* Equitas’ retained surplus – that is, the amounts of its assets minus its expected liabilities – was reduced to £458 million.

* The retained surplus expressed as a percentage of net claims outstanding fell to 12 percent. In other words, Equitas expects its net claims to total roughly £3.8 billion. (p.6)

* Equitas paid £672 million in settlement of claims, including payment for 32 direct asbestos claims and 15 direct pollution claims. (p.4, 7) In this context, this means payments in commutation of policy obligations. (Some of these payments likely were to policyholders with both asbestos and pollution liabilities, and perhaps with more than one stream of liabilities, so one should not assume that Equitas did deals with 47 (32 + 15) different policyholders.) In the reporting period, Equitas completed more asbestos-driven policy buyouts than in any previous year (p.6) In these asbestos buyouts, Equitas is making payment on the assumption that Federal asbestos-reform legislation is not passed, but if such legislation does pass it will receive a give back from the settling policyholders totaling £280 million. (p. 43)

* Even considering these settlements, Equitas increased its asbestos reserves by £103 million, roughly the same amount that it increased reserves last year (£116 million), which makes up 53 percent of Equitas’s total reserves (with environmental and other health-hazards constituting another 24 percent of the reserves) (p. 41). The present value of the asbestos reserves is £2.2 billion, with a nominal value of £3.4 billion (p.5). For the first time in seven years, Equitas increased its reserves for environmental liabilities too. Equitas assumes it will be making payments for these classes of claims for at least another 40 years (p.41). Further, Equitas assumes that the mean term of its liabilities, “that is the weighted average period to settlement where the weights are the undiscounted expected cash flows in each future period,” will be approximately 11 years, one year longer than the assumption made a year ago.

* Equitas continues its aggressive liquidation of its reinsurance asset, with an undiscounted asset of £700 million and a discounted value of £360 million (p. 7, 14). Reinsurers’ share of claims paid was reduced from last year from £209 million to £190 million, a reduction that is not surprising given the reduction in claims payment from Equitas and the dwindling value of the remaining reinsurance. One can express sympathy with Equitas for its problems in collecting from its reinsurers: “We see a growing trend for some reinsurers to dispute claims for no other reason than to demand discounts in the hope we will be afraid of the costs of collecting these balances.” (p.7)

* Equitas identifies the amount of “profit” it has made on settlements, profit in this context being the amount of reserves freed from a settlement at a figure less than the reserved amount. £435 million of Equitas’ surplus is acknowledged by it to be attributable to settlements it has made over the past four years at amounts less than the reserves it had previously established for the claims. Last year, settlements contributed £81 million to Equitas’s bottom line. (p.4) In other words, 95 percent (!) of Equitas’s net surplus is attributable to these reserving-freeing settlements.

* There are several related threads to follow to grasp the significance of this figure. When Equitas was established in 1996, it is known that the money it raised was reverse engineered based on predictions on what it could collect in settlements with brokers, managing agencies, and the reinsured names. The initial Equitas premium indication was widely viewed as being unacceptable to the individual participants at Lloyd’s, so the Equitas premium number was reduced to a level that the “names” would accept. When Equitas began operations in 1996, it had a “solvency” margin of 5.6%, meaning its then projections of liabilities were 5.6% less than its assets. In order to open for business, Equitas could not be insolvent the first day, so its reserves had to be reduced to allow it to (barely) show a solvency margin.

* Equitas has since hiked its reserves substantially, particularly for asbestos. Reserve adjustments affect the year they are made (p. 35), so a settlement with policyholder X in 2003 that yielded a settlement profit of, e.g., $10 million should be recognized as yielding a settlement profit of a significantly greater amount if the associated reserves would have floated upwards with other reserve adjustments in subsequent years. So Equitas’s announcement of its settlement profit in the prior year understates the true profit amount, since the policyholder sold out its coverage for an even greater discount than it may have anticipated at the time of settlement.

* So, the reserve number for any given settling policyholder is likely to have been underestimated for either of two reasons: (i) all reserves were understated in the reverse engineering process to generate an acceptable Equitas “finality” premium and (ii) reserves subsequently have been adjusted upward either to compensate for that (conscious) underestimation or because then-unforeseen events yield higher valuations of the claim streams.

* Given that virtually all of Equitas’s solvency margin (and surplus) is attributable to policyholders’ settling out their coverage too cheaply, one can fairly say that the only thing keeping Equitas afloat is policyholders’ settling for too little (even from Equitas’s perspective).

* In this light, and perhaps in response to my constant harping on this issue (a theme I don’t see elsewhere), the CEO of Equitas offers the following defense of its claims-settlement practices:

“When we settle claims, whether those coming into us, or those we make on reinsurance policies, sometimes we pay or receive more than we had reserved, and other times less. . . . [S]ome deals were ‘winners’ (producing a contribution to surplus) while others were ‘losers’, but in the aggregate we achieved a win.” (p.4).

* I would challenge even the verity of the statement that some were ‘losers’ (for the reasons above) but at all events in the aggregate it is indisputable that Equitas’s effectiveness in snookering policyholders into settling for less than the reserve is Equitas’s margin.

* Given the tremendous success that Equitas has had in extinguishing major liabilities with its reinsureds’ direct policyholders (it has settled with all 10 of the largest direct asbestos policyholders identified in 2001 (p.2)), Equitas has now turned its attention to its “inwards” reinsurance with US insurance companies. (p. 10) Since the time of the annual report, Equitas has achieved a major settlement with The Hartford (and which resulted in Hartford’s realizing less than its booked reinsurance receivable). So perhaps policyholders can take solace that they are in good company.

Notes: My commentary is available for Equitas Financials 2005 and 2004.

On March 31, 2006, 1 pound equaled $1.74.