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August 30, 2007

The "Insurance Hoax" -- Insurers Paying Too Little and Too Late

Bloomberg recently published a hard-hitting piece decrying the property-casualty industry's claims-handling practices. Insurers perceive that the article to punches below the belt, as this response from the Insurance Information Institute shows. The III piece is interesting to me because of its immoderate tone, something at odds with most of the writing that comes from III, which is a great source of financial statistics in particular on the performance of the P-C insurance industry. While the III is certainly right that insurers pay claims every day, the III and the rest of the industry need to recognize the wide-spread perception that at the point of claim insurers adopt an adversarial posture. Experienced, thoughtful observers of the industry have written about this at length (and the linked article is I think the most important thing ever written on the P-C industry), and the point of first-party insurance bad-faith law in part is to counterbalance the power imbalance that insurers hold over their insureds at the time of claim -- at the time their insureds are most in need and dependent on their performance, which explains the emotional oomph that typifies through-the-eyes-of-insureds' reporting on insurers' claims-paying (or claims-denying) practices.

I agree with the III that the Bloomberg story is too facile, and it is inappropriate to leap from the observation that an insurer paying less than what the policyholder wanted ineluctably means that the insurer is paying less than what the policyholder deserved. I recently suffered a major homeowners' loss when a (crazed) intruder broke into my home and caused huge amounts of damage; our insurer was fantastic in dispatching someone to board up a broken door, arrange for a contractor to do repair work, and reimburse us for other loss (including paying the vendor of our choice on some home electronics). So I know first hand that insurers can ride to the rescue, treat their customers with "good hands," and live up to their advertising slogans. On the other hand, I bring suits against insurers on behalf of clients when I think amounts are owed and unpaid, and I am kept busy by wrongful denials by insurers inflicted against my corporate clients (both large and small). At a time when respected news outlets like Bloomberg (and CNN and PBS) feel comfortable producing pieces that seem well suited to the Fight Bad Faith Insurance Companies website, the insurance industry should look deep into its practices and understand the perceptions of consumers and businesses to ensure that insurers' historic mission of helping their insureds, being "there" in the time of need, is embraced and, more importantly, put into practice every day in paying claims.

Posted by Marc Mayerson at 1:06 PM | Comments (6) | TrackBack

The "Insurance Hoax" -- Insurers Paying Too Little and Too Late

Bloomberg recently published a hard-hitting piece decrying the property-casualty industry's claims-handling practices. Insurers perceive that the article to punches below the belt, as this response from the Insurance Information Institute shows. The III piece is interesting to me because of its immoderate tone, something at odds with most of the writing that comes from III, which is a great source of financial statistics in particular on the performance of the P-C insurance industry. While the III is certainly right that insurers pay claims every day, the III and the rest of the industry need to recognize the wide-spread perception that at the point of claim insurers adopt an adversarial posture. Experienced, thoughtful observers of the industry have written about this at length (and the linked article is I think the most important thing ever written on the P-C industry), and the point of first-party insurance bad-faith law in part is to counterbalance the power imbalance that insurers hold over their insureds at the time of claim -- at the time their insureds are most in need and dependent on their performance, which explains the emotional oomph that typifies through-the-eyes-of-insureds' reporting on insurers' claims-paying (or claims-denying) practices.

I agree with the III that the Bloomberg story is too facile, and it is inappropriate to leap from the observation that an insurer paying less than what the policyholder wanted ineluctably means that the insurer is paying less than what the policyholder deserved. I recently suffered a major homeowners' loss when a (crazed) intruder broke into my home and caused huge amounts of damage; our insurer was fantastic in dispatching someone to board up a broken door, arrange for a contractor to do repair work, and reimburse us for other loss (including paying the vendor of our choice on some home electronics). So I know first hand that insurers can ride to the rescue, treat their customers with "good hands," and live up to their advertising slogans. On the other hand, I bring suits against insurers on behalf of clients when I think amounts are owed and unpaid, and I am kept busy by wrongful denials by insurers inflicted against my corporate clients (both large and small). At a time when respected news outlets like Bloomberg (and CNN and PBS) feel comfortable producing pieces that seem well suited to the Fight Bad Faith Insurance Companies website, the insurance industry should look deep into its practices and understand the perceptions of consumers and businesses to ensure that insurers' historic mission of helping their insureds, being "there" in the time of need, is embraced and, more importantly, put into practice every day in paying claims.

Posted by Marc Mayerson at 1:06 PM | Comments (8) | TrackBack

November 17, 2006

Now You See It, Now You Don’t: Payments Received from Insolvent Insurers

Insurers collect premiums, invest them, incur overhead, and pay claims. Sometimes this life cycle gets out of whack, leading to the voluntary or forced insolvency of an insurance company. Whenever an insolvency occurs, one job of the rehabilitator or liquidator is to equitably distribute whatever money is available to the policyholders with unpaid claims in the queue. And a policyholder that already received payment from the insurer may be required to disgorge those monies back to the estate if it is found that the claim payment constitutes a preference.

This was the issue in a recent decision of the Utah Supreme Court, Wilcox v. Anchor Wate Co., (Utah Nov. 3, 2006). Anchor Wate was a policyholder of an insurer that soon after making part payment was placed into involuntary liquidation by Utah insurance regulators. The policy at issue provided $5 million of coverage, and the insurer had paid $3 million toward the claim and entered into an agreement to pay the remaining $2 million owed in four equal installments. After the insurer made its initial $3.5 million payment, the order of liquidation was entered (and Anchor Wate submitted a proof of claim for $1.5 million).

Before the liquidation order, the insurer had received the cash to make the payment to Anchor Wate from its reinsurers, which were required under the preexisting reinsurance certificates to make advance payments whenever there was a large loss (as with Anchor Wate). Advancing a number of theories, Anchor Wate sought to fend off the liquidator’s effort to recover the $3.5 million payment as a preference.

The Utah court found that Anchor Wate had no direct rights under the reinsurance agreements: it was not an express third-party beneficiary; there was no “cut through” clause; nor did the reinsurers assume the obligations of the later-insolvent insurer by essentially substituting themselves in discharging the insurer’s obligations. The court did not find any fraud on the part of the insurer that would warrant imposing a constructive trust. And the Utah court found that the “earmarking” doctrine did not apply. Compare In Re Moses, 256 B.R. 641, 6445 (10th Cir. 2000). Accordingly, the Utah court ordered repayment of the $3.5 million in insurance proceeds, plus interest (subject to Anchor Wate’s receiving whatever ratable distribution of the assets to which creditors of its class were entitled).

Of course, this is not a satisfactory result for Anchor Wate, which had received $3.5 million in cash and would have been entitled to a ratable distribution for its claim of $1.5 million against the estate. Instead, Anchor Wate had to disgorge the cash already received and was left with a claim for $5 million against an insolvent estate.

Is there anything a policyholder in Anchor Wate’s position could have done to ensure it received maximal payment? Put more directly, is there a way to structure a preference in favor of one policyholder that will be insulated from claw back by the liquidator?

Where reinsurance policies contain a cut-through clause, the policyholder has direct rights against the reinsurers that it may enforce outside of the insolvent-insurer’s estate, and there has been recent litigation in the Reliance and Legion insolvencies, for example, over whether there a cut through was implied in fact in the circumstances of a particular arrangement covering a policyholder or group of policyholders. Such arrangements are unusual, and typically involve facultative reinsurance (that is, a reinsurance policy or policies issued in connection with the sale of an insurance policy to a particular insured).

In the absence of a cut through, however, probably the best the policyholder can do is to try to shoehorn its way into the earmarking doctrine, whereby money is deemed to pass outside the estate from a debtor of the estate to one of the estate’s creditors. In Anchor Wate’s situation, it might have sought to get its insurer to agree to the following:

a. In consideration of the policyholder’s release of claim, the insurer agrees to obtain all advance payments from its reinsurers to which it is entitled.

b. The insurer will segregate the proceeds so obtained from the reinsurers into a separate account for the purpose of paying the insured.

c. The insurer will notify the reinsurers from which it is obtaining the advance that it will devote the payment to the policyholder’s claim for coverage.

d. The policyholder agrees upon receipt of payment to release the reinsurers from any claims it may have against them (some element of consideration needs to be offered from the policyholder to the reinsurