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CEO's venture to buy back the insurer he founded takes controversial turn

A change in ownership for a U.S.-based insurer customarily requires a sign-off from all the states in which its subsidiaries are domiciled.

But Applied Underwriters Inc. CEO Steve Menzies, as part of a planned acquisition of a group of workers compensation insurance companies he co-founded, opted for a controversial workaround that has raised questions about the status of the transaction itself and the future of the business more broadly.

An investor group led by Menzies entered a stock purchase agreement with Applied Underwriters majority owner Berkshire Hathaway Inc. in January that required, among other things, approvals from insurance regulators in Iowa, Texas and California. As the regulatory review process was ongoing in those states, The San Diego Union-Tribune published reports that raised concerns about interactions between California Department of Insurance officials and representatives of the buyer.

The newspaper reported that Menzies' associates had donated more than $46,000 to California Insurance Commissioner Ricardo Lara's 2022 re-election campaign. Lara's senior deputy intervened in department proceedings at least five times to the benefit of Applied Underwriters, the newspaper added.

Although Iowa conditionally approved the transaction in late September, the parties had not secured the sign-off from California regulators by the drop-dead date of Sept. 30 in the stock purchase agreement. And even as Menzies announced completion of the transaction Oct. 16, it soon came to light that California had not approved the deal.

California's insurance regulator said Oct. 21 that it was denying the Form A application for the change in control of California Insurance Co., citing an "abrupt and unilateral decision" to merge the company with a New Mexico-domiciled entity without seeking or obtaining California's prior approval. It further warned that the subsidiary would lose its license to do business in the state if the deal closed.

Menzies said in a release that he pursued an option presented by New Mexico's insurance regulator to merge California Insurance Co. into the newly formed New Mexico-domiciled California Insurance Co. II.

"The [California Department of Insurance] was notified last week that the California Insurance Co. voluntarily stopped writing business in California, so I am baffled by the CDI's current approach," he told S&P Global Market Intelligence in an email.

Menzies views the acquisition as "fully completed" and "final."

New Mexico approval came quickly

A review of public records shows that New Mexico arranged a public hearing on the proposed intercompany merger with approximately 24 hours of prior notice. The order providing notice of the hearing was submitted Oct. 8 at 12:28 p.m. MT, and the hearing was scheduled to begin at 1 p.m. MT on Oct. 9.

Insurance laws in certain other states specify that there must be a minimum number of days of notice before a public hearing can be held, but the statutes cited by New Mexico in scheduling the hearing make no reference to such a requirement in that state.

According to a press release from the New Mexico Office of Superintendent of Insurance, California and Texas regulators participated in a conference call prior to the Oct. 9 hearing during which the California regulators did not give any basis for denying the proposed merger under New Mexico law.

"Under California law, a proposed merger must be approved unless the merger would potentially injure policyholders," the New Mexico department wrote in the release. "CDI agreed that because of [California Insurance Co.'s] considerable capital, surplus and deposits, the proposed merger presented no risks to California policyholders."

The California Department of Insurance monitored the public hearing held in New Mexico and was also given the opportunity to raise objections, but it chose not to at that time.

New Mexico regulators signed off on the Form A about two hours after the public hearing finished, according to time stamps on the applicable documents.

The timeline is in stark contrast to the most recent previous Form A process the New Mexico regulators conducted. In the case of Peachtree Casualty Insurance Co.'s bid to buy New Mexico P&C Insurance Co., the department gave more than three weeks' notice prior to the public hearing and did not sign off on the filing until more than a month later.

New Mexico P&C had also been in runoff for more than six years and had ceased writing new policies in 2012, according to the transcript of the hearing.

But speed appeared to be of the essence in the Applied Underwriters situation. New Mexico's regulator in a press release said the California Department of Insurance had informed Menzies on Sept. 27 that it could "neither approve nor disapprove the requested transfer" by the Sept. 30 closing date. Menzies then obtained a 10-day extension and received expedited permission from New Mexico to create California Insurance Co. II in New Mexico and merge it into California Insurance Co.

"If that transaction failed to close, [California Insurance Co.] would have been placed in runout; the dedicated insurance professionals employed by that company would lose their jobs; and thousands of policyholders would have needed to find replacement coverage," the New Mexico regulator said.

California provided a significant chunk of Applied Underwriters' premiums

In an Oct. 18 letter to Menzies' lawyer, Jeffrey Silver, the California Department of Insurance said providing notice of the New Mexico Form A hearing the day prior to the proceeding and the Department's decision to "monitor the proceeding" without objecting "[do] not obviate the applicant's obligation to comply with California law or divest this department of its authority to review the transaction in advance and either approve or disapprove of it."

Michael Soller, a spokesperson for the California Department of Insurance, said in an interview that the primary concern is for California Insurance Co.'s existing policyholders and covered workers.

"We are evaluating all enforcement actions to protect policyholders and workers," he said.

While California has not indicated what its next step might be, it served noticed that not only would California Insurance Co.'s certificate of authority terminate if the deal is closed, its successor would not be qualified to write business in the state.

The subsidiary was responsible for all of the business Applied Underwriters wrote in California in 2018. Applied Underwriters generated a large plurality, 41.20%, of its total direct written premiums in California. A little less than 38% of its direct premiums in the first half of this year came from the Golden State.

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