Report 93113 Summary - May 1994

Poor Management Practices at the Department of Insurance's Conservation and Liquidation Division Warrant the Department's Corrective Action

Results in Brief

The Conservation and Liquidation Division (division) of the Department of Insurance 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. 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:

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 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;

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 Taken by the Division

The department has taken steps to address most of the weaknesses discussed in this report. In October 1993, the department terminated the employment of the general manager of the division and demoted the 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.


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 Comments

With few exceptions, the Department of Insurance concurs with the conclusions and recommendations in our report.