased significantly from 1991 to 1993.
Specifically, overtime payments for 1991 totaled approximately
$69,000, while in 1993, the amount paid for overtime totaled
approximately $357,000, an increase of 418 percent in two years.
Figure 8 shows the division overtime expenditures in 1991, 1992, and
1993. Overtime payments for 1992 alone increased by more than
$183,000 from those reported for 1991, an increase of 265 percent.
For example, ten employees received overtime payments exceeding
38
seeyolpmE
fo
rebmuN
100
91
90
78
80
70
60
47
50
41
40
30
20
10
0
1990 1991 1992 1993
The Division's
Overtime Usage
Increased
Significantly
$10,000 each in 1992, with one employee receiving almost $34,000.
The latter employee's gross salary in 1992 from regular and overtime
pay was approximately $101,360.
Figure 8 Conservation and Liquidation Division
Overtime Expenditures
1991-1993
$400,000
$357,000
$350,000
$300,000
$252,000
$250,000
$200,000
$150,000
$100,000
$69,000
$50,000
$0
1991 1992 1993
We inquired about the increased use of overtime during 1992. The
chief of rate enforcement, who was the former deputy commissioner for
enforcement and investigation responsible for oversight of the division
during 1992, told us that he was not aware that the increase in overtime
was so dramatic, but offered four possible reasons for the
increase: initiation of enforcement conservations, the closure of insurer
estates, an increase in the number of insurer insolvencies, and
correcting the deficiencies identified by the Department of Finance as a
result of its 1991 audit of the division. He stated that he believed that
1992 was the year that the Department of Insurance began enforcement
conservations, which are seizures of illegal or unlicensed insurance
companies. The seizures caused additional work for division
employees. The chief also stated that he was pressuring the division to
close estates during 1992. Closing an estate involves applying to the
court for an order to liquidate the insurer and distributing the liquidated
assets, the final distribution of which serves as the closure of that
insurer. Finally, the chief stated that in 1991, 21 insurance companies
became insolvent and came under the division's management.
39
However, it was during this same two-year period that the division
added 44 employees to its work force and the asset base it
managed declined approximately $267.4 million, from approximately
$682 million in 1991 to approximately $414.6 million in 1993. These
factors seem to indicate that either the division did not properly utilize
the resources it had or it did not know the full extent of its workload
needs. The total assets managed by the division from 1989 to 1993 are
shown in Figure 2 on page 2 of Chapter 1.
In a meeting held after our fieldwork was completed, the division
expressed a concern that its asset base was not the best indicator of the
division's workload. To address this concern, we allowed the division
an opportunity to provide us with information it felt would better
characterize the division's workload. The division provided this
unaudited information shown in Figure 9. These figures represent the
dollar amount of distributions of liquidated insurer assets, including
advances to guarantee associations to pay covered claims, funds
returned to domiciliary states, and distributions to creditors for each of
the six-month periods ending June and December 1991 through 1993.
As the figure shows, the asset distributions for the division fluctuated
widely during the period from 1991 through 1993. In the six months
ending June 1991, the division distributed nearly $10 million whereas,
in the six months ending December 1993, the division distributed
approximately $55 million.
40
Figure 9 Distributions Made by the
Conservation and Liquidation Division
(In Millions)
$60.0
$55.2
$54.2
$50.0
$40.0
$30.0
$20.0
$11.5
$9.5
$10.0 $7.7
$4.0
$0.0
Jun-91 Dec-91 Jun-92 Dec-92 Jun-93 Dec-93
The Division's Use According to its past policies and procedures, the division required
of Overtime Was written preauthorization for overtime worked during the period from
Not Controlled March 1986 until the division discontinued this
requirement in January 1992. In addition, the division required
written preauthorization before working overtime that would result in
an employee earning compensatory time during the period from
December 1990 until this policy was discontinued in January 1992.
However, neither the administration manager nor the payroll and
benefits administrator was able to find any evidence that these policies
had ever been adhered to. As mentioned previously, during 1991,
payments for overtime totaled approximately $69,000. The overtime
may have been worked without written preauthorization in contrast to
the division's stated policy.
Moreover, exempt employees were allowed to earn compensatory time
totaling 1,503 hours during 1991 without written preauthorization even
though it was required by the division's policy at that time. An exempt
employee is an employee working in an administrative, executive, or
professional capacity who, under both state and federal law, is exempt
from overtime provisions.
41
Furthermore, during calendar year 1990, exempt employees were
allowed to earn 1,390 hours of overtime and were allowed to take 1,456
hours of time off work. Some of the compensatory time taken by
exempt employees in 1990 had been earned in 1989. Allowing exempt
employees to earn and take compensatory time was a violation of the
division's policy that prohibited exempt employees from earning
overtime. To quantify the cost to the conserved insurers' estates of the
division's failure to adhere to this particular policy, we obtained the
1991 hourly pay rates (the earliest year for which the division could
readily supply this information) for all exempt employees who earned
overtime during 1990. Using these pay rates, we determined that the
cost borne by the conserved estates for the 1,456 hours of
compensatory time used in calendar year 1990 was approximately
$27,400. Finally, we determined that at the end of calendar year 1990,
exempt employees' overtime balances totaled 746 hours. Assuming
that all these employees subsequently used their compensatory time off,
we estimate that the additional cost to the conserved estates was
approximately $14,600.
These examples illustrate occasions when the division, despite having
established policies, failed to adhere to them. And as indicated, the
consequences of the division's failure to adhere to established policies
can be costly to the conserved insurer estates managed by the division.
We also noted instances when the division lacked effective internal
controls to manage overtime. For example, the division's policies for
overtime were amended as of January 1, 1992, so that written
preauthorization was no longer required before employees worked
extra hours. According to the current overtime policy, employees
must get approval in advance of working any overtime. However, the
administration manager reports that most overtime approvals are given
verbally. This is not an effective way of controlling the use of
overtime, especially because the division does not develop budgets
based on workload indicators derived from the units within the division
(see page 12 of this report for further discussion regarding preparation
of budgets). Without budgetary forecasts concerning workloads, and
in the absence of requiring written preauthorization for overtime, the
managers of the division do not have the tools necessary to make either
short-term decisions regarding the cost versus benefits derived from
employees working extra hours, or long-term decisions regarding the
hiring needs of the division. Furthermore, without advance knowledge
of the amount of overtime requested and the ability to measure
employee productivity, the managers of the division have limited
42
ability to assess whether the use of overtime is necessary or productive
and whether the productivity of employees working large amounts of
overtime is being adversely affected.
These factors may have contributed to the dramatic increases in the use
of overtime in 1992 and 1993, even though the division had increased
its work force by a net total of 44 employees while the overall level of
insurer assets under its management had declined during those two
years. Moreover, a division budget designed using unit workload
indicators has the added benefit of providing benchmarks for
supervisors and managers to use in evaluating division employees' job
performance in the areas of productivity and cost containment in a
much less subjective way than has previously been the case.
Improper Overtime From 1990 through 1993, former division management improperly paid
Payments Were its exempt employees more than $119,300 in overtime payments in
violation of stated policies and procedures. The improper overtime
Made to Employees
was paid from the assets of the conserved insurers under the
in Violation of
management of the division.
Stated Policies
Although the division's policies and procedures regarding CTO for its
exempt employees has changed, it was never the division's policy to
make cash payments to exempt employees for the overtime accrued by
these employees. The division's original written policy regarding this
subject became effective in March 1986 and stated that exempt
employees may be expected to work extra hours without receiving
additional pay because the requirement for overtime work is inherent in
the responsibilities of an exempt employee. This policy was changed
in December 1990 to allow exempt employees to earn and accumulate
CTO with the prior approval of a supervisor, who recorded the
approval on a CTO authorization form. All exempt employees were
required to use their CTO within one year of earning it, or it was to be
forfeited. The division again changed its policy in January 1992,
removing the requirements that the earning of CTO be preapproved in
writing and used within one year of its being earned. However, none
of these policies in their various forms allowed exempt employees to
receive cash payments for their accrued CTO. Nevertheless, the
managers of the division improperly paid exempt employees more than
$119,300 to cash out accrued CTO. In fact, the division paid one
exempt employee $1,124 in November 1990, before the division even
had the policy allowing exempt employees to accrue CTO.
