Determining the Financial Condition of an Insurance Carrier

Sources of Financial Information

The most basic and reliable source of financial information about an insurance carrier ' at least if its own representations are to be believed ' is its annual statement filed with various state insurance departments or insurance commissions. An insurance carrier's annual statement typically contains a 'balance sheet,' which specifies all of the company's assets and all of its liabilities. The difference between the assets and liabilities 'is called [a] normal corporate account's net worth. In insurance reports it is called policyholders surplus.' Testimony of Richard Stewart, Northrop Corp. v. Am. Motorists Ins. Co., No. C 710 571 (Cal. Los Angeles County Super. Ct.), Transcript at 2508 (July 13, 1993), settled on appeal [hereinafter Stewart Testimony]. Stewart is a former Superintendent of Insurance for the State of New York. He also served as president of the National Organization of Insurance Commissioners and as chief financial officer for the Chubb Group of Insurance Companies. Thus, perhaps the easiest way to establish an insurance carrier's net worth, as well as to provide information about its annual profits and revenues, is to refer to its sworn records filed with government agencies. An insured can usually obtain judicial notice of these records. See, e.g., Fed. R. Evid. 1005 ('The contents of an official record ' if otherwise admissible, may be proved by copy, certified as correct ”); Cal. Evid. Code '452(d) ('Judicial notice may be taken of the … Records of … any state of the United States.').

Another reliable source of financial information about insurance carriers is A.M. Best in its Best's Insurance Reports. Best rates insurance carriers:

to provide an opinion of an insurer's financial strength and ability to meet ongoing obligations to policyholders. The assigned rating is derived from an in-depth evaluation of a company's balance sheet strength, operating performance and business profile as compared to Best's quantitative and qualitative standards.

I Best's Insurance Reports Property-Casualty viii (2005) (hereinafter 'Best's').

Best also categorizes insurance carriers by their financial size. The financial size category is designed to provide 'a convenient indicator of the size of a company in terms of its most recent cross-checked submission of year-end, first, second or third quarter statutory surplus and related accounts.' Id. at xx. It 'is based on reported policyholders' surplus plus conditional or technical reserve funds, such as the asset valuation reserve (AVR), other investment and operating contingency funds and miscellaneous voluntary reserves reported as liabilities in U.S. dollars.' Id. Best's financial categories range from a Class I (the smallest) to Class XV (the largest). Id. Of the more than 2100 property/casualty companies reported on by Best's in 2002, 469 fall within the largest financial size category, which means that each of these companies (or their groups) has an adjusted policyholders' surplus (that is, net worth) of $2 billion or more. Id. Furthermore, Best is an extremely reliable source of information about a carrier's financial condition because its review of financial condition and operating performance 'is based on an analysis of each company's reported financial performance, utilizing over 100 key financial tests and supporting data.' Id. at xi. Thus, the Best ratings should be considered in assessing an insurance carrier's financial condition because those ratings are used in the insurance marketplace as an accurate way to assess the financial condition of a carrier. See Stewart Testimony at 2520.

As an additional indicator of an insurance carrier's financial condition, one also could apply the test used by insurance regulators. In 1974, the National Association of Insurance Commissioners ('NAIC') introduced its Insurance Regulatory Information System ('IRIS') 'for the purpose of identifying companies which might require further regulatory review.' I Best's Insurance Reports-Property-Casualty xxi (1999) ('Best's 1999'). In considering an insurance carrier's financial condition, insurance regulators look at the NAIC financial ratio results, which consist of 11 ratios. Stewart Testimony at 2515. These ratios provide a basis for comparing the resources of the insurance carrier with its liabilities and expenses. They 'give a very early indication' of whether or not any aspect of the insurance company's financial condition 'is outside the normal range where the community of insurance companies clusters.' Id. at 2516. The IRIS ratios function as an 'early warning test' with respect to the financial condition of insurance carriers. Id.

The 11 IRIS ratios are as follows:

1) Net premiums written to policyholders' surplus;

2) Percentage change in net premiums written;

3) Surplus aid to surplus;

4) Two-year overall operating ratio;

5) Investment yield;

6) Change in policyholders' surplus;

7) Liabilities to liquid assets;

8) Agents' balances to policyholders' surplus;

9) One-year reserve development to policyholders' surplus;

10) Two-year reserve development to policyholders' surplus; and

11) Estimated current reserve deficiency to policyholders' surplus.

