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The Pennsylvania insurance commissioner has sued a number of former officers and directors of financially troubled PHICO Insurance Co., accusing them of breach of fiduciary duty, negligent misrepresentation and professional negligence in the handling of the insurer’s finances. PHICO wrote policies for medical malpractice and workers’ compensation, primarily for hospital systems. The 50-page complaint names 15 defendants, including a former state insurance commissioner and former general counsel and senior vice president of the insurer. The complaint, filed in Commonwealth Court, asserts that the insurer’s financial troubles stem from the poor handling of company funds, including a strategy of offering low insurance prices in highly competitive, unfamiliar and therefore risky markets. The rapid growth strategy eventually led to an increase in claims and losses. “In light of the insolvencies of other medical malpractice carriers in the late 1990s, the defendant directors of the company should have been on a heightened state of alert about the company’s rapid growth,” the complaint says. “During this period of rapid growth, however, the directors took no action to evaluate or control the risks associated with the company’s aggressive underwriting and pricing growth strategy, nor did the directors make any reasonable effort to inform themselves of the nature and extent of those risks.” The complaint was filed on behalf of the insurance commissioner by attorneys Jerome J. Shestack, Joseph C. Crawford, William G. Frey and Claire Rocco from Philadelphia’s Wolf, Block, Schorr and Solis-Cohen. Insurance Commissioner M. Diane Koken was appointed statutory rehabilitator of PHICO in August. A spokeswoman at the insurance department said that this sort of liability investigation is part of every rehabilitation. The rehabilitation process surrounding PHICO will continue, and the spokeswoman said it is still too early to tell if the company is headed toward liquidation. The named defendants in the case are: Carolyn F. Scanlan, Barry Persofsky, Donald R. Creamer, Robert S. Damerjian, Elliot H. Fixler, Robert L. Fletcher, Constance B. Foster, Kevin P. Kearns, Mark. O Mitchell, Donna A. Mulholland, Robert F. Nation, Victoria A. Reider, Gary J. Schultz, Michael P. Sullivan and David L. Tressler. Foster was state insurance commissioner from 1987 to 1992. The board of directors appointed Foster to serve as the interim president and CEO after Persofsky stepped down from that position. Reider was vice president and general counsel. PHICO Group Inc. is the sole shareholder of the insurer, and the sole shareholder of PHICO Group is Health Alliance of Pennsylvania. The directors of PHICO Insurance were also directors of PHICO Group. PHICO regularly paid dividends from its surplus to the shareholders of PHICO Group, the complaint says, continuing through 1999 when the company’s surplus was diminishing. According to the complaint, in late 1996, PHICO’s board of directors hired Persofsky to serve as the new president and CEO of PHICO. The board and Persofsky worked together to develop a new strategy for the insurer, which involved PHICO offering medical malpractice, worker’s compensation and other insurance products in new markets. From 1997 through 1999, the company “experienced enormous premium growth,” with the company becoming licensed to write policies in all 50 states. The company’s net profits increased from $172 million in 1996 to $268 million in 1999, the complaint says. “The company achieved this enormous premium growth by, in part, substantially underpricing its competitors, even though competition was intense and premiums were already low,” the complaint says. “The company aggressively underpriced the competition even in markets in which the company had no previous experience.” The complaint says that Persofsky and the board knew the risks of instituting such a strategy. The complaint details the alleged continual breach of fiduciary duty committed by the board of directors and other named defendants. The complaint asserts that board members failed to react properly to reports from an outside auditor and outside actuarial firm that suggested the insurer needed to increase its reserves. “In view of the magnitude of the range of recommended reserve increase, amounting to more than half of the company’s net worth, the directors knew on December 14, 1999, that the company faced a financial crisis of enormous proportions,” the complaint says. “Every member of the board of directors (and officers) understood that a reserve increase of $120 million or more meant that the company had exposed itself to losses on claims far in excess of any level that could be justified by the amount of premium that the company had collected.” The complaint further alleges that the board knew or should have known that policies written during Persofsky’s tenure caused the loss and subsequent need to increase reserves, even though Persofsky listed other reasons for the loss. At one point, the board acknowledged that it had a fiduciary duty to “provide independent oversight with respect to the company’s elimination of the claims reserve, underwriting and pricing deficiencies,” the complaint asserts. The complaint also alleges that the board hired PricewaterhouseCoopers to evaluate the company’s underwriting process, but then never inquired about PWC’s report. “Although the directors received one or more oral reports from PWC on claims, underwriting and pricing issues, the directors knowingly or recklessly failed to inform themselves of the conclusions PWC had reached.” The complaint says that through the board’s failure to provide oversight of PHICO’s underwriting and pricing practices, the company sustained huge losses, all of which represent a breach of fiduciary duty. Plus, the complaint says, the directors continued to pay dividends to PHICO Group until April 2000, when the insurance department reprimanded the board. In May 2000, the complaint says Persofsky ordered the claims department to handle cases where PHICO insured more than one defendant in a certain way. He said to set a reserve for only the most culpable defendant and then reduce the reserve amount for the other defendants to zero. “In September 2000, Persofsky caused [the senior vice president of claims] to depress claims reserves even further,” the complaint says. “He did this for the purpose of making the company’s loss ratio appear to be better than it really was, as part of an effort to prevent downgrading of the company by the rating agencies.” The complaint said senior vice president and general counsel Reider had a fiduciary duty as a senior executive officer and a professional obligation as an attorney to investigate and disclose information to the board of directors concerning any breach of fiduciary duty by other officers. In the beginning of 1998, Reider allegedly developed concerns about the company’s aggressive strategy. “Despite these concerns, Reider did not undertake any investigation or report her concerns to the directors,” the complaint says. “Instead, Reider decided to speak with Persofsky, under whose guidance this aggressive growth strategy had occurred, about her concerns.” “Reider told Persofsky that she was concerned about whether the company was operating within the constraints of the law based on the company’s writing so much business and possibly underpricing that business,” the complaint says. “Reider has claimed that Persofsky was sarcastic and belittled her. She did nothing else after this treatment by Persofsky.” The complaint asserts Reider further breached her fiduciary duty and committed professional malpractice by discouraging others from approaching the board directly about the company’s procedures under Persofsky. The insurance commissioner’s outside counsel, Shestack, said there is no estimated value of damages at this point. REACTION Pennsylvania Trial Lawyers Association president Clifford A. Rieders said he knew the suit in PHICO rehabilitation was imminent. He also said that the public needs to know that it isn’t a surge in the filing of medical malpractice suits that has led to increased medical malpractice premiums. “Insurance companies have gotten into trouble because they have not managed the medical risks, they have not safeguarded their reserves from the vagaries of the marketplace and they have insisted on sticking with consent-to-settle clauses,” Rieders said. “The problem with medical malpractice premiums is medical malpractice,” Rieders said. “You’ve got to get the medical errors under control, have a responsible underwriting system and make sure that innocent victims of malpractice are compensated.”

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