43
In September 1993, the division once again changed its policy
regarding CTO. Effective October 1, 1993, exempt employees were
no longer allowed to accrue CTO for hours worked in excess of 40
hours a week. Further, any CTO accrued before this most recent
policy change must be taken between October 1, 1993, and December
31, 1995, or it will be forfeited. Finally, all employees who terminate
employment with the division before December 31, 1995, will be paid
for any CTO that they have not used by that date.
The Division In May 1993, the division developed a salary schedule to be used with
Recently Adopted written job descriptions that were developed previously. The schedule
was divided into six salary grades, with approximately $10,000
a Salary Schedule
separating the lowest and highest salaries established within each grade
for Its Employees
level. Each level was intended to correspond with various job
descriptions, depending on the content of the particular job.
According to the findings of a compensation analysis conducted by a
management consulting firm hired by the division, there is a wide
variance in pay between the lowest and the highest paid employees in
each salary grade. According to the consultant's findings, the wide
salary ranges allowed the division to incorporate employees recruited
from failed companies with widely varying pay practices. However, it
was the consultant's opinion that these hiring practices have a very
negative impact on employee morale, particularly where individuals
performing similar duties are paid significantly differently. In
addition, the analysis found that for employees with salaries ranging
between $35,000 and $45,000 a year, individuals in jobs with much
greater responsibilities were being paid the same or less than
individuals in jobs with decidedly fewer responsibilities. The
consultant stated that this practice was demotivating because
employees in complex roles feel undervalued relative to other positions
within the division.
Other Personnel Our review of the division's personnel practices showed that the
Practices That division engaged in other improper and questionable personnel
practices. Specifically, the division improperly made severance
Were Questionable
payments to its employees. We also found that in most instances the
or in Violation
division hired its employees without formally advertising for the
of Stated Policies
positions. Finally, until recently the division did not have written job
descriptions for its employees.
44
The Division Made Improper Severance
Payments to Its Employees
Two former managers of the division improperly paid almost $90,000
in gross severance payments to employees who never severed their
employment with the division. The improper payments were paid out
of the assets of the conserved insurers under the management of the
division. In addition, a department legal counsel estimated that the
outside legal counsel retained by the department to investigate the
circumstances surrounding the division's actions in making these
payments will cost the conserved estates an additional $15,000.
The earliest written policy we could find regarding severance payments
was in the division's employee handbook, effective as of October 1983.
Under that policy, an employee with at least two years of service who
was terminated by reason of a layoff or unadaptability was entitled to
one week of severance pay for every year of employment in excess of
one year. The employee handbook defined "layoff" as a reduction in
the work force because of a lack of work. "Unadaptability" was
defined as those cases where the employee lacks the proper aptitude but
is trying to the best of his or her ability to meet performance standards.
On December 31, 1991, the division discontinued the severance policy,
notified all employees of their severance balances as of that date, and
told the employees that the division would not pay any future severance
benefits other than those benefits already earned. The severance
benefits already earned by division employees would be paid to them at
termination. Contrary to the division's policy, the former general
manager and former chief of the division decided to pay off the
severance balances of 26 employees in June 1993, even though none of
the employees had terminated their employment with the division as of
the date of payment.
Division management's payment of these accrued severance balances to
employees who had not yet severed their employment had a negative
effect on the estates of the conserved insurers under the management of
the division. Specifically, the cost of these payments, almost $90,000,
was allocated inappropriately to the conserved estates managed by the
division.
Section 1057 of the California Insurance Code states that the
commissioner is deemed to be a trustee for the benefit of all creditors
and other persons interested in the estate of a person against whom
proceedings for conservation or liquidation are pending.
45
In addition, Section 16040 of the California Probate Code states that a
trustee must administer a trust with the care, skill, prudence, and
diligence under the circumstances at the time that a prudent person
acting in a like capacity and familiar with such matters would use in
conducting enterprises of a like nature.
In October 1993, the department referred the matter of these severance
payments to the Los Angeles District Attorney's Office. Also, in
November 1993, the division contacted all the employees who received
unauthorized severance payments and requested repayment by
December 15, 1993, or, if they were unable to repay in full by that date,
to arrange for a repayment schedule. We reviewed the records to
determine how many employees had made repayments as of March 15,
1994. According to the information we reviewed, of the original total
net severance payment of approximately $72,000, just over $9,000 has
been repaid. Four employees have repaid their severance payments in
full and one employee has since been laid off by the division and
therefore was allowed to keep the severance payment. The remaining
21 employees elected to have specific amounts withheld from their
monthly salaries. The repayment rates and amounts varied. For
example, two employees owing approximately $9,000 each have
elected to repay in $50 monthly installments. Additionally, two
employees who owe more than $3,000 each, had not made any
repayments as of March 15, 1994.
We noted another instance of a questionable severance payment made
by the division to an employee whom the division terminated in
June 1992. The division's most recent policies and procedures state
that there are no severance benefits, yet they do not address other final
payments made to employees terminated by the division. However,
according to the payroll and benefits administrator and the
administration manager for the division, when employees are fired, as
was the case for this employee, they do not normally receive pay as a
replacement for proper notification or additional final pay.
Nevertheless, the former chief of the division approved the final
payment of more than $11,100 to this employee. Five checks were
issued: $1,442 for two weeks in lieu of notice, $2,527 for accrued
vacation, $3,463 for severance pay, $3,463 as additional pay for being a
manager, and $244 for payment of accrued CTO. Because this
termination was not the result of a layoff or unadaptability, we question
the propriety of the payment in lieu of notice, severance pay, and
additional pay for being a manager, totaling $8,368.
The Division's Hiring Practices Were Questionable
46
According to the administration manager, before November 30, 1992,
the division had no formal policies and procedures for the hiring of
division employees. Even the November 1992 hiring guidelines were
in the form of a memorandum and were distributed only to division
managers. The memorandum, written by the former general manager
of the division, stated that the hiring guidelines "might be formalized in
writing later, as needed. . . ." However, the division's hiring practices
were never formalized.
According to interviews we conducted with the division's manager of
administration and a survey taken of division employees, the
advertisement of open positions is accomplished mainly through word
of mouth, with most of the employees hired having formerly worked
for one of the failed companies being conserved or liquidated by the
division. However, this practice of recruiting staff for the division is
not acceptable for a public entity because it does not give all
individuals who might be interested and qualified for the open positions
an opportunity to compete for them. Further, by limiting its recruiting
pool to former employees of failed insurers, the division may not have
recruited the most qualified and competent employees.
The selection of division employees generally is based on a written
application and interview with either a division supervisor or manager,
or both. Once hired, employees of the division are required to
complete a three-month probationary period during which time certain
benefits are not available. After the probationary period has ended,
employee performance typically is evaluated once each year.
Employees also receive merit salary increases. According to our
survey of division employees, merit salary increases normally are given
annually. Generally, none of the employees in our survey who had
been employed more than one year had been refused merit increases,
which were reported to be as low as 6 percent and as high as 15 percent
per year. In September 1992, the division made its first attempt to
develop merit increases that were tied to performance ratings.
According to the administration manager, for all merit increases
received by at-will employees before that time, managers
recommended the amount of the merit increases they thought
appropriate and either the former chief of the division or his successor
approved them.
47
Also, before November 1992, no written job descriptions were
available for any of the positions filled by at-will division employees.