See Best's 1999 at xxi-xxiv.

Of these eleven ratios, only nine are considered in determining the impact of a damage award on an insurance carrier. The second ratio (change in writings) would not be affected by a loss caused by a damage award, and the fifth ratio (investment yield) only would be marginally affected. Because a punitive damage award likely would be paid from the policyholders' surplus (net worth), an award probably would have the most direct impact on the sixth ratio, 'change in surplus.' Therefore, this ratio is perhaps the most important one to consider in assessing the amount of a punitive damage award. Stewart Testimony at 2517. If this ratio declines by more than 10% because of a single event or payment, then it could move outside the normal range of declines, drawing the attention of regulators. See Id. at 2518. In other words, any one judgment against an insurance carrier probably should not exceed 10% of the carrier's policyholders' surplus, at least if the intent is to avoid any negative impact on the carrier's ability to function in the insurance marketplace and ensure that the carrier would be treated by the regulators exactly as it was treated before the award. Under IRIS, in assessing the change in surplus, a deferred acquisition expense is added to the policyholders' surplus, which typically results in a larger surplus than the statutory surplus result indicated by the insurance company on its financial statements. Thus, if one simply uses 10% of the reported statutory policyholders' surplus rather than the IRIS number, the amount is even more fiscally conservative. Id. at 2522. An award of up to 10% of an insurance carrier's policyholders' surplus would leave the carrier 'essentially in the same position that [it is] now in with the insurance regulators … [It] would leave [the carrier] in a position to do exactly the same business with the same old stand in the same old way tomorrow that [it] did yesterday.' Id. at 2522.

Thus, if punitive damages were awarded in an amount equal to 10% of a carrier's policyholders' surplus, the carrier's financial position, its financial ratings, and how it is regarded in the insurance marketplace would not be adversely affected. In other words, a 10% award would permit the carrier to continue to operate exactly as it did in the past, meaning that such an award would have no economic deterrent effect upon the carrier. Thus, the only deterrent effect would come from an award greater than 10% of the carrier's net worth. As a third check on the financial condition of an insurance carrier, the carrier's financial position could be assessed under the risk-based capital measure that the NAIC has adopted. Under this new approach, the question is what kind of award would be necessary to eliminate the excess of policyholders' surplus over the 'company action level risk-based capital.' In many, if not most, cases, the number derived from application of this test will be substantially greater than the number derived from simply considering the policyholders' surplus. Thus, this test would warrant an even larger award.

Pooled Companies

Punitive damage awards in bad faith litigation against insurance carriers often may not be large enough to have a deterrent effect. The financial information presented in courts too often reflects only a small percentage of an insurance carrier's wealth. This is because many insurance carriers are 'pool' companies. Pool insurance companies are companies related by a common ownership and shared management. The revenues and losses of such companies are pooled with, and shared by, their sister companies. The true value of a 'pool' company cannot be determined simply by looking at just the net worth of that company, but only by considering the net worth of the entire pool of companies. This is not a small problem ' there are more than 450 insurance carriers involved in pooling arrangements. Best at xix.

The use and existence of pooled companies is a result of historical practices. As Best's explains:

For many insurance groups, Best's quantitative evaluation is based on a consolidated approach applied to an insurance group or pool, recognizing the importance of inter-company arrangements that financially link individual insurers by investment, pooling, or reinsurance agreements. Such arrangements are common in the property/casualty industry. Id. at xii.

As Best's 1999 further explains:

Historically, there have been a number of reasons insurers have established multiple legal entities that support one common operation. For instance, companies writing business in more than one state often establish an affiliate to take advantage of a particular state's lower premium tax for a domestic insurer. Multi-line writers may establish an affiliate to write casualty lines of coverage in order to isolate the parent from the potential loss exposure of these more volatile lines or they may establish an affiliate in a state in order to utilize another rate filing. Best's 1999 at xxii.

When insurance carriers are pool companies, it is essential in considering the financial condition of one of the insurance carriers to consider the financial condition of the pool. As Best's 1999 explains:

[A] common type of affiliation is an intercompany pooling arrangement whereby companies under common management or ownership, pool virtually all of their net business through a reinsurance agreement. Each member of the pool transfers (or cedes) its net premium volume to the pool and accepts (or assumes) a fixed percentage of the pool's premiums and losses. These pooling arrangements permit smaller individual companies to benefit from a greater spread of risk. Id. at xxii.

See also I Best's Insurance Reports-Property-Casualty xix (1994) ('The analysis of the financial performance of a company participating in a pooling arrangement must be based on the consolidated performance of the pooling group of companies'). In other words, all of an insurance carrier's income and all of its losses are combined in the pool and then redistributed among the pooling companies. See Stewart Testimony at 2466. The pool 'is probably the most important financial resource that any pool company has.' Id. As a result, 'the only way to evaluate the strength of a company that ' participates in a pool is to look at the strength of the pool.' Id.

The consideration of a carrier's pool in determining the financial worth of the individual company has a direct counterpart with which everybody is familiar: A person's checking account. If a person's net worth is being determined, the person's checking account (and other bank accounts) surely would be considered. See, e.g., Lara v. Cadag, 13 Cal. App. 4th 1061, 1064-65, 16 Cal. Rptr. 2d 811, 812-13 (1993) (court should look beyond income to all assets of defendant in order to determine financial condition). Even though the person does not physically possess the money in the checking account, that person has access to all of the money in the account, and can deposit as much money as he or she wants into that account. The balance of the account will have bearing on that person's net worth and is an item typically considered by lenders in assessing a person's financial condition. This concept is not altered if the person's checking account is a joint checking account, where another person also can make deposits to and withdrawals from the account.

An insurance carrier's pool is just like a checking account ' the carrier makes deposits (premium receipts) and withdrawals (payments of liabilities) just as individuals do with their checking accounts. Thus, the only way to consider a carrier's true net worth is to consider its checking account ' the pool in which it participates.

An example of how to calculate the true value of a carrier is found in Northrop Corp. v. American Motorists Corp. In this case, Stewart was asked to determine the size of a judgment that could be entered against American Motorists Insurance Company ('AMICO') without affecting its ability to do business. Stewart looked at a financial statement for AMICO that showed AMICO's net worth, as of Dec. 31, 1992, at $245.7 million. If only AMICO's individual net worth were considered and the award were to be 10%, then the award would be $25 million.

However, in assessing the financial condition, Stewart said that he would look beyond that statement to the pool. According to its financial statement, AMICO received 15% of the pool's surplus. This means that the pool's surplus was approximately $1.63 billion. In order to assess the financial condition of the
pool, Stewart looked to the statement for Lumbermens Mutual Casualty Company. Stewart also looked at the Best's rating for the Kemper National Insurance Companies. The rating listed all of the companies in the pool, including AMICO, and the total assets for the entire pool. Stewart testified that looking at that financial statement is the most accurate way to judge the total value of the pool's net worth.

When asked to look at certain factors he considers in assessing the financial condition of an insurance carrier, Stewart explained how a judgment or claim could affect AMICO's rating: A decline in AMICO's surplus of 10% would alert regulators, but in order for AMICO's surplus to decline 10%, the entire pool's surplus must decline by 10%, or about $163 million. Thus, given the value of the pool, AMICO readily could absorb a judgment of $163 million. In fact, Stewart specifically testified that an award of this size would not jeopardize the financial condition of AMICO or its pooled companies. This is because a punitive damage award against an insurance carrier typically is spread among, and shared by, the pool members. As Stewart explained, 'the normal, as far as I know, unvarying way of handling a pool … is essentially everything goes in and then everything comes out in shares that basically track how much surplus or net worth each company has.' Stewart Testimony at 2514.

Thus, when it comes to judging the financial condition of insurance carriers, the companies should be judged as insurance regulators judge them. And when the wealth of pool companies is considered, the wealth of the entire pool should be considered, because the company's wealth includes the pool. Indeed, a California court of appeal has so recognized:

The evidence established that Ohio Casualty Corporation, the parent company, owned 100 percent of the stock of defendant Ohio Casualty Insurance Company and other companies; that these companies occupied the same office space, used the same claims manual and claims handling procedures, and employed many of the same personnel; and that one consolidated set of financial statements was prepared for these companies. For all intents and purposes, therefore, these companies were one and the same.

Downey Sav. & Loan Ass'n v. Ohio Cas. Ins. Co., 189 Cal. App. 3d 1072, 1100, 234 Cal. Rptr. 835, 851 (1987), cert. denied, 486 U.S. 1036 (1988).

As the example with AMICO shows, when an insurance carrier's true financial condition is considered, the size of the award needed to have a deterrent effect will increase drastically ' in AMICO's case from $25 million (if AMICO were considered alone) to $163 million (when the pool was considered).

Conclusion

Not all insurance coverage disputes are bad faith cases. But when a carrier may have breached the implied covenant of good faith and fair dealing, an insured should pursue all of its remedies, including punitive damages. Furthermore, insurance carriers that portray financial condition based on the combined assets of their 'pool' should be bound by their word. They should not be permitted to tell regulators and others in the insurance world that they have a strong financial condition, but plead poverty when it comes time to pay for their misconduct. Instead, they should be judged by their true financial condition and should pay accordingly.

Kirk Pasich is a founding partner of the Los Angeles office of Dickstein Shapiro LLP. He represents insureds in complex coverage matters.

Punitive damages long have been awarded 'to punish wrongdoers and thereby deter the commission of wrongful acts … ' Neal v. Farmers Ins. Exch. , 21 Cal. 3d 910, 928 n.13, 148 Cal. Rptr. 389, 399 n.13 (1978). In order to accurately determine how large a punitive damage award should be, the financial condition of a defendant must be evaluated. If a punitive damage award is not large enough, then it is not likely to have any deterrent effect. Instead, because it simply would be a cost of doing business, it actually may serve as an incentive to further wrongful conduct. Therefore, in order to accurately determine how much of a punitive damage award is enough, but not too much, the financial condition of an insurance carrier needs to be evaluated. Id. at 928 (the wealth of defendant must be considered or else 'the function of deterrence … will not be served if the wealth of the defendant allows him to absorb the award with little or no discomfort'); Adams v. Murakami , 54 Cal. 3d 105, 111-12, 284 Cal. Rptr. 318, 321 (1991) ('The most important question is whether the amount of the punitive damages award will have deterrent effect ' without being excessive … This balance cannot be made absent evidence of the defendant's financial condition.').

The financial condition of the carrier typically is judged at the time of trial, but it is appropriate to consider the carrier's future financial prospects and ability to borrow money. In Rufo v. Simpson , 86 Cal. App. 4th 573, 103 Cal. Rptr. 2d 492 (2001), for example, the court addressed the propriety of the punitive damages award against O.J. Simpson. Simpson challenged the punitive damage award, arguing that the amount of the award exceeded his net worth. The court of appeal affirmed the trial court's decision, stating:

Although net worth is the most common measure of the defendant's financial condition, it is not the only measure for determining whether punitive damages are excessive in relation to that condition. Id. at 624.

The court noted that there are a variety of factors that can be considered, including a defendant's future financial prospects. See Model Punitive Damages Act '7(a) (listing nine factors to be considered by a jury in determining the amount of punitive damages).

A similar conclusion was reached in Zaxis Wireless Communications, Inc. v. Motor Sound Corp ., 89 Cal. App. 4th 577, 582, 10 Cal. Rptr. 2d 308, 312 (2001). In Zaxis, the defendant challenged a punitive damage award of $300,000, arguing that it had a negative net worth of $6.3 million. The court of appeal refused to accept a defendant's net worth as the governing standard, noting that '[n]et worth is too easily subject to manipulation to be the sole standard for measuring a defendant's ability to pay.' The court then discussed other evidence:

Perhaps the most compelling evidence of [the defendant's] ability to pay was … testimony that as of the time of trial, [defendant] had a credit line of $50 million of which $5.3 million dollars was unexpended at the end of 1999. This line of credit indicates the lender made a determination [defendant] had the ability to pay amounts well in excess of the $300,000 punitive damage award. Id. at 583.

These decisions indicate that insureds can point to a carrier's various economic factors, such as projected future premium collections and credit lines, as a basis to argue that the amount of punitive damages should be greater than the carrier's net worth might otherwise suggest.

Sources of Financial Information

The most basic and reliable source of financial information about an insurance carrier ' at least if its own representations are to be believed ' is its annual statement filed with various state insurance departments or insurance commissions. An insurance carrier's annual statement typically contains a 'balance sheet,' which specifies all of the company's assets and all of its liabilities. The difference between the assets and liabilities 'is called [a] normal corporate account's net worth. In insurance reports it is called policyholders surplus.' Testimony of Richard Stewart, Northrop Corp. v. Am. Motorists Ins. Co., No. C 710 571 (Cal. Los Angeles County Super. Ct.), Transcript at 2508 (July 13, 1993), settled on appeal [hereinafter Stewart Testimony]. Stewart is a former Superintendent of Insurance for the State of New York. He also served as president of the National Organization of Insurance Commissioners and as chief financial officer for the Chubb Group of Insurance Companies. Thus, perhaps the easiest way to establish an insurance carrier's net worth, as well as to provide information about its annual profits and revenues, is to refer to its sworn records filed with government agencies. An insured can usually obtain judicial notice of these records. See, e.g., Fed. R. Evid. 1005 ('The contents of an official record ' if otherwise admissible, may be proved by copy, certified as correct ”); Cal. Evid. Code '452(d) ('Judicial notice may be taken of the … Records of … any state of the United States.').

Another reliable source of financial information about insurance carriers is A.M. Best in its Best's Insurance Reports. Best rates insurance carriers:

to provide an opinion of an insurer's financial strength and ability to meet ongoing obligations to policyholders. The assigned rating is derived from an in-depth evaluation of a company's balance sheet strength, operating performance and business profile as compared to Best's quantitative and qualitative standards.

I Best's Insurance Reports Property-Casualty viii (2005) (hereinafter 'Best's').

Best also categorizes insurance carriers by their financial size. The financial size category is designed to provide 'a convenient indicator of the size of a company in terms of its most recent cross-checked submission of year-end, first, second or third quarter statutory surplus and related accounts.' Id. at xx. It 'is based on reported policyholders' surplus plus conditional or technical reserve funds, such as the asset valuation reserve (AVR), other investment and operating contingency funds and miscellaneous voluntary reserves reported as liabilities in U.S. dollars.' Id. Best's financial categories range from a Class I (the smallest) to Class XV (the largest). Id. Of the more than 2100 property/casualty companies reported on by Best's in 2002, 469 fall within the largest financial size category, which means that each of these companies (or their groups) has an adjusted policyholders' surplus (that is, net worth) of $2 billion or more. Id. Furthermore, Best is an extremely reliable source of information about a carrier's financial condition because its review of financial condition and operating performance 'is based on an analysis of each company's reported financial performance, utilizing over 100 key financial tests and supporting data.' Id. at xi. Thus, the Best ratings should be considered in assessing an insurance carrier's financial condition because those ratings are used in the insurance marketplace as an accurate way to assess the financial condition of a carrier. See Stewart Testimony at 2520.

As an additional indicator of an insurance carrier's financial condition, one also could apply the test used by insurance regulators. In 1974, the National Association of Insurance Commissioners ('NAIC') introduced its Insurance Regulatory Information System ('IRIS') 'for the purpose of identifying companies which might require further regulatory review.' I Best's Insurance Reports-Property-Casualty xxi (1999) ('Best's 1999'). In considering an insurance carrier's financial condition, insurance regulators look at the NAIC financial ratio results, which consist of 11 ratios. Stewart Testimony at 2515. These ratios provide a basis for comparing the resources of the insurance carrier with its liabilities and expenses. They 'give a very early indication' of whether or not any aspect of the insurance company's financial condition 'is outside the normal range where the community of insurance companies clusters.' Id. at 2516. The IRIS ratios function as an 'early warning test' with respect to the financial condition of insurance carriers. Id.

The 11 IRIS ratios are as follows:

1) Net premiums written to policyholders' surplus;

2) Percentage change in net premiums written;

3) Surplus aid to surplus;

4) Two-year overall operating ratio;

5) Investment yield;

6) Change in policyholders' surplus;

7) Liabilities to liquid assets;

8) Agents' balances to policyholders' surplus;

9) One-year reserve development to policyholders' surplus;

10) Two-year reserve development to policyholders' surplus; and

11) Estimated current reserve deficiency to policyholders' surplus.

See Best's 1999 at xxi-xxiv.

