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SACRAMENTO, Calif.-American International Group Inc.'s failed bid for Golden Eagle Insurance Co. is spawning an increasingly ugly battle with California regulators that is now spilling over into the state Legislature.

The Insurance Department announced July 11 it will investigate AIG's business practices in the state, citing allegations that AIG is "deliberately spreading false statements to third parties" about a proposed rehabilitation plan that awarded Golden Eagle's business to Liberty Mutual Insurance Co.

The investigation "will necessarily require the subpoena of witnesses, including officers, directors and agents" of AIG, the department said.

AIG last week labeled the move retaliation for its opposition to the Liberty Mutual deal: "The department cannot protect one competitor at the expense of another, and it cannot trample on free speech and competition," AIG VP/General Counsel Florence A. Davis said.

The announcement also drew a stinging response from the head of the state Assembly's Insurance Committee, who accused Insurance Commissioner Chuck Quackenbush of using "the power of your office to exact vengeance" on AIG. Assemblywoman Liz Figueroa, D-Fremont, threatened to initiate her own hearing on the Insurance Department's action.

Meanwhile, the Legislature has responded to purported shortcomings in the Golden Eagle rehabilitation plan with a bill that would alter state insurance insolvency law in several ways. The bill was approved by the Assembly Committee on Insurance last week despite opposition from the Insurance Department, which accused AIG of pushing the bill in hopes of derailing the Golden Eagle plan.

Golden Eagle, one of California's largest workers comp insurers, was seized in January by the Insurance Department, which then initiated a bidding process for takeover of the insurer's business.

Regulators initially picked AIG as the winning bidder, but a state judge last month rejected the deal and chose a revised bid from Liberty Mutual instead.

AIG has appealed the judge's decision, charging that Liberty Mutual won by negotiating a backdoor settlement of litigation between Golden Eagle owner John C. Mabee and the Insurance Department (BI, July 14).

While AIG's appeal is pending, a separate court hearing on approval of the Golden Eagle rehabilitation plan is scheduled for Wednesday.

Golden Eagle's business has eroded as the rehabilitation battle wears on, though there is "no indication" that the business has gone to AIG, said Liberty Mutual Senior Vp Fred Marziano. Golden Eagle's new and renewal business dropped about 17% between January and May and fell another 7% in June before leveling off in July, he said.

The California department's fight with AIG took a nasty turn July 11, when regulators announced an investigation of the insurer.

"Concerns have mounted regarding AIG's conduct following its losing bid in the Golden Eagle insolvency proceedings," according to the department, which said it "has been alerted to AIG's attempt to disrupt the economic relations between the rehabilitated Golden Eagle and its new owner, Liberty Mutual. The efforts by AIG allegedly include deliberately spreading false statements to third parties in an effort to create anxiety and start problems for the new Golden Eagle company."

Karl L. Rubinstein, Golden Eagle's deputy conservator, said the alleged falsehoods include statements that the rehabilitation plan will bar policyholder claims filed after Feb. 27, 1998. In fact, he said, the bar date does not apply to claims for coverage under Golden Eagle policies but only to non-insurance claims, such as general creditor and bad faith claims.

California Superior Court Judge William Cahill signed an order July 11 clarifying that the bar date does not apply to policyholder claims.

However, Roxani Gillespie, a lawyer representing AIG and a former California insurance commissioner, said California liquidation law automatically sets a bar date for policyholder claims of six to 12 months from notice of a liquidation.

"There is no choice," said Ms. Gillespie, who is with Buchalter, Fields, Nemer & Younger in San Francisco. "They do not have the authority to do something by agreement when the law specifies otherwise."

Lawyers for the Insurance Department counter, though, that the Golden Eagle plan is initially a rehabilitation-not a liquidation-and that the statute cited by Ms. Gillespie won't apply until a later date, when Golden Eagle's business is spun off to newly formed companies and the shell of the old company is liquidated.

Lawyers for the Insurance Department also dismissed AIG's contentions that Mr. Mabee will be collecting large sums from the Golden Eagle estate. The plan, for example, calls for Liberty Mutual-not the estate-to pay Mr. Mabee $20 million for an option to buy his Golden Eagle shares. Of this, Mr. Rubinstein said, Mr. Mabee will pledge $10 million to secure Golden Eagle's reinsurance recoverables from Mesa Reinsurance Co. Ltd., which Mr. Mabee also owns.

The option allows Liberty Mutual to buy Mr. Mabee's shares for $375 million, but Mr. Rubinstein said he doubted there will be enough money left in the company-after the spinoff of its business and payment of creditors' claims-to tempt Liberty to exercise the option.

"I don't think (Mr. Mabee) will be within smelling distance of that kind of money," he said of the $375 million purchase price.

The Insurance Department's planned AIG investigation brought a sharp response from Assemblywoman Figueroa, who told Mr. Quackenbush in a July 14 letter that "to now turn to the power of your office in an effort to silence a party with which you disagree is truly frightening."

"The very fact that you are announcing an investigation-a matter generally conducted quietly unless and until there are results-by press release strongly underscores your improper motives," she wrote. "It seems to me that you are sending a loud message to the industry: 'Do not disagree with me, or face the consequences.'*"

"It is unfortunate that we are required to call a hearing into matters such as this, but we cannot allow these practices to occur in our state," she added.

The exchange came as the Assembly Insurance Committee was considering a version of S.B. 1042, introduced by state Sen. Patrick Johnston, D-Stockton, and co-authored by Assemblywoman Figueroa.

The bill would, among other things, amend California's insolvency law to forbid a liquidator from setting a claims bar date shorter than 10 years from notice of a liquidation; and to bar owners of insolvent insurers from receiving any compensation or other benefit until all claimants and creditors are paid in full.

After approval by the insurance Committee last week, the bill still faces votes in another Assembly committee and on the Assembly floor. It would then be referred for a concurrence proceeding in the Senate, where the companion bill is pending.

A California department spokes-woman said the bill is "disastrous for consumers" and would create long claim payment delays in future conservation proceedings.