In November 1992, the former general manager of the division
developed job descriptions and desired qualifications for 43 of the 64
at-will employee positions in the division at that time. However, it
was not until almost six months later in May 1993, that a salary
schedule was developed that accompanied those written job
descriptions. According to the findings of a compensation analysis
conducted by a management consulting firm hired by the division in
October 1993, there did not seem to be a high-performance culture at
the division. The analysis stated that the employees recruited from the
failed companies conserved by the division may not always be of the
highest caliber. The analysis concluded that, while hiring from
conserved insurers eliminates the need for initial training, retaining
these employees after the winding up of the affairs of the failed
insurer's estate leads to significant retraining and morale issues,
including integrating different job titles and pay practices into the
division. As of January 1, 1994, the division employed 5 civil service
employees and 91 at-will employees.
Corrective Action Although the division has taken a variety of corrective actions aimed at
Taken by the the areas discussed in this chapter, we believe that additional action is
needed.
Division
Since October 1993, the division has undergone a reorganization and
amended some of its existing personnel policies. For example, in
March 1994, the division reinstated a requirement for written
preauthorization for an employee to work overtime. Also, the division
has developed a budget, developed a conflict-of-interest policy for its
employees, developed new policies regarding salary administration and
employee performance appraisals, developed job descriptions for all
at-will job positions, and commissioned a compensation study for its
executives and managers and its other employees. In addition, the
Department of Insurance recently fired the division's general manager
and transferred its chief to a position elsewhere in the department as a
result of their authorization of the inappropriate payment of
compensatory time to exempt employees and the improper payment of
severance to employees who had not severed employment with the
division.
Many of the corrective actions described above were taken so recently
that we were unable to assess how effective they will be after they are
fully implemented. However, we did review the compensation study
commissioned by the division and have some concerns with the
methodology that the consultants were directed to use by the division.
48
In its request for proposals (RFP) for conducting a wage and salary
survey, the division advised prospective consultants that the purpose of
the RFP was to determine a salary matrix for the division that would
measure and rank the relative worth of each job. The salary matrix
was to explain the meaning of midpoint, minimum, and maximum
salary for each job classification and how the going salary rate for a
particular job was determined. The salary matrix was to include salary
ranges with multiple steps after a comparison with private industry that
would include accounting for any differences caused by regional pay
differences.
We reviewed the methodology used by the consultant selected to
conduct the wage and salary surveys for the division's executive-level
personnel, managers, and other employees. In both surveys, most of
the competitive market data were from the private sector. The
executive survey used information drawn from various salary studies of
the insurance, banking, and financial industries representing companies
with varying ranges of assets under their management and different
geographic locations. The manager and employee survey drew its
salary comparisons from a variety of studies representing certain
groups in terms of the group's function or geographic location.
Examples of the comparative studies used included an information
systems compensation study; a finance, accounting, and legal
compensation study; executive, middle management, and supervisory
compensation studies; insurance industry studies; technician and skilled
trades studies; a geographic salary study of California and sections of
southern California; office support studies; and an employee benefits
survey.
We interviewed the consultant in charge of both of the salary surveys to
find out why the surveys mainly relied on salaries paid in the private
sector. According to the consultant, the chief of enforcement and a
special deputy commissioner, both of whom had acted as interim chiefs
of the division, instructed the consultant on what market comparisons
to use in the survey for the division. Namely, they wanted the
consultant to use comparative executive salaries of insurance
companies managing assets in the range of $200 million to
$500 million for the executive survey and local insurance and
noninsurance industries for the manager and employee survey. The
consultant stated that the chief of enforcement and the special deputy
wanted the consultant to survey the market they intended to recruit
from, which was the private sector. The consultant also stated that she
49
used comparative salary information from a study prepared by the
California Insurance Guarantee Association (CIGA) of the insurance
industry as a means of comparing lower level salaries.
All salary recommendations made by the consultant in the surveys for
executive, management, and other division employees have been
approved by the division. As a result, most of the division's
employees will receive salary increases. Specifically, of the 68
employees and managers for which the consultant made salary
recommendations, 58 will receive salary increases, 6 will receive salary
reductions, and the salaries of 4 employees will remain the same. The
percentage range for the approved salary adjustments of the division's
managers and employees ranges from 0.75 percent to approximately 42
percent. For example, one employee formerly paid $37,212 per year
was promoted into a new position and now will make $52,800 per year,
while another employee who made $39,840 per year before now will
make $40,637 per year. The net annual increase to the salaries of
managers and employees as a result of the salary recommendations
totaled approximately $100,000, or 4 percent.
The executive survey salary recommendations are for five positions
that did not exist before the division's most recent reorganization. The
five new positions include a chief executive officer (CEO), financial
officer, operations officer, estate trust officer, and estate trust manager.
The new CEO's position will replace the position held by the former
chief of the division, who was a civil service employee, while the
individuals filling the other four positions will perform new duties for
the division.
The recommended midpoint salaries approved by the division are
$195,000 per year for the CEO, $150,000 per year for the financial
officer, $130,000 per year for the estate trust officer, and $115,000 per
year for the operations officer. The executive salary survey also
recommended a salary range of $50,000 to $80,000 per year for the five
new estate trust manager positions established under the division's
reorganization plan. As of March 28, 1994, the division had hired a
new CEO and filled all five of the estate trust manager positions. As
of April 15, 1994, the division hired a financial officer and an estate
trust officer.
Although much of the methodology used by the consultant in
formulating the recommended salary levels shown in the two studies
seemed to us to be appropriate, we question whether the surveys should
have relied so much on private sector data. Based on our review of the
job descriptions developed by the division to cover the positions it
employs, many seem to be similar to public sector jobs. For example,
50
we selected 8 civil service positions that were similar to the job
descriptions of the duties and minimum qualifications established for 8
of the at-will job positions of the division, as shown in Table 1. In one
case, the comparable civil service job offered a higher salary both at the
entry level, and at the maximum for the range. For two other of our
comparative positions, the civil service rate was higher at the entry
level but the division offered a higher maximum salary. Finally, there
were five comparable positions for which the division offered a higher
entry level and maximum salary than were offered by the civil service.
51
Insert Table 1
52
Blank page inserted for reproduction purposes only
Table 1
A Comparision Between Conservation and Liqu
Salary Ranges for Selected Positi
and State Civil Service Position
Conservation and Liquidation Civil Service Classification Dolla
Division Salary Range Salary Range Min
Administrative Assistant Office Technician
$26,900 $36,500 $23,748 $28,860 $3,152
Word Processing Operator Word Processing Technician
$21,900 $29,700 $20,508 $26,772 $1,392
Receptionist Office Assistant (general)
$19,800 $26,800 $18,660 $24,912 $1,14
Personnel Assistant Office Technician
$26,900 $36,500 $23,748 $28,860 $3,152
Warehouse Supervisor Warehouse Manager I
$29,800 $40,300 $31,752 $41,880 ($1,952
MIS Supervisor Info Systems Tech Supervisor I
$34,800 $47,000 $33,336 $40,068 $1,464
Accounting Manager Accounting Administrator III
$52,800 $79,200 $61,548 $64,620 ($8,74
Administration Manager Staff Services Manager III
$47,400 $71,200 $61,548 $64,620 ($14,14
Notes:
Ranges are analyzed from monthly figures reported by the State Personnel Board to allow a more direct comparison to
Negative figures (indicated with parentheses) reflect higher salary levels in the civil service position classification.
53
Chapter 4 The Division Has Not Properly Managed
Its Consultant Contracts and Its
Contracts for Legal Services
Chapter We attempted to review 31 consultant contracts entered into by the
Summary Conservation and Liquidation Division (division) during 1991, 1992,
and 1993. We selected for review all contracts that resulted in
payments to the consultant of more than $100,000 in one year. These
contracts were for professional services, such as management
consulting, investment advice, and assistance in managing the
day-to-day operations of conserved insurers. They also included
agreements with law firms for assistance in handling the conservation
and liquidation of failed insurers. In four instances, the division
entered into oral, rather than written, contracts with the consultants,
although the division paid $1.4 million to these contractors over the
three-year period. Two of these four contracts were for legal services,
one of the contracts was for tax assistance from a public accounting
firm, and the fourth contract was for the services of a consultant to
manage the day-to-day operations of one of the conserved insurers.