Of these eleven ratios, only nine are considered in determining the impact of a damage award on an insurance carrier. The second ratio (change in writings) would not be affected by a loss caused by a damage award, and the fifth ratio (investment yield) only would be marginally affected. Because a punitive damage award likely would be paid from the policyholders' surplus (net worth), an award probably would have the most direct impact on the sixth ratio, 'change in surplus.' Therefore, this ratio is perhaps the most important one to consider in assessing the amount of a punitive damage award. Stewart Testimony at 2517. If this ratio declines by more than 10% because of a single event or payment, then it could move outside the normal range of declines, drawing the attention of regulators. See Id. at 2518. In other words, any one judgment against an insurance carrier probably should not exceed 10% of the carrier's policyholders' surplus, at least if the intent is to avoid any negative impact on the carrier's ability to function in the insurance marketplace and ensure that the carrier would be treated by the regulators exactly as it was treated before the award. Under IRIS, in assessing the change in surplus, a deferred acquisition expense is added to the policyholders' surplus, which typically results in a larger surplus than the statutory surplus result indicated by the insurance company on its financial statements. Thus, if one simply uses 10% of the reported statutory policyholders' surplus rather than the IRIS number, the amount is even more fiscally conservative. Id. at 2522. An award of up to 10% of an insurance carrier's policyholders' surplus would leave the carrier 'essentially in the same position that [it is] now in with the insurance regulators … [It] would leave [the carrier] in a position to do exactly the same business with the same old stand in the same old way tomorrow that [it] did yesterday.' Id. at 2522.

Thus, if punitive damages were awarded in an amount equal to 10% of a carrier's policyholders' surplus, the carrier's financial position, its financial ratings, and how it is regarded in the insurance marketplace would not be adversely affected. In other words, a 10% award would permit the carrier to continue to operate exactly as it did in the past, meaning that such an award would have no economic deterrent effect upon the carrier. Thus, the only deterrent effect would come from an award greater than 10% of the carrier's net worth. As a third check on the financial condition of an insurance carrier, the carrier's financial position could be assessed under the risk-based capital measure that the NAIC has adopted. Under this new approach, the question is what kind of award would be necessary to eliminate the excess of policyholders' surplus over the 'company action level risk-based capital.' In many, if not most, cases, the number derived from application of this test will be substantially greater than the number derived from simply considering the policyholders' surplus. Thus, this test would warrant an even larger award.

Pooled Companies

Punitive damage awards in bad faith litigation against insurance carriers often may not be large enough to have a deterrent effect. The financial information presented in courts too often reflects only a small percentage of an insurance carrier's wealth. This is because many insurance carriers are 'pool' companies. Pool insurance companies are companies related by a common ownership and shared management. The revenues and losses of such companies are pooled with, and shared by, their sister companies. The true value of a 'pool' company cannot be determined simply by looking at just the net worth of that company, but only by considering the net worth of the entire pool of companies. This is not a small problem ' there are more than 450 insurance carriers involved in pooling arrangements. Best at xix.

The use and existence of pooled companies is a result of historical practices. As Best's explains:

For many insurance groups, Best's quantitative evaluation is based on a consolidated approach applied to an insurance group or pool, recognizing the importance of inter-company arrangements that financially link individual insurers by investment, pooling, or reinsurance agreements. Such arrangements are common in the property/casualty industry. Id. at xii.

As Best's 1999 further explains:

Historically, there have been a number of reasons insurers have established multiple legal entities that support one common operation. For instance, companies writing business in more than one state often establish an affiliate to take advantage of a particular state's lower premium tax for a domestic insurer. Multi-line writers may establish an affiliate to write casualty lines of coverage in order to isolate the parent from the potential loss exposure of these more volatile lines or they may establish an affiliate in a state in order to utilize another rate filing. Best's 1999 at xxii.

When insurance carriers are pool companies, it is essential in considering the financial condition of one of the insurance carriers to consider the financial condition of the pool. As Best's 1999 explains:

[A] common type of affiliation is an intercompany pooling arrangement whereby companies under common management or ownership, pool virtually all of their net business through a reinsurance agreement. Each member of the pool transfers (or cedes) its net premium volume to the pool and accepts (or assumes) a fixed percentage of the pool's premiums and losses. These pooling arrangements permit smaller individual companies to benefit from a greater spread of risk. Id. at xxii.

See also I Best's Insurance Reports-Property-Casualty xix (1994) ('The analysis of the financial performance of a company participating in a pooling arrangement must be based on the consolidated performance of the pooling group of companies'). In other words, all of an insurance carrier's income and all of its losses are combined in the pool and then redistributed among the pooling companies. See Stewart Testimony at 2466. The pool 'is probably the most important financial resource that any pool company has.' Id. As a result, 'the only way to evaluate the strength of a company that ' participates in a pool is to look at the strength of the pool.' Id.

