The Accident Fund of Michigan is facing an identity crisis.

In the past dozen years, the workers compensation insurer has spent more than $700,000 in legal fees as it attempts to cut its ties with the state insurance department to become recognized as a private insurer, something the fund says it has always been.The bitter battles in federal and state courts have pitted the state attorney general's office and insurance department against the accident fund, which holds about 20 percent of the workers compensation insurance market in the state.

The controversy took another turn last week, when the state Office of the Auditor General released the results of an audit. The audit, which covers the period from July 1, 1983 to Sept. 30, 1987, questions the tax treatment of various fund expenses, including $52,000 in commuting expenses incurred by the fund's top executive, said Kenneth Smiley, audit manager in the state office.

Frank Nerat, assistant manager and general counsel for the accident fund, defended the expenditures. He said the expenses were entirely appropriate and were authorized by the 15-member policyholders board, which acted within its authority as a private entity.

The dispute, which dates back to 1976, centers on whether the fund is a private entity or an arm of the state insurance department.

State officials say the fund was created by the Legislature in 1913 and is a state agency that is responsible to the state insurance commissioner, said Dominic D'Annunzio, deputy insurance commissioner.

Officials at the fund say it is was created in 1912 under enabling state legislation that allowed five or more employers who needed workers compensation insurance to petition the state insurance commissioner and create an insurer, Mr. Nerat said.

We're a private entity, controlled by our policyholders, Mr. Nerat said. The fund now has more than 30,000 policyholders.

Workers compensation laws were first enacted by a group of states in 1911 to provide compensation to workers hurt on the job, regardless of who was at fault. Private insurance carriers hold about 70 percent of the nationwide market while the remainder is filled by state funds and self-insurance mechanisms.

At the center of the Michigan dispute is the use of $52 million in surplus monies that fund officials want to return to their policyholders in the form of a special dividend.

Mr. Nerat said the surplus belongs to the present and former policyholders who paid their premiums over the years and controlled their losses.

The state did not create it (surplus). Employees have paid the premium in, Mr. Nerat said. The Michigan fund reported $150 million in premiums for the year 1987, he said.

State officials say the funds belong to the state and distribution of the surplus monies could jeopardize the fund's future financial stability.

If the courts find the 400-employee organization is a private entity, it could be liable for federal taxes back to 1913, Mr. D'Annunzio said.

There could be a tremendous federal tax liability. It could put them out of business, Mr. D'Annunzio said. If they win, they could lose.

Mr. Nerat labels the department's argument about back taxes patently ridiculous.

Mr. D'Annunzio questioned the motives of the fund's officials.

It's not a company. They were created by law. They have no name or definition, Mr. D'Annunzio said. Maybe it's an attempt to take the money and run with it.

Mr. Nerat termed that statement totally ridiculous.

Mr. D'Annunzio said fund officials may want to use the surplus funds to write lines of insurance in other states.

Mr. Nerat said the officials want the state Legislature to revise the state statue so the fund can operate competitively with other private carriers, such as allowing it to insure the out-of-state operations of Michigan insurers.

He said the company may consider writing insurance for businesses out of the state if the statute is changed.

The fund recently has filed suit in Ingham County Circuit Court in Lansing against the state insurance commissioner, Herman W. Coleman. The suit charges Mr. Coleman with making misleading statements about the fund's activities.

In another suit, the Michigan Court of Appeals is considering a lower court ruling that held the fund to be a state entity. Mr. Nerat said he expects the appeal to take several years.

Last October, the appeals court issued a stay of the Ingham Circuit Court ruling.

We're going to continue our efforts to get the Legislature to clarify the statute, Mr. Nerat said. We're not going to roll over.