The contract for tax assistance was a $100,000 verbal extension of an
existing contract. In addition, the contract for the services of a
consultant to manage the day-to-day operations of a conserved insurer
was approved by the court after the contract had been awarded even
though the contract was never put into writing.
Our review of the remaining 27 written contracts indicates that, in
entering contracts with consultants or law firms, the division did not
always seek competition for the contracts. In addition, the division did
not incorporate key provisions into the written contracts that would
have allowed the division to manage each of its consultant contracts
effectively. More specifically, 8 of 27 contracts reviewed did not
contain a detailed description of the work to be accomplished by the
consultant or deadlines for interim or completed work. Twenty-two of
the 27 contracts did not include maximum dollar amounts to be spent
on the contracts, and 21 did not have provisions for periodic progress
reports from the consultant, even though some of these contracts lasted
for a year or more. In 17 of the 27 written contracts we reviewed, the
division did not specify the ending dates of the contract. Furthermore,
the division did not sufficiently review invoices submitted by the
consultants before paying the invoices. Our review uncovered several
instances of erroneous payments.
56
In response to recommendations made in 1991 regarding contracting
practices, the division implemented new procedures for initiating and
managing its contracts with law firms in November 1993 and with
other consultants in March 1994.
Background The division spent $3.8 million in 1991, $4.5 million in 1992, and
$6.5 million in 1993 on contracts for professional services. These
expenditures were for consulting and attorney services related to
liquidating failed insurers and the litigation associated with various
liquidations, as well as other specialized services related to the
operation of the division. Amounts spent on contracts for professional
services are funded from the assets of conserved and liquidated
insurers.
During 1991, 1992, and 1993, the period of time covered by our audit,
the division did not have written procedures for awarding, managing,
and paying for its contracts with outside consultants and law firms.
We make numerous references in the sections that follow to sound
business practices that should be followed by public entities to ensure
that public contracts are properly awarded, managed, and paid for.
These sound business practices should include procedures that detail
those essential provisions that a consulting services contract should
contain, such as a detailed description of the work to be accomplished
by the consultant, provisions defining how the contracting department
will review periodically the progress of the consultant, and a limit on
the amount to be spent on the contract. Sound contracting procedures
also describe steps that contracting departments are to follow in making
progress payments to consultants. The division has a responsibility to
establish controls that would enable it to effectively award, manage,
and pay for services provided by its outside consultants and law firms.
Also, as we point out at the end of this chapter, the division adopted
procedures outlining how it will award, manage, and pay for its
contracts with law firms in November 1993 and with other outside
consultants in March 1994.
The Division In most instances, it is a sound business practice to seek competing
Awarded proposals before obtaining the services of a consultant. When
competition is curtailed, the contracting organization may pay more
Contracts
than necessary for the consultant's services. In instances when more
Without Seeking
than one source for consultant services cannot be identified, it is
Competing
justified for the contracting organization to award a contract on a
Proposals sole-source basis. However, the contracting organization should
attempt to identify more than one contractor that can provide the
needed services.
57
For the 27 written contracts that we reviewed, the division did not
always seek competition for the services of an outside consultant or law
firm. The former division chief informed us that he selected most
consultants and law firms based on his familiarity with the consultant's
or firm's expertise. In some cases, he selected the consultant based on
the recommendation of others. Although the former division chief
selected all the outside consulting firms, he did not select all the law
firms engaged to work on the division's liquidations and conservations.
In several instances, the department's general counsel selected the law
firms. According to the department's general counsel, she and the
chief deputy selected law firms based on their familiarity with the work
that the department needed done and the law firm's areas of
specialization. Often, the deputy attorney general assigned to assist
the division with a particular legal matter would recommend a law firm
to the department.
We acknowledge that many of the consultant and legal services
contracts were for highly specialized services related to the
conservation or liquidation of failed insurers, which could make it
difficult to obtain competition. However, not all of the contracts that
we reviewed were for consultants in highly specialized fields. For
example, 4 of the 27 consultant contracts that we reviewed were for the
services of general management consultants, who are widely available
in California. Another of the contracts we reviewed was for computer
consulting services, which could be provided by many qualified
experts.
The Division's Good business practice suggests that contracts be formalized in a
Contracts Did written agreement that contains the essential provisions of the
agreement. The written agreement should identify the parties to the
Not Always
agreement, timelines for the performance or completion of the contract,
Specify All the
and the amount to be paid to the consultant. On the matter of payment,
Terms of the
the written agreement should clearly express the maximum amount and
Agreement the basis on which the payment is to be made. Furthermore, the
written agreement should include a clear and complete statement of the
work, service, or product to be performed or provided.
However, 4 of the 31 contracts that we reviewed had no written
agreements, although the division paid $1.4 million to these consultants
during 1991, 1992, and 1993. For 8 of the remaining 27 contracts, the
written agreement did not include sufficient detail about the scope of
work to be performed. The 8 contracts stated only in general terms the
work to be done by the consultant and specified the hourly rate to be
paid to the consultant. These agreements did not specify the schedule
to be met, what progress reports were to be made, and the final deadline
58
for the completed work. Seventeen of the 27 written contracts did not
contain specific time frames for the performance or completion of the
contracts, 22 did not stipulate maximum amounts to be paid on the
contracts, and 21 did not have provisions for periodic progress reports
from the consultants, although most of the contracts lasted for at least a
year.
The Division's Because many contracts that the division enters into with its consultants
Process for run at least several months or, in some cases, years, the division usually
makes periodic progress payments to the consultants. Most of the
Reviewing
consultants submit monthly invoices to the division. Before paying
Invoices From Its
the invoice, someone in the division who is familiar with the work
Consultants Was
produced by the consultant should approve the reasonableness and
Flawed appropriateness of the invoice before it is paid by the division's
accounting office. Typically, the consultants bill for their services in
two categories. The consultant seeks payment for the hours spent
providing services to the division, and the consultant seeks
reimbursement for out-of-pocket expenses incurred while providing
services to the division. Typical out-of-pocket expenses include
travel, long-distance telephone calls, and photocopying. Invoices from
the division's legal consultants also include such out-of-pocket
expenses as the cost of legal research services or fees for the service of
court documents.
To evaluate the sufficiency of the division's procedures for reviewing
invoices, we selected a sample of 200 invoices that 16 of the division's
consultant or law firm contractors submitted during 1993. For 9 of the
16 consultants, the division's review of the invoices was flawed. For
three invoices submitted by 2 consultants, the division paid the invoices
twice. For one of the same consultants, a law firm, the invoices were
reviewed by an administrative assistant who had no familiarity with the
work that the law firm was performing. Also, one of these consultants
was reimbursed for inappropriate expenses. For 5 of the 16
consultants, the division did not require the consultant to submit a
detailed breakdown, sufficient support, or actual receipts for the
out-of-pocket expenses for which the division reimbursed the
consultant. Finally, for 2 consultants, we found that the division paid a
higher rate than the contract specified. For contracts with law firms,
the division's procedure was to call the consultant to ask for more detail
if a charge or an out-of-pocket item appeared questionable. However,
as we discuss below, this approach was not totally effective because it
resulted in the division's making questionable payments to its outside
consultants and law firms.
59
The Division Our review of the division's contracts for consultant services and legal
Has Made services produced the following examples of inappropriate or
unreasonable payments:
Questionable
Payments to
In three instances, the division paid for the same legal work twice.
Its Outside
The division made these payments, totaling over $34,000, in 1993.
Consultants and For two of these duplicate payments, the consultant sent an invoice
Law Firms to the department's legal division and a courtesy copy of the invoice
to the division. However, the division paid both invoices. The
department has established new procedures for the review and
payment of bills from outside counsel that establish a single route
for these invoices. These improved procedures should prevent a
repeat of this type of occurrence. The third duplicate payment of
$792 resulted from a clerical error, in which an accounting clerk
failed to thoroughly research the accounting records to determine if
the consultant had already been paid for the services. The division
has developed a desk procedure so that such omissions will not be
repeated in the future. Since we brought these duplicate payments
to the division's attention, the division has taken steps to recoup
these payments. In fact, during April 1994, the division received
reimbursement for the $792 duplicate payment.