The consideration of a carrier's pool in determining the financial worth of the individual company has a direct counterpart with which everybody is familiar: A person's checking account. If a person's net worth is being determined, the person's checking account (and other bank accounts) surely would be considered. See, e.g ., Lara v. Cadag , 13 Cal. App. 4th 1061, 1064-65, 16 Cal. Rptr. 2d 811, 812-13 (1993) (court should look beyond income to all assets of defendant in order to determine financial condition). Even though the person does not physically possess the money in the checking account, that person has access to all of the money in the account, and can deposit as much money as he or she wants into that account. The balance of the account will have bearing on that person's net worth and is an item typically considered by lenders in assessing a person's financial condition. This concept is not altered if the person's checking account is a joint checking account, where another person also can make deposits to and withdrawals from the account.

An insurance carrier's pool is just like a checking account ' the carrier makes deposits (premium receipts) and withdrawals (payments of liabilities) just as individuals do with their checking accounts. Thus, the only way to consider a carrier's true net worth is to consider its checking account ' the pool in which it participates.

An example of how to calculate the true value of a carrier is found in Northrop Corp. v. American Motorists Corp. In this case, Stewart was asked to determine the size of a judgment that could be entered against American Motorists Insurance Company ('AMICO') without affecting its ability to do business. Stewart looked at a financial statement for AMICO that showed AMICO's net worth, as of Dec. 31, 1992, at $245.7 million. If only AMICO's individual net worth were considered and the award were to be 10%, then the award would be $25 million.

However, in assessing the financial condition, Stewart said that he would look beyond that statement to the pool. According to its financial statement, AMICO received 15% of the pool's surplus. This means that the pool's surplus was approximately $1.63 billion. In order to assess the financial condition of the
pool, Stewart looked to the statement for Lumbermens Mutual Casualty Company. Stewart also looked at the Best's rating for the Kemper National Insurance Companies. The rating listed all of the companies in the pool, including AMICO, and the total assets for the entire pool. Stewart testified that looking at that financial statement is the most accurate way to judge the total value of the pool's net worth.

When asked to look at certain factors he considers in assessing the financial condition of an insurance carrier, Stewart explained how a judgment or claim could affect AMICO's rating: A decline in AMICO's surplus of 10% would alert regulators, but in order for AMICO's surplus to decline 10%, the entire pool's surplus must decline by 10%, or about $163 million. Thus, given the value of the pool, AMICO readily could absorb a judgment of $163 million. In fact, Stewart specifically testified that an award of this size would not jeopardize the financial condition of AMICO or its pooled companies. This is because a punitive damage award against an insurance carrier typically is spread among, and shared by, the pool members. As Stewart explained, 'the normal, as far as I know, unvarying way of handling a pool … is essentially everything goes in and then everything comes out in shares that basically track how much surplus or net worth each company has.' Stewart Testimony at 2514.

Thus, when it comes to judging the financial condition of insurance carriers, the companies should be judged as insurance regulators judge them. And when the wealth of pool companies is considered, the wealth of the entire pool should be considered, because the company's wealth includes the pool. Indeed, a California court of appeal has so recognized:

The evidence established that Ohio Casualty Corporation, the parent company, owned 100 percent of the stock of defendant Ohio Casualty Insurance Company and other companies; that these companies occupied the same office space, used the same claims manual and claims handling procedures, and employed many of the same personnel; and that one consolidated set of financial statements was prepared for these companies. For all intents and purposes, therefore, these companies were one and the same.

Downey Sav. & Loan Ass'n v. Ohio Cas. Ins. Co ., 189 Cal. App. 3d 1072, 1100, 234 Cal. Rptr. 835, 851 (1987), cert. denied , 486 U.S. 1036 (1988).

As the example with AMICO shows, when an insurance carrier's true financial condition is considered, the size of the award needed to have a deterrent effect will increase drastically ' in AMICO's case from $25 million (if AMICO were considered alone) to $163 million (when the pool was considered).

Conclusion

Not all insurance coverage disputes are bad faith cases. But when a carrier may have breached the implied covenant of good faith and fair dealing, an insured should pursue all of its remedies, including punitive damages. Furthermore, insurance carriers that portray financial condition based on the combined assets of their 'pool' should be bound by their word. They should not be permitted to tell regulators and others in the insurance world that they have a strong financial condition, but plead poverty when it comes time to pay for their misconduct. Instead, they should be judged by their true financial condition and should pay accordingly.

Kirk Pasich is a founding partner of the Los Angeles office of Dickstein Shapiro LLP. He represents insureds in complex coverage matters.