Audits Hit Insurance Providers for Kentucky Cities, Counties

January 10, 2010

A state audit of a Kentucky municipal association – the second in as many months – has found problems with compensation, spending, conflicts of interest and procurement matters including in the operation of the organization’s insurance services.

State Auditor Crit Luallen said her agency’s examination of the Kentucky League of Cities (KLC) found a “staff-driven” organization with weak board oversight that resulted in executive staff receiving unprecedented salaries and exorbitant retirement bonuses that cost more than $500,000; more than $350,000 in excessive or questionable spending; and numerous conflicts of interest.

Many of the abuses occurred with little or no board knowledge, the report said.

Among the allegations is that KLC executive staff did not inform the executive board of a harassment investigation that raised concerns involving KLC’s chief insurance services officer, who was said to have possibly “unethical business practices” and “explosive” outbursts.

The KLC audit was released just weeks after Luallen issued another critical report on the Kentucky Association of Counties (KACo). That report found a “self-serving” culture that resulted in more than $3 million in excessive or questionable spending over a three-year period.

Luallen’s office announced its plans to audit KLC and the Kentucky Association of Counties (KACo) in July after media reports raised questions about the finances at both agencies. Both KACo and KLC are non-profit associations funded primarily with public dollars that offer insurance services, training, lobbying and other services for member government entities. KLC members include 382 cities; KACo has 120 county governments as members.

“Our findings clearly point out the need for the board to strengthen policies and procedures to ensure that it maximizes benefits back to its member cities,” Luallen said about the KLC audit, echoing comments she made after the KACo audit.

The findings have been referred to state and federal law enforcement agencies, as well as to the Internal Revenue Service and the Kentucky Departments of Revenue and Insurance.

KLC, which is currently searching for a new executive director, said it has already taken some steps to address the issues raised by the audit but has more work to do. “The auditor’s findings and opinions give us definitive points of clarity in areas integral to our organization and further inspire us to continuously improve our measurement systems,” said Michael D. Miller, mayor of the city of Jackson, who is current president of KLC.

Among the concerns cited in the report is that the insurance programs of KLC have not been independent of KLC’s other member association activities, a matter that has also concerned the state’s insurance regulator. In July, the Kentucky Department of Insurance requested that KLC implement a distinct separation to guard against illegal inducements.

According to Luallen, KLC has begun to enforce a separation but further separation may be needed because the insurance program boards consist of several of the same members that serve as officers of the KLC executive board and it appears KLC’s executive director is also directing the insurance programs.

KLC’s operations include KLC Insurance Services, which operates the KLC Workers’ Compensation Trust and the KLC Unemployment Compensation Reimbursement Trust. Another entity, KLC Insurance Agency, sells health, life, and bonding insurance to municipalities and markets the insurance offered by KLCIS. KLCIS pays a commission to KLCIA for accounts marketed by KLCIA.

In fiscal year 2008, 87 percent of KLC revenue came from the fees and commissions paid by the insurance programs.

From fiscal year 1998 to fiscal year 2008, KLC’s revenues increased 155 percent from $4.3 million to $11 million, thanks to higher fees paid by KLCIS and its related insurance trust programs and to bigger commissions earned by the KLC insurance agency.

The exam also uncovered numerous conflicts of interest at KLC including that it paid $1.4 million to a law firm where the spouse of KLC’s executive director is a partner and made payments of $14,413 to the wife of the chief insurance services officer who provided decorating services. Several family members of the chief insurance services officer either currently work or previously worked for vendors of KLC. Also, a current KLC executive board member, who also chairs KLC’s Insurance Services, serves as a private independent insurance agent for products sold by KLC.

The audit also lists numerous gifts, trips and gratuities executive staff received from KLC’s reinsurers and other vendors.

County Insurance

The similar audit of the association that sells insurance to Kentucky’s 120 counties found that organization operates with a “self-serving culture” that has resulted in at least $1.4 million in questionable spending the past three years.

The examination of KACo found that as revenues increased 75 percent from 2003 through 2008 to more than $5.7 million, the level of discretionary spending also increased dramatically- on parties, adult entertainment, expensive meals, sporting events, retirement benefits, even condo rentals for executives.

More than 90 percent of KACo’s revenue comes from the insurance programs.

Luallen said KACo should have found ways to return increases in revenues to member counties as lower membership dues and insurance premiums or as additional training programs instead of on wasteful spending.

She said the KACo board has begun to take remedial steps. She also said some board members and employees of KACo resisted excesses.

The KACo insurance units include Commonwealth Insurance Co. , which provides employee dishonesty fidelity bond, business income and extra expense coverages; KACo Insurance Agency, which markets the KACo group health plan as well as public official bonds, excess earthquake and spectators’ liability coverages; the KACo Workers’ Compensation Fund; and KACo All Lines Fund, a pool for auto liability, general liability, property, law enforcement and public officials liability, employment practices, and intentional tort and criminal defense that also offers risk management and loss control training.

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