Bad deal puts state on the hook for liabilities of workers' comp firm. (Up Front).

For most workers' compensation insurers, having a business taken over by the state is bad news. For Fremont General Corp. it's money in the bank.

The decision earlier this month by the Department of Insurance to place the company's failing workers' compensation unit into conservation would mean likely bankruptcy for most insurers. But Fremont General is not your average insurer.

The Woodland Hills-based company has a thriving business in sub-prime lending that drove a record $41.6 million in earnings for the quarter ended March 31.

Under an agreement Fremont General reached with insurance regulators last July to prop up the workers' comp business, the state takeover will actually release the company from an obligation to pump up to $73 million into the ailing unit over seven years.

The deal, put together under former Insurance Commissioner Harry Low, allowed Fremont General to retain tax loss carryforwards in exchange for a commitment to pour several million dollars into the insurance unit each quarter.

The carryforwards, valued at $220.5 million as of Dec. 31, can be used by Fremont General to offset profits at its other businesses with prior years' losses at the insurance unit, thereby lowering its tax bills.

Despite the unit being taken over, Fremont gets to keep the carryforwards.

As a result, Fremont walks away without any repercussions after paying only $20 million of its original $92.8 million commitment, and despite a shortfall at the unit of more than $200 million.

"This is a raw deal for the employers of California, and the big question is, why isn't anybody being held accountable for this?" said J. Nils Wright, a former editor of the Workers' Comp Executive, an industry newsletter.

Fremont General said it has done nothing wrong.

"We don't have to make those payments anymore," said Marilyn Hauge, the company's manager of investor relations, citing the text of the 2002 agreement. She otherwise declined to comment.

Big growth, big losses

Fremont General was among the leaders in California's workers compensation business just a few years ago. Like other insurers, it cut rates and boosted its business following deregulation of the state market in the mid-1990s.

But those moves led it to price its business too low. Although it became the second largest private carrier in the state, it also posted huge losses in 2000 totaling $506 million. Worried regulators put the unit under informal state supervision that year, and by 2001 the company decided to exit the business and focus on running its thrift, which has made big profits in the subprime lending market.

Last year, its ongoing workers' compensation business was sold to Employers Insurance Co. of Nevada, but Fremont kept managing its past, money-losing business, which can drag on for years as claims are paid out.

By last summer, state regulators were ready to take over the operation, place it into conservation and likely liquidation. But Fremont General asked for more time to run it, contending it ultimately might be able to make some money on it, said Norris Clark, chief of financial surveillance for the state Insurance Department.

That desire prompted state regulators, who have seen two dozen workers' compensation insurers fail over the last several years, to work out a July 2002 deal in an effort to keep another insurer out of state hands.

Questionable deal

According to a copy of the agreement filed by Fremont General with the Securities and Exchange Commission, the state agreed to assist the company in keeping its tax loss carryforwards if it were taken over.

In exchange, regulators decided the company should have to kick in up to $92.8 million to prop up the unit if it continued to sour.

Fremont General didn't want to put all the money in up front, in case the business got worse quickly and regulators took it over. A compromise was struck. The company would make annual payments of $13.25 million over seven years.

The agreement was structured to allow Fremont to stop paying into the teetering unit if the state had to take it over before March 2004. Clark said state regulators were at a disadvantage.

Unlike most insurers, Fremont could have simply allowed the unit to be taken over at that time, he said. Usually, the failure of an insurance unit will bring down the parent because it's often the company's primary business.

In Fremont's case, the parent had already turned its attention to the new lending business. The insurance unit was dead wood, except for any benefit that could be wrung from the tax loss carryforwards.

Ultimately, regulators went ahead with the deal because they believed that with the ongoing infusions, it was unlikely that the insurance unit would need to be taken over for at least a couple of years, Clark said.

Turns sour

Instead, the unit began hemorrhaging money, paying out claims at a far faster rate than expected.

Regulators already asserted control over the decision-making at the unit during the fourth quarter, according to Fremont filings. By the end of March, in its last quarterly report to regulators, the unit had liabilities of $1.2 billion with assets of just $887 million, according to the state.

So earlier this month, the state moved to place it into conservation, and is expected to petition a Superior Court judge within the month to liquidate its assets. After that, claims would be paid by the California Insurance Guarantee Association, the already overburdened fund supported by state business fees.

Clark blamed the outcome on the state's troubled workers' compensation market, which has been beset with skyrocketing medical costs, litigation and fraud. He said no one could have predicted the unit would fail so quickly.

Low, who signed off on the deal, agreed. "It unfortunately just didn't work out quite as we had originally planned," he said.

Others are not so sanguine.

Attorney Nicholas Roxborough, who represents businesses in their dealing with carriers, said it looks like undermanned regulators got outgunned by industry attorneys.

"Sometimes things get by them, because the carriers have figured out all the chess moves," said Roxborough, who has chaired a state task force set up this year by Commissioner John Garamendi to examine market reforms.

"They are up against an army of highly paid skillful lawyers who have planned out their strategy, and not always can the department figure out what they are up to," Roxborough said.

Garamendi refused comment on the matter.

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