ALJDEC decisions subject to certification as final

04A-180-INS · Department of Insurance · 2005-05-11

IN THE OFFICE OF ADMINISTRATIVE HEARINGS

HEARING: December 28, 2004 and March 8, 2005. The record closed on May 11, 2005, after submission and review of written closing arguments and legal memoranda. APPEARANCES: J. Michael Low, Esq. for Republic Western Insurance Company; Assistant Attorney General Moira McCarthy on behalf of the Arizona Department of Insurance ADMINISTRATIVE LAW JUDGE: Lewis D. Kowal _____________________________________________________________________ FINDINGS OF FACT 1. Republic Western Insurance Company (“Republic”) is an Arizona domiciled insurer licensed to transact property, casualty, worker’s compensation, disability, marine and transportation, surety and vehicle insurance. 2. Republic is a wholly-owned subsidiary of AMERCO, Inc. (“AMERCO”), a publicly owned and traded holding company. 3. AMERCO is the parent company of U-Haul International (“U-Haul”). 4. U-Haul is an international rental, moving and storage company. 5. Republic and U-Haul are sister companies. 6. Republic provides insurance coverage for AMERCO and affiliated companies such as U-Haul, ranging from general liability and umbrella policies to business auto policies. 7. In April 2002, Republic issued a general liability policy to AMERCO (“GL02 policy”) effective April 1, 2002-April 1, 2003. 8. On February 1, 2003, the Chairman of AMERCO’s Board wrote to AMERCO’s President requesting that the GL02 policy be canceled as of the inception period. Subsequently, Republic notified the Department that it was retroactively canceling the GL02 policy. 9. On July 10, 2003, the Department advised Republic that pursuant to A.R.S. § 20-1123, the GL02 policy could not be retroactively canceled but that the policy could be considered prospectively canceled as of February 2003. 10. On May 5, 2003, Republic wrote the Department to obtain approval of an endorsement to the GL02 policy (“Proposed GL02 Endorsement”), and submitted an opinion letter from the law firm of Low & Childers, P.C., which supported Republic’s ability to effectuate the Proposed GL02 Endorsement. 11. The pertinent provisions of the GL02 policy referred to during the hearing are: SECTION 1-COVERAGES COVERAGE A: BODILY INJURY AND PROPERTY DAMAGE LIABILITY 1. Insuring Agreement

a. We [Republic] will pay those sums that the insured becomes legally obligated to pay as damages because of “bodily injury” or “property damage” to which this insurance applies.

Exhibit D1 at 1. * * * LIMITS OF INSURANCE [Endorsement #3]

It is understood and agreed that Limit of Insurance for any one “occurrence” or “accident” is $2,000,000 for Coverage A, B and D. The Limit of Insurance for Coverage C is $25,000. each “occurrence”. . . . The Limit of Insurance stated herein is [the Company’s [Republic’s] total limit of liability for all damages including legal fees, court costs, interest and other allocated loss expenses arising out of the same occurrence regardless of the number of claims or claimants. The term damages, wherever used, shall include, but is not limited to, General, Special and Statutory Damages and shall include Punitive and Exemplary Damages, fines and penalties except where prohibited by law . . . You [AMERCO] shall promptly reimburse the Company [Republic] for 95% of all loss payments and loss adjusting expenses paid by the Company [Republic] for the first $250,000 per occurrence/incident.

Exhibit D1a. * * * AMENDMENT TO ENDORSEMENT #3 [ENDORSEMENT #30]

The Company amends coverage of 100% of the Deductible for all loss payments and loss adjusting expenses paid for the first $250,000.00 per occurrence/incident from Inception of Policy.