The division reimbursed costs for photocopying expenses
that were unnecessarily expensive. It paid 15 cents per page for
approximately 135,000 pages of copying that, according to our
research, could have cost 6 cents per page for the first 100 pages
and 3 cents per page for the remaining 134,900 pages if an outside
copy service had been used. The difference between the two prices
is $16,200. At our request, the department asked the law firm
submitting this request for reimbursement about our concern
regarding these expenses. The law firm responded that, ordinarily,
it would send such a large production to an outside copy service
and bill the division at a reduced rate but that the need for this
photocopying was urgent and that the attorneys had to review the
records as they were being copied. However, we found that on
five more occasions during this same year, this law firm billed the
division 15 cents per page for a total 101,000 pages of
photocopying at a cost of $15,150. According to the law firm, it
used outside copying services on 32 occasions since December
1990. The law firm stated that on such occasions it paid an 8 to 10
cent copy charge per page, depending on the size and time demand
of the job.
Forty-eight of the 200 invoices that we reviewed were from law
firms providing services to the division. Law firms typically
submit monthly invoices that present the hours that the firms spent
60
on the division's legal work and the firms' out-of-pocket expenses.
Thirty-eight of the invoices included claims for reimbursement of
out-of-pocket expenses, but only 11 of the invoices contained
detailed breakdowns or actual receipts for those expenses. Without
such detail, the division has reimbursed its law firms for expenses
that, in our view, could be excessive. Because of this shortcoming,
we obtained from the consultant's accounting records the detailed
breakdown for several reimbursements that we observed on these
invoices. In one instance, the division paid the travel expenses of
an attorney that included a $165-per-night hotel room, in-room
movies and a beverage bar, expenses for the hotel's health club, and
long-distance telephone calls not related to division business.
Since we brought these reimbursements to the attention of the
division, it has taken steps to recoup the payments for the health
club, the movies, and the unrelated telephone calls. Also,
according to the general counsel for the department, the department
will conduct an audit of this firm's billings after this firm's work for
the division is completed.
We identified two instances in which the division's consultants
were paid more than the rates specified in the contract. Payments
to one of the consultants totaled $9,450 more than the rate specified
for one attorney in this consultant's written agreement. According
to the written contract dated October 7, 1991, the consultant was to
be paid $225 per hour for one attorney. Initially, this is the rate
that the consultant was paid, according to an invoice dated August
1992. However, beginning in September 1992, and continuing
through May 1993, the consultant billed the division, and the
division paid the consultant, at a rate of $250 per hour. According
to the department's general counsel, this higher rate was agreed to
orally by the department, but the contract was never formally
amended to reflect this change. In the second example, the
consultant was paid $325 per hour, although the contract specified
the consultant's rate to be $300 per hour. In this instance, the
consultant was paid $1,125 more than the rate specified in the
contract. According to a department senior staff counsel, this
higher rate was agreed to orally by the department, but there was no
written amendment.
One instance of a reimbursement to a law firm for a travel expense
was clearly inappropriate. The division reimbursed the law firm
$70 for the cost of clothing that the attorney purchased while
traveling on division business.
61
Lack of Although other state departments follow the contracting procedures
Procedures Has spelled out in the California Public Contract Code and the State
Administrative Manual, according to the department's general counsel,
Hindered the
the division is not required to do so. However, the division is still
Division's
responsible for properly managing those resources that it devotes to
Management of
consultant contracts and contracts for legal services. The division
Consultant clearly has a responsibility to establish controls that would better
Contracts and enable it to effectively award, manage, and pay for the contracted
Contracts for services of consultants and law firms. In 1991, the Department of
Finance, at the completion of an audit of the division's business
Legal Services
practices, recommended that the division establish better controls over
the contracting and management of its consultants. During their
review, the Department of Finance's auditors found that the division
had contracted with four consultants at a cost of $150,000 without
written contracts or descriptions of duties to be accomplished by these
consultants.
In January 1991, the department directed the former division chief to
establish better controls over the division's consultant contracts. In
February 1991, the division's chief sent a memorandum to the
department's chief deputy outlining a proposal for establishing a
process for contracting with outside counsel. The chief's proposal
discussed the process for selecting a particular law firm and the
negotiation of rates with the law firm selected.
Recently, the division established two sets of written procedures for
contracting with consultants. One set of procedures pertains to
contracts with outside legal counsel, and the other set pertains to
contracts with other professional service providers.
Corrective Action The division's procedures for contracting with outside legal counsel,
Taken by the which were adopted in November 1993, require the division to
pre-screen law firms to ensure that they meet basic qualifications. The
Division
division places firms that meet these basic qualifications on a list of
available law firms. The procedures also require law firms that
contract with the division to make conflict-of-interest disclosures,
provide periodic status reports, and submit case plans and budgets.
The case plans and budgets provide a tool with which the division can
effectively evaluate the efficiency of the legal services provided. In
addition, the division has established guidelines for the use of project
extensions and standards for the reimbursing of out-of-pocket expenses,
including a requirement for the law firms to provide supporting detail
for such expenditures.
The division's procedures for contracting with other professional
service providers require the division to issue a request for proposals
62
(RFP) and to obtain at least three responses to the RFP. These
procedures require a more complete written agreement than past
division contracts, including a description of the work to be
accomplished, accompanied by a deadline for completion of the work,
the amount to be paid to the consultant, and the basis on which such
payments are to be made. The procedures also include a method for
evaluating the proposals and selecting the consultant.
Since adopting its procedures for contracting for professional services
in March 1994, the division has awarded two contracts to consultants.
Both of these contracts are for the services of consultants who are to
assist the division in its conservation of two insurers. The division's
award of these contracts and their drafting of the written agreements
has improved under the division's new contracting procedures. For
one of the contracts, we reviewed the process for selecting the
consultant and found that the division reviewed four potential
consultants before awarding the contract. This is clearly an
improvement over past practices; however, the basis for selecting the
consultant could have been better documented.
Chapter 5 The Division's Allocation of Costs Results
in Disproportionate Charges to
Conserved Insurers
Chapter
During our review, we found that the Conservation and Liquidation
Summary Division (division) improperly charged costs to some insurers.
Specifically, because of the division's misapplication of its method of
allocating costs initially incurred by the division and later allocated to
the conserved and liquidated insurers, a disproportionate share of the
costs was allocated to the insurers with more assets. The division has
since obtained repayments for such expenses incurred in fiscal year
1992-93. However, the division is still allocating some costs
associated with conserved and liquidated insurers with few assets to
conserved and liquidated insurers with more assets. The department
has submitted budget documents to obtain funding for such expenses
incurred in fiscal years 1993-94 and 1994-95, but these funding
requests have not yet been approved.
63
The Division Has Section 1035 of the California Insurance Code requires that all
Misapplied Its expenses related to taking possession of, conserving, conducting,
liquidating, disposing of, or otherwise dealing with the business and
Method of
property of an insurer shall be paid out of the assets of the insurer.
Allocating Costs
The Code further states that if the property of the insurer does not
contain cash or liquid assets sufficient to defray the cost of the services
required to be performed, the commissioner may at any time or from
time to time pay the cost of these services out of the appropriation for
the maintenance of the department.
However, our review of the division's cost allocation process showed
that the division improperly allocated costs to conserved insurers, in
particular those having more assets. The division uses a method of
allocating its personnel and indirect costs to the conserved insurers
based on the labor hours expended by its staff on those insurers. The
division established a fictitious account called the "allocation company
account" that it uses as a cost pool to collect all its payroll and indirect
operating costs. These costs are then allocated to the conserved
insurers that received the division's services during the previous month.
Although we feel the allocation method is reasonable, we noted several
instances where the division has misapplied it.
The Division Did Not Properly Allocate Its Costs
We reviewed 66 expenditures from calendar years 1992 and 1993
having a total allocated cost of approximately $940,000. We
judgmentally selected a month's expenditures from each quarter during
1992 and 1993.
From our review of these expenditures, we found that the division did
not properly allocate costs to the conserved insurers. Specifically, in
January 1992, the division allocated two reimbursements totaling
approximately $162,000 to the conserved insurers that represented a
refund of unused self-insurance medical premiums and the cash balance
from the closure of an account that belonged to conserved and
liquidated insurers that had few assets. These funds were contributed
by specific conserved insurers and should have been returned to those
insurers. However, by reallocating the reimbursements through the
cost allocation process when these reimbursements occurred, some
insurers received more than their fair share of the reimbursements
based on the labor hours for that period, while others received less than
their fair share.
In addition, during 1992 and 1993, the division improperly allocated
approximately $75,000 in indirect costs that applied to periods other
than the period to which they were allocated. These indirect costs
64
consisted of expenditures for services and depreciation that should have
been spread over a period of months instead of being charged and
allocated to the insurers all at once. Because allocation rates vary
from month to month due to fluctuations in conserved insurer
workloads, and because expenses sometimes were allocated in months
other than the ones in which they were incurred, some insurers were
being charged more than their fair share of the expenses, and others
were charged less than their fair share.
The Labor Hours Used As a Basis of Allocation
of Division Costs Were Not Accurate
The division based its allocation rates on the number of hours its
employees spent on each conserved insurer. These hours are
determined from the semimonthly time sheets that division employees
submit. Each month, these time sheets are summarized by units within
the division on a cost allocation worksheet to show how many hours
the employees spent on each conserved insurer during that month.
65
Based on the hours that employees recorded on their cost allocation
worksheets, the division then allocates its personnel and indirect costs
to the conserved insurers.
We reviewed 35 time sheets from 7 different months during 1992 and
1993 and found that for 24 of the 35 time sheets, the time charges
reported on the time sheets did not agree with the time charges
recorded in the cost allocation worksheets. For example, in July 1993,
a division employee charged 111 hours to a conserved insurer on her
time sheet; however, the cost allocation worksheet indicated that only
38 hours were charged to the conserved insurer.
In addition, we found that some conserved insurers were charged hours
on the cost allocation worksheets when no time had been reported on
the employees' corresponding time sheets. For example, in
October 1993, a conserved insurer was charged 19.5 hours per the
allocation worksheet when the employee's time sheet for that month
showed that no time was charged to that conserved insurer. We also
found that some conserved insurers were not charged any time on the
cost allocation worksheets when the employees' time sheets indicated
that time was charged that month to the conserved insurers. For
example, in October 1993, a division employee charged 27 hours to a
conserved insurer per the semimonthly time sheet; however, the cost
allocation worksheet did not show any hours charged to the conserved
insurer that month.
Because the method used by the division to allocate costs to the
conserved insurers is based on direct labor hours, a conserved insurer
that is not charged for time that should have been charged will not
absorb its fair share of division personnel or indirect costs. Likewise,
a conserved insurer that is charged for time that should not have been
charged will absorb division costs for services the insurer did not
receive.
According to the division's accounting manager, the reason the
employees' time sheets and the cost allocation worksheets did not
match is that in April 1993, the division began using employees' time
sheets from the last pay period of the preceding month and the first pay
period of the current month as the basis for the current month's
allocation. She indicated that before April 1993, the division used
employees' time sheets for the current month's pay period to allocate
the current month's costs. She also indicated that the change was made
as a result of a conversation with a Department of Finance auditor
regarding the way the division allocated overtime payments from the
previous month. However, according to our review, there were many
occasions in 1992 and before April 1993 when the division's time
66
sheets did not agree with its allocation worksheets. Because overtime
earned is not paid until the subsequent pay period, an allocation rate
may be used that is not representative of the pay period when the
overtime was worked. Although the observation made by the
Department of Finance is valid for overtime, these costs are typically
minor compared to the total costs allocated each month by the division.
Therefore, by continuing to use the time sheets from a prior month's
pay period to allocate the current month's operating expenses, the
division is not matching the costs it incurs in a given month to the
conserved insurers that benefited from the division's services that
month.
The Division Improperly Allocates Its Costs of Servicing
Conserved Insurers With Few Assets to Conserved
and Liquidated Insurers With More Assets
The division also improperly allocated $181,000 in costs it incurred
servicing conserved insurers with few assets to those conserved
insurers it manages with more assets. In 1992, the division began
responding to the need to conserve and liquidate unlicensed insurers
and agencies with actions known as enforcement conservations or
liquidations. These actions are part of an overall department objective
to prevent the illegal operation of unlicensed insurers and agencies in
California by gaining control of the assets, furniture, and equipment of
the illegal operations to prevent them from re-entering the insurance
business in California. However, after the division seizes these
unlicensed insurers and agencies, it often finds that they have few
assets.
From July 1992 through June 1993, the division had charged those
conserved insurers with assets approximately $181,000 in expenses for
services it rendered to insurers with few assets. According to the
division's accounting manager, before July 1993, the division was not
allocating any of the costs of the services it rendered to conserved
insurers having insufficient assets to reimburse the division. Instead,
the division allocated the costs it incurred servicing the insurers without
assets to those conserved insurers the division managed having assets
sufficient to reimburse it. As a result, the division had not attempted
until recently to seek the necessary funding authority to reimburse it for
the services it renders to insurers having few assets.
The department acknowledged that it had improperly allocated these
costs to the conserved insurers with assets. In February 1994, the
division sought funding from the department's insurance fund to
reimburse the approximately $181,000 in expenses that it had
67
overallocated to conserved insurers with more assets. The department
granted the funding request in March 1994 and the division has been
paid in full. Also, in January 1994, the department submitted a request
for funding a budget deficiency to the Legislature for fiscal year
1993-94, in part to fund the division's ongoing services of conserving
and liquidating conserved insurers with few assets. The deficiency
requested for this purpose totaled approximately $623,000. However,
according to the department's chief of the enforcement division, the
deficiency request is still being reviewed by the Department of Finance.
In July 1993, the division began allocating its costs for rendering
services to all the insurers it manages, regardless of whether or not the
insurers have assets, according to their proportionate share of the costs.
However, because the division does not have funds to cover the
ongoing costs of conserving or liquidating conserved insurers with few
assets, the insurers with more assets are still bearing a disproportionate
share of the division's costs of conserving insurers having few assets.
Specifically, the division is being reimbursed each month from the
assets of conserved insurers to replenish the deficits created from
services it renders for conserved insurers with few assets in the
division's fictitious allocating account. The negative balance in this
fictitious account is then allocated to those insurers having more assets
at the end of each month.
Our review of a sample of 66 calendar year 1992 and 1993
expenditures allocated by the division showed that the division had
allocated a total negative balance of approximately $15,000 to the
conserved insurers with more assets during June and July 1993 alone.
According to the department's chief of the enforcement division, the
division has created a procedure to bill the department's insurance fund
for payment of these deficits during the current fiscal year. He further
stated that the insurance fund is obligated to pay these expenditures
within the limits of the department's spending authority. Assuming the
department receives approval for its budget requests, this problem will
be resolved at least through fiscal year 1994-95.
When the division improperly allocates its costs for servicing insurers
with few assets to those conserved insurers with more assets, the
division is not ensuring that the assets of the conserved and liquidated
insurers it manages are protected. Furthermore, the division is not
ensuring that the assets of those conserved insurers are maximized so as
to ensure a maximum return of assets upon liquidation to the
policyholders and general creditors of liquidated insurers.
68
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Chapter 6 Other Inappropriate Practices at the Division
Chapter Our review also showed that the Conservation and Liquidation
Summary Division (division) engaged in other inappropriate practices.
Specifically, we found that the division did not properly dispose of
liquidated insurers' assets in a way that ensured that the assets were
sold for their fair market value. Further, the division did not always
process the claims of liquidated insurers promptly.
The Division Did When the insurance commissioner (commissioner) determines that it
Not Properly would be futile to rehabilitate a conserved insurer, he may apply to the
court for an order to liquidate the assets of the insurer. When the
Handle the
liquidation order is received, the division, on behalf of the
Disposition of
commissioner, will start to liquidate the assets of the conserved insurer.
Assets of
From 1991 through 1993, the division conducted nine liquidation sales
Liquidated of liquidated insurers' assets.
Insurers
Because the division has the responsibility to protect the assets of a
liquidated insurer and maximize the return to the policyholders and
creditors, the division should adopt procedures relating to the sale of
liquidated insurers' assets necessary to ensure that those responsibilities
are met. These procedures should include: inventorying the assets to
be sold; when cost effective to do so, establishing the fair market value
of the salable assets through the use of a professional appraiser or other
independent means; advertising the sale to the general public; properly
assigning the duties relating to the sale so that there is no opportunity
for a real or apparent conflict to occur; and ensuring that all sales are
"arm's length" transactions. However, until recently the division failed
to adopt such procedures.
In view of the division's not having developed procedures, we question
its ability to have obtained fair market values for the assets of
69
liquidated insurers it disposed of. These assets generally consisted of
furniture and fixtures, office equipment, computers, and
computer-related equipment. Specifically, during our review of the
Department of Insurance's (department's) internal investigation report
and other pertinent documents on the division's disposition of assets,
we found that the division allowed its employees, consultants,
investigators from the department's Investigation Bureau, former
employees of the liquidated insurers, and friends and family members
to purchase the assets of liquidated insurers.
According to the department's internal investigation, the department
found that there was no evidence of criminal intent or acts of
dishonesty by division employees. Further, according to the report,
the main reason for allowing employees to participate in the liquidation
sale was to increase participant turnout. The report also stated that
even though division employees were allowed to participate in
liquidation sales, the liquidated insurers probably did not suffer any
financial loss because of it.
One of the nine liquidation sales that occurred between 1991 and 1993
occurred in February 1993. According to the department's internal
investigative report, in this liquidation sale, the division purchased and
retained a substantial amount of the furniture and equipment for its own
use. The division sold furniture and equipment having a book value of
approximately $131,000, according to the liquidated insurer's records,
for approximately $64,000. The book value of an asset is the value of
the asset as it appears on the accounting records of a company for
accounting purposes and may not reflect the actual fair market value of
the asset. Because of the difference in the book and sale values, the
division wrote off the remaining value of approximately $67,000 as a
loss on the sale of the furniture and equipment for accounting purposes.
Of the $64,000 worth of furniture and equipment sold, the division
purchased approximately $14,000 of it for its own use. In addition,
division employees, a division contract consultant, investigators from
the department's Investigation Bureau, former employees of the
liquidated insurer, and friends and family members purchased
approximately $6,000 worth of furniture and equipment, including
more than $1,200 worth of computer equipment purchased by one of
the division's contract consultants. Finally, approximately $44,000
worth of furniture and equipment was purchased by private businesses
and the general public during public sales conducted by the division.
On several occasions, employees of the division and former employees
of the liquidated insurers were allowed to preview and purchase items
in advance of the public sales. For example, according to the
department's internal investigation report, before a January 1993 sale to
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the public, the same division employee responsible for conducting the
inventory and pricing the furniture and equipment of a liquidated
insurer also arranged for the sale of some of the assets to herself, other
employees of the division, and former employees of the liquidated
insurer. She received and approved several bids that were submitted
by these individuals and allowed them to pick up the sale items before
the date of the public sale. Moreover, she approved a bid of $130 that
she had submitted for herself for the purchase of 2 two-drawer file
cabinets, a four-drawer file cabinet, a kitchen table, 2 kitchen chairs,
and a small, damaged table. She picked up these items before the date
of the public sale. She indicated that she had purchased the furniture
for a friend. According to the department's internal investigation
report, in June 1993 the department's chief of the enforcement division
ordered the practice of allowing employees to participate in liquidation
sales discontinued.
In addition to the appearance of self-dealing, the division could have
attempted to sell some liquidated property sooner. For example, three
oil paintings worth a total of approximately $35,000 were retained in
the division office until early August 1993. One painting was hanging
in a division conference room, and the other two were hanging in the
office of the assistant chief of the division. The paintings were
transferred to the division from an insurer whose assets were liquidated
in April 1991. Transferring the paintings to the division and hanging
them on the walls was questionable because the division's
responsibility is to promptly sell liquidated property for the best price
possible. These paintings are now securely stored elsewhere. The
division made some initial efforts to sell the paintings, but as of April
1, 1994, the paintings remain unsold.
In another example discussed in the department's internal investigation
report, in May 1990 before the liquidation sale, the assistant chief of
the division received and approved a bid for the purchase of customized
computer software and all the proprietary rights for $1,500 from a
former employee of the liquidated insurer. However, according to the
division employee who handled the sale, the division did not
independently ascertain the value of the software before selling it to a
former employee of the liquidated insurer before the public sale.
Without an independent valuation of the software, the division cannot
be sure that it received the fair market value for the software when it
sold the software for $1,500. A division employee who used to work
at the liquidated insurer before it was conserved stated that she believed
that the former president of the company used one of his employees to
purchase the software with the intention of marketing the software
program himself. Further, the division employee stated that the
development costs for the software exceeded $100,000.
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According to the division employees who had handled liquidation sales
in the past, the division did not have any written policies and
procedures for disposing of assets of liquidated insurers. Furthermore,
the division used its own employees to estimate the value of the assets
of liquidated insurers. In addition, our review of the Department of
Finance audit findings on the division's disposition of assets since 1991
showed that the division was aware of its internal control weaknesses in
this area. However, until March 1994, the division had not addressed
these weaknesses adequately.
Corrective Action In October 1993, the department referred the matter of the division's
Taken by the selling the assets of liquidated insurers to its own employees to the
Los Angeles District Attorney's Office. In addition, the commissioner
Division
stated in his July 1993 response to a Department of Finance audit report
that he had directed his staff to develop written procedures to control
the disposition of assets. He indicated that the procedures should
address the methodology for the valuation and sale of property, the
detailed recordkeeping of inventory and disposition of assets, and
controls to ensure that no fraud or self-dealing would occur and that the
maximum value on the sale of assets would be achieved.
In March 1994, the division implemented the new policies and
procedures regarding the disposition of the assets of liquidated insurers.
Specifically, the division prohibits any of its employees, department
employees, liquidated insurer employees, department contractors, and
friends and relatives from purchasing assets from a liquidation sale.
Further, the division's policy regarding the sale of assets states that the
fair market value of items to be sold must be determined before the
sale.
However, even though these procedures suggest the use of a qualified
independent appraiser to value the furniture and equipment of the
liquidated insurer, they are not clear as to the proper segregation of
duties during sales of liquidated insurers' assets to ensure that
maximum value is achieved and no real or apparent conflict occurs.
Specifically, the procedures indicate only that "designated division
employees" prepare for and conduct the sales and account for the
receipts of the sales. They do not address the need for the proper
segregation of the duties of setting up the sale, conducting the sale, and
accounting for the receipts to ensure that assets are sold properly and
for the maximum value. According to division employees, the
division has not had a liquidation sale since the new policies and
procedures were developed.
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Sections 1037(a) and (d) of the California Insurance Code require the
commissioner, as conservator or liquidator of an insurer taken into his
possession, to act as necessary to conserve or protect the assets of the
insurer and to sell or dispose of any property of the insurer at its
reasonable market value.
Because the division did not develop procedures for the disposition of
assets of liquidated insurers until recently, we could not determine
whether it received fair market values for the assets it disposed of.
Further, because the division's newly established policies and
procedures do not address the proper segregation of duties during sales
of the assets of liquidated insurers, the division cannot ensure that the
assets of the liquidated insurers will be properly sold.
The Division When an insurer is conserved, the division acts much as an insurance
Does Not Always company in organizing the conserved insurer's claims records and
processing the claims for payment. If the insurer is in liquidation, the
Process Claims
division will determine if the claim is covered by an insurance
Promptly
guarantee association. If so, the division will forward the claim to the
association for payment. If the claim is not covered, the division will
evaluate the claim and notify the claimant of its determination and hold
the claim until the commissioner applies for and receives a distribution
order from the court to conduct a final distribution of the assets of the
liquidated insurer.
We judgmentally selected and reviewed one claim each from ten
liquidated insurers. Five of these claims were property and casualty
claims, and the remaining five were life and health claims. Six of
these claims were covered by an insurance guarantee association and
therefore were processed by the insurance guarantee association.
However, four claims were not covered by an insurance guarantee
association and were processed by the division.
Our review of the four claims that the division processed showed that it
took the division from two to three years to process three of the claims.
However, the division took only four months to process the other claim
we reviewed. In addition, we found that for one of the claims covered
by an insurance guarantee association, the division had yet to process
the portion of the claim representing a $100 deductible not covered by
the insurance guarantee association even though the insurance
guarantee association paid the covered portion of the claim in
May 1991.
Even though our sample of claims may not represent the claims
processed by the division, the division ought to review its claims
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processing to determine if its claims staff normally takes two to three
years to process a claim. If the division determines that its claims staff
takes an inordinate amount of time to process a claim, it should review
its staffing to ensure that claims are processed more promptly.
Sound management practices would require the division to process its
claims promptly to enable the division to close the estate of the
liquidated insurers promptly. The responsibilities of the division,
acting as the conservator or liquidator, require that the division process
claims promptly and close the estates of liquidated insurers promptly.
By doing so, the division would be acting in the best interest of the
policyholders and general creditors of the liquidated insurers in
protecting the assets of these liquidated insurers.
Chapter 7 Conclusions and Recommendations
In conducting its activities as the conservator and liquidator of
insurance companies on behalf of the insurance commissioner, the
Conservation and Liquidation Division (division) is granted broad
authority by the California Insurance Code and believes it is exempt
from the oversight normally afforded to public agencies regarding the
division's budget, expenditures, contracting and purchasing practices,
and personnel and salary administration.
The division feels that adequate oversight of its operations is provided
through the internal management of the department, the superior courts
and judges that approve the conservation and liquidation orders, and
audits conducted by the Department of Finance. However, the results
of our review of the division's operations, centering on the previous
three calendar years, indicate the need for more focused oversight in
several of the areas discussed below.
The division has not developed a strategic management plan for closing
the conserved and liquidated insurance companies it manages that
includes specific goals and milestones to monitor the plan's success.
Without such a plan, the division cannot effectively project its
workload, project its staffing requirements, or measure its effectiveness
and efficiency in managing the assets of the insurance companies under
its control.
The division developed a budget for 1994, but it was not based on its
activity level or performance standards, and it does not include the
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projected direct annual costs of the consultants it contracts with.
Without a meaningful budget, the division has no way to effectively
monitor its operating expenses and to provide incentives to control
costs.
In the area of its personnel practices, the division failed to adequately
advertise when it had open positions, thus failing to provide qualified
and interested candidates an opportunity to compete for those jobs. In
addition, until the latter part of March 1994, the division used
questionable practices in the hiring of employees and in granting merit
salary increases and promotions.
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Further, the division failed to adhere to various policies it had
established, and lacks other policies necessary to control overtime
usage. This practice contributed to a more than 400 percent increase
in overtime compensation during the last two calendar years and led to
improper overtime payments to its exempt employees totaling more
than $119,000.
Additionally, two of the division's former managers authorized
inappropriate severance payments totaling approximately $90,000 to
division employees who did not terminate their employment. Finally,
the former chief of the division made a questionable payment of $8,368
to an employee fired by the division.
A review of 31 consultant contracts revealed that for 4 of the contracts,
the division did not have written agreements with its consultants.
Also, the division did not always attempt to obtain competition before
it awarded contracts and did not always write all the essential
provisions into its contracts. In addition, the division's process for
reviewing invoices was flawed, leading to questionable payments to its
consultants, such as three payments totaling more than $34,000 that
were made twice for the same work, and reimbursements to consultants
for questionable items, such as the expense of a hotel health club and
long-distance calls not related to division business.
In addition, the division misapplied the method used to allocate the
indirect costs it incurs in providing services to the insurers under its
management that resulted in an inequitable allocation of costs.
Moreover, pending a Department of Finance decision regarding a
deficit funding request, the division has been unfairly allocating costs it
incurs servicing insurers having few assets to those insurers having
assets sufficient to reimburse the division.
Furthermore, the division did not properly handle the sale of assets in
several of its most recent liquidation sales. Finally, in some instances
the division did not process claims promptly.
Recommendations To ensure that the division addresses the problems identified in our
report, it should take the following specific actions:
Establish strategic management plans that include specific goals,
milestones, and time lines for all the insurance companies under its
management;
Develop meaningful budgets that are based on the level of
conservation and liquidation activities of the division and that
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include all the division's costs, including consultants' costs, to
ensure effective monitoring of the division's expenditures;
Fully implement and follow the recently developed performance
management program manual to ensure that all merit salary
increases and promotions are equitable and based on employee job
performance;
Ensure that the March 1994 reinstatement of its policy requiring the
prior written authorization of overtime for nonexempt employees is
followed and that the proposed form be amended to include the
dates that overtime will be worked and the approval date;
Investigate the propriety and recovery of all severance payments
made by the division;
Develop policies and procedures for the hiring of division
employees that ensure that all qualified candidates have an
opportunity to compete for job openings;
Ensure that future surveys conducted to adjust employee salaries
include public sector comparisons where appropriate;
Require consultants and outside law firms the division contracts
with to submit detailed explanations or actual receipts with their
claims for reimbursement for out-of-pocket expenses, or conduct
audits of consultants' invoices to ensure that the consultants or law
firms have not been paid more than what is due;
Ensure that expenses that are identifiable to particular conserved or
liquidated insurers are charged to those conserved or liquidated
insurers;
Ensure that the time recorded by division employees on the cost
allocation worksheet is accurate and agrees with the time reported
by them on their time sheets for the period of allocation;
Ensure that the conserved and liquidated insurers that have borne a
disproportionate share of past division expenses, particularly the
expenses related to the cost of conserving and liquidating insurers
with few assets, are reimbursed;
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Secure funds to cover the ongoing costs of conserving and
liquidating insurers with few or no assets;
Ensure that qualified independent appraisers are used, whenever it
is cost effective, in the valuation of assets of liquidated companies
before such assets are sold;
Ensure that division employees follow the newly developed policies
and procedures in the disposition of assets that prohibit self-dealing
and ensure that assets are sold at fair market value; and
Ensure that there is proper segregation of duties in inventorying the
assets of liquidated insurers, conducting the sales, and accounting
for the receipts from the sales of liquidated insurers' assets.
To ensure that proper oversight of the division's operations are
provided, we recommend that a followup review of the division be
conducted by the Bureau of State Audits or by another independent
auditor in one year. This review should include the following:
Assess the effectiveness of the corrective actions recently taken or
planned by the division;
Review of the division's consulting contract practices;
Review the quality of the division's efforts in preparing budgets and
management plans for the insurers it manages; and
Review the adequacy and effectiveness of the division's internal
accounting and administrative controls.
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We conducted this review under the authority vested in the state auditor by Section 8543
et seq. of the California Government Code and according to generally accepted
governmental auditing standards. We limited our review to those areas specified in the
audit scope of this report.
Respectfully submitted,
KURT R. SJOBERG
State Auditor
Date: May 5, 1994
Staff: Steven M. Hendrickson, Audit Principal
Douglas Cordiner
Dave Biggs
Tammy Bowles
Stephen Cho
Paul Navarro
Jennifer Olivas
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