All other terms and conditions remain unchanged. Exhibit P4 at 83. 12. The Proposed GL02 Endorsement (Exhibit D2) provides: “Policyholder [AMERCO] agrees to pay directly to all claimants any amounts required to be paid with respect to bona fide claims reported under this Policy, provided that such payments shall not exceed the deductible amount.” 13. The Proposed GL02 Endorsement is intended to be made retroactive to the date of issuance of the GL02 policy. 14. On May 9, 2003, the Department declined to approve the Proposed GL02 Endorsement concluding that it would violate A.R.S. § 20-1123, which prohibits retroactive annulment of liability. At that time, the GL02 policy provided for a $250,000.00 deductible and that AMERCO would reimburse Republic for 95% of payments made within the deductible. 15. In 2003, the Department had concerns regarding Republic’s credit risk relating to its insurance transactions with AMERCO and affiliates. Specifically, the Department was concerned with Republic’s contingent credit exposure from the GL02 policy. 16. On May 12, 2003, AMERCO solicited an opinion letter from the law firm of Bryan Cave, L.L.P. (“Bryan Cave”) regarding the Proposed GL02 Endorsement. That opinion letter concluded that the Proposed GL02 Endorsement did not violate A.R.S. § 20-1123. Complainant submitted the Bryan Cave opinion letter to the Department. 17. On May 15, 2003, the Office of the Attorney General, State of Arizona, through Assistant Attorney General Jennifer Boucek, issued a letter setting forth why the Department believed the Proposed GL02 Endorsement violated A.R.S. § 20-1123. On May 18, 2004, Republic obtained a third legal opinion letter from the law firm of Squire, Sanders & Dempsey, L.L.P. That opinion letter concluded, as had the letter from Bryan Cave, that the Proposed GL02 Endorsement did not violate the provisions of A.R.S. § 20-1123. 19. On September 29, 2004, Republic filed with the Department a request that the Proposed GL02 Endorsement be approved. 20. The Department requested that it be provided with a complete copy of the GL02 policy that could be reviewed in conjunction with the Proposed GL02 Endorsement. Subsequently, Republic provided the Department with a copy of the GL02 policy, a version that contained Endorsement #3 but did not contain Endorsement #30. 21. On November 1, 2004, the Department disapproved the GL02 Endorsement finding that the endorsement effectively annulled the GL02 policy and therefore violated the provisions of A.R.S. § 20-1123. In reaching that conclusion, the Department relied on the opinion letter from Assistant Attorney General Jennifer Boucek. 22. On November 2, 2004, Republic filed with the Department a demand for hearing, resulting in this matter being set for an administrative hearing before the Office of Administrative Hearings. 23. At all times material to this matter, Republic was under supervision. The Director of the Department had appointed Ron Frantz (“Mr. Frantz”) as the Supervisor. In that capacity, Mr. Frantz was responsible for the oversight of Republic’s financial activities and for reporting to the Department as to Republic’s financial condition. 24. Steven Ferguson (“Mr. Ferguson”), Assistant Director of the Financial Services Division of the Department, testified that the Order placing Republic under supervision required Republic to submit for approval any proposed changes that affected the financial condition of Republic. 25. Mr. Ferguson reviewed the Proposed GL02 Endorsement with other Department personnel and sought legal advice from the Department’s counsel, in determining that the Proposed GL02 Endorsement could not be approved. 26. Jack Peterson (“Mr. Peterson”), U-Haul’s Chief Financial Officer, testified: a. U-Haul filed for bankruptcy protection under Chapter 11 as a result of not able to secure funding for a bond that had an effect on other obligations of U-Haul. b. U-Haul has emerged from bankruptcy and no policyholder of Republic was affected by the bankruptcy. c. Prior to August 2003, in administering the GL02 policy, Republic would review and process claims and for claims that were paid, obtain reimbursement from U-Haul. d. Since August 2003, with respect to the GL02 policy, Republic has reviewed, processed, and paid claims from a U-Haul account with funding provided by U-Haul. e. The Proposed GL02 Endorsement was being submitted to clarify what the actual business relationship was between AMERCO and Republic, namely that it was not Republic that paid the claims but AMERCO, through U-Haul. f. AMERCO is responsible for maintaining insurance under the bankruptcy plan and it is in AMERCO’s and U-Haul’s best interest to maintain a profitable relationship with Republic. g. AMERCO is capable of and willing to pay all claims within the deductible of the GL02 policy. 27. Mr. Ferguson testified that: a. Within a few days prior to the hearing, the Department received for the first time a version of the GL02 policy containing Endorsement #30, which amends Endorsement #3. b. The actual dealings between AMERCO and Republic with respect to the GL02 policy only came to his attention during preparation for the instant hearing through disclosures made by Republic’s counsel. c. The GL02 policy, Petitioner’s Exhibit 4, was never submitted for the Department’s approval and has not been formally submitted for review and approval. d. The Department had not received Endorsement #30 when it issued the determination to disapprove of the Proposed GL02 Endorsement. e. Pursuant to A.R.S. § 20-481.2(b), Republic was required to submit the GL02 policy for approval and has not done so. However, even though the Department was aware at the time it reviewed the Proposed GL02 Endorsement that the GL02 policy had not been submitted for approval, the failure of Republic to obtain such approval was not considered by the Department as a basis for the disapproval of the Proposed GL02 Endorsement. 28. The GL02 policy also provides: SECTION IV-COMMERCIAL LIABILITY CONDITIONS 1. Bankruptcy. Bankruptcy or insolvency of the insured or of the insured’s estate will not relieve us or our obligation under this Coverage Part.

Department’s Exhibit 1, at 9. 29. In the above-mentioned opinion letter authored by Assistant Attorney General Jennifer Boucek, reference was made that the above provision “takes on special significance” because if AMERCO was to declare bankruptcy, Republic would have to pay the claims that AMERCO would legally have to pay. Department’s Exhibit 4, at 2. 30. The Department maintains that based on the above insuring provisions, Republic is obligated to pay claims within the deductible amount and that the change made in the Proposed GL02 Endorsement, which changes who is responsible for payment of those claims, affects Republic’s credit risk. 31. According to Republic’s interpretation of the insuring clause of the GL02 policy, Republic is not required to pay any claim arising out of the deductible. Republic maintains that the Proposed GL02 Endorsement only clarifies who is responsible to pay claims up to the deductible amount and does not annul the GL02 policy. 32. Republic contends that the Proposed GL02 Endorsement reflects what the business practices of Republic and AMERCO have been. 33. Republic presented credible evidence through the testimony of Douglas Bell, Vice-President of Republic, that AMERCO and Republic intended and have operated as if the deductible amount of the GL02 policy was $2,000,000.00 rather than $250,000.00. 34. The evidence of record contains references to three versions of the GL02 policy: the version submitted to the Department when it reviewed the Proposed GL02 Endorsement; the version presented to the Department during the exchange of exhibits to be offered at the hearing of this matter (Petitioner’s Exhibit 4); and the version that reflects the manner in which AMERCO/U-Haul and Republic claim to have been administering the GL02 policy i.e., with a deductible equal to the policy limit of $2,000,000.00, though it was never memorialized in writing. 35. None of the above-mentioned versions of the GL02 policy has been presented to the Department for its approval; therefore, none has been approved. 36. Republic presented the testimony of Dr. John O’ Connell (“Dr. O’ Connell”), the CV Starr Professor of Insurance at the American Graduate International School, Thunderbird Campus, who has testified in court as an expert witness on interpreting insurance contract provisions, and who was established to be an expert in the insurance field. 37. Dr. O’ Connell testified that it is not uncommon in the insurance industry for insurers and insureds to act in a manner different than that set forth in the insurance contract between them and that such actions show the true intent of the parties. 38. Dr. O’ Connell testified: a. In the insurance industry, it is common for insurers and policyholders to renegotiate terms such as payment of deductibles without memorializing such terms in writing. However, he acknowledged that the GL02 policy he reviewed (Petitioner’s Exhibit 4) has a provision requiring that changes to the policy be in writing. b. Proposed Endorsement GL02 clarifies the GL02 policy in that it explains that the policyholder is responsible for payment of claims within the deductible. c. The Proposed GL02 Endorsement is beneficial to Republic in that it reduces Republic’s credit exposure. d. The Proposed GL02 Endorsement does not abrogate or nullify the GL02 Policy because Republic would still be responsible for investigating and processing claims and hiring legal counsel. e. Generally, within the insurance field, it is industry custom and practice for the policyholder of a general commercial policy, and not the insurer, to pay claims within the deductible. f. If the GL02 policy had the deductible been equal to the policy limit of $2,000,000.00, Republic would still have certain responsibilities consisting of administering claims and incurring investigative costs and legal fees. 39. Republic asserts that through its two examinations of Republic as well as through Mr. Frantz acting as Supervisor of Republic, the Department knew or should have known that Republic and AMERCO were treating the deductible amount of the GL02 policy as being $2,000,000.00, the policy limit. 40. When the Department considered the Proposed GL02 Endorsement, it did not consider the GL02 policy as having a deductible amount of $2,000,000.00. 41. Republic asserts that the Proposed GL02 Endorsement does not annul the GL02 policy and that Republic still would process claims, pay investigative and legal fees and maintain records for AMERCO regarding the claims. 42. While the Department expressed concerns as to AMERCO’s financial condition and Republic presented evidence as to its current financial condition, the Department acknowledged that the issue to be decided is not predicated on AMERCO’s financial condition and that AMERCO’s financial condition is only relevant to the issue of whether a claimant would have any recourse against Republic in the event that the Proposed GL-02 Endorsement violates the provisions of A.R.S. § 20-1123. APPLICABLE PROVISIONS OF LAW 1. A.R.S. § 20-1111(A) provides: A. The director shall disapprove any form of policy, application, rider or endorsement or withdraw any previous approval thereof only: 1. If it is in any respect in violation of or does not comply with this title. 2. If it contains or incorporates by reference any inconsistent, ambiguous or misleading clauses, or exceptions and conditions which deceptively affect the risk purported to be assumed in the general coverage of the contract. 3. If it has any title, heading or other indication of its provisions which is misleading. 4. If the purchase of such policy is being solicited by false, deceptive or misleading advertising matter, sales material or representations. B. The director may disapprove any proof of death or loss form only if it imposes unreasonable requirements, or is in violation of this title, or contains deceptive or ambiguous matter. C. The director may disapprove any advertising matter or sales material which is in violation of this title. 2. A.R.S. § 20-481.12 states, in pertinent part: A. Transactions within a holding company system to which an insurer subject to registration is a party are subject to the following standards: 1. The terms are fair and reasonable. 2. Charges or fees for services performed are reasonable. 3. Expenses incurred and payment received are allocated to the insurer in conformity with customary insurance accounting practices consistently applied. 4. The books, accounts and records of each party to all transactions clearly and accurately disclose the nature and details of the transactions including any accounting information that is necessary to support the reasonableness of the charges or fees to the respective parties. 5. The insurer's surplus as regards policyholders following any dividends or distributions to shareholder affiliates is reasonable in relation to the insurer's outstanding liabilities and adequate to its financial needs. B. The following transactions involving a domestic insurer and any person in its holding company system may not be entered into unless the insurer notifies the director in writing not less than thirty days before entering the transaction, unless the director permits a shorter notification period, of its intention to enter into the transaction and the Director does not disapprove the transaction within that period: 1. Sales, purchases, exchanges, loans or extensions of credit, guarantees or investments if the transactions equal or exceed, with respect to nonlife insurers, the lesser of three per cent of the insurer's admitted assets or twenty-five per cent of surplus as regards policyholders as of December 31 next preceding or, with respect to life insurers, three per cent of the insurer's admitted assets as of December 31 next preceding. 2. Loans or extensions of credit to any person who is not an affiliate if the insurer makes the loans or extensions of credit with the agreement or understanding that the proceeds of the transactions, in whole or in substantial part, are to be used to make loans or extensions of credit to, to purchase assets of or to make investments in any affiliate of the insurer making such loans or extensions of credit if the transactions equal or exceed, with respect to nonlife insurers, the lesser of three per cent of the insurer's admitted assets or twenty-five per cent of surplus as regards policyholders as of December 31 next preceding or, with respect to life insurers, three per cent of the insurer's admitted assets as of December 31 next preceding. 3. Reinsurance agreements or modifications to reinsurance agreements in which the reinsurance premium or a change in the insurer's liabilities equals or exceeds five per cent of the insurer's surplus as regards policyholders as of December 31 next preceding, including those agreements that may require as consideration the transfer of assets from an insurer to a nonaffiliate if an agreement or understanding exists between the insurer and the nonaffiliate that any portion of the assets will be transferred to one or more affiliates of the insurer. 4. All management agreements, service contracts and cost-sharing arrangements. 5. Any material transaction that is specified by rule and that the director determines may adversely affect the interests of the insurer's policyholders.

3. A.R.S. § 20-1123 provides: No insurance contract insuring against loss or damage through legal liability for the bodily injury or death by accident of any individual, or for damage to the property of any person, shall be retroactively annulled by any agreement between the insurer and the insured after the occurrence of any injury, death or damage for which the insured may be liable, and any attempted annulment shall be void.

CONCLUSIONS OF LAW 1. Republic has the burden of proof and the standard of proof on all issues is by a preponderance of the evidence. See A.A.C. R2-19-119. 2. A preponderance of the evidence is “such proof as convinces the trier of fact that the contention is more probably true than not.” Morris K. Udall, Arizona Law of Evidence § 5 (1960). It is “evidence which is of greater weight or more convincing than the evidence which is offered in opposition to it; that is, evidence which as a whole shows that the fact sought to be proved is more probable than not.” Black’s Law Dictionary 1182 (6th ed. 1990). 3. The Department’s denial of the Proposed GL02 Endorsement was based on a determination that the endorsement negates Republic’s obligations to pay claims within the deductible amount that Republic is obligated to pay under the insuring provisions of the GL02 policy. The Department maintained that because the Proposed GL02 Endorsement shifts the obligation to pay claims within the deductible limits of the policy from Republic to AMERCO, it effectively annuls the GL02 policy as to that portion and violates the provisions of A.R.S. § 20-1123. 4. The evidence of record established that after the Department disapproved of the Proposed GL02 Endorsement, and after the appeal of that determination, the Department first learned that there exists another version of the GLO2 policy, which contains Endorsement #30 (Petitioner’s Exhibit 4), which was not presented to the Department during its review of the Proposed GL02 Endorsement. Additionally, Republic presented evidence that it has been treating the GL02 policy as having a deductible amount of $2,000,000.00 rather than $250,000.00, and AMERCO’s reimbursement obligation for claims paid within the deductible is 100% of the deductible amount paid by Republic rather than 95%. 5. The Department asserted in its Opening Statement that it is premature to consider approval of the Proposed GL02 Endorsement until the Department reviews and approves the GL02 policy that is currently in effect. However, in its Closing Statement, the Department appears to have shifted its position and asserted that regardless of which GL02 policy is considered, the effect of the application of the Proposed GL02 Endorsement is the same, i.e., that it retroactively annuls the GL02 policy. 6. Republic argued that the Department, through its examinations of Republic and Mr. Frantz acting a Supervisor of Republic, was or should have been aware of the GL02 policy and how it was being administered by Republic. Therefore, Republic maintains that the GL02 policy to which the Proposed GL02 Endorsement applies is the version in which the deductible amount is equal to the policy limit of $2,000,000.00. 7. Republic would have the Administrative Law Judge consider the course of conduct between AMERCO and Republic as determinative of the terms of the GL02 policy. However, the GL02 policy requires that any changes be made in writing. Consequently, the Administrative Law Judge concludes that the GL02 policy to which the Proposed GL02 Endorsement applies is Petitioner’s Exhibit 4. 8. While Petitioner’s Exhibit 4 is a version of the GL02 policy that has not received the Department’s approval, which the Department contends is required by A.R.S. § 20-481.12, it is noted that the GL02 policy that was reviewed by the Department in consideration of the Proposed GL02 Endorsement also had not been submitted for the Department’s approval. Yet, the failure to obtain approval of the GL02 policy was not a basis for the disapproval of the Proposed GL02 Endorsement. Therefore, the Administrative Law Judge concludes that even though the Department did not approve the version of the GL02 policy that the Administrative Law Judge considers to be the one in effect, the absence of such approval does not preclude a ruling on this matter by the Administrative Law Judge.[1] 9. The term “annulment” is defined as: “To nullify, to abolish, to make void by competent authority.” Black’s Law Dictionary 91 (6th ed. 1990). 10. The Arizona Court of Appeals in Stojnik v. General Insurance Company of America, 201 Ariz. 430, 36 P.3d 1200 (App. 2001) interpreted the term “annulment” in A.R.S. § 20-1123 to include either complete termination of the insurance policy or impairment or reduction of an insurer’s obligation under the policy. The Court stated that the intent of A.R.S. § 20-1123 is to “prohibit[s] an insurer and its insured, after the occurrence of any ‘injury, death or damage’ for which the insured may be liable for invalidating their insurance policy as of a date prior to the covered event.” Id. at 35, 36 P.3d at 1205. 11. The Administrative Law Judge concludes that the Insuring Agreement provisions of the GL02 policy that require Republic to pay all claims it is legally obligated to pay does not, by virtue of industry custom and practice, obligate Republic to pay claims within the deductible amount of the GL02 policy. Without the Proposed GL02 Endorsement, the GL02 policy requires AMERCO to promptly reimburse Republic only if Republic pays claims within the deductible, which is discretionary. 12. Given the absence of a requirement for Republic to pay claims within the deductible amount of the GL02 policy, the Proposed GL02 Endorsement clarifies the current practice of AMERCO and Republic that AMERCO is primarily responsible to pay all claims required to be paid within the deductible and does not shift a portion of Republic’s obligation to pay claims required under the GL02 policy (Petitioner's Exhibit 4), does not retroactively annul the GL02 policy (Petitioner’s Exhibit 4), and is not violative of A.R.S. § 20-1123. 13. The Administrative Law Judge concludes that Republic met its burden and proved by a preponderance of the evidence that the disapproval of the Proposed GL02 Endorsement by the Department should be reversed. ORDER Based on the above, the Department shall affirm the Proposed GL02 Endorsement with respect to the GL02 policy in effect (Petitioner’s Exhibit 4). Done this day, May 16, 2005.

______________________________________ Lewis D. Kowal Administrative Law Judge

Original transmitted by mail this ____ day of ____________, 2005, to:

Department of Insurance Christina Urias, Director 2910 North 44th Street, Ste. 210 Phoenix, AZ 85018

By ___________________________

----------------------- [1] It is noted that during the course of the hearing both parties had an opportunity and did in fact present arguments as to how they each consider the application of the Proposed GL02 Endorsement to the version of the GL02 policy reflected in Petitioner’s Exhibit 4.

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Office of Administrative Hearings 1400 West Washington, Suite 101 Phoenix, Arizona 85007 (602) 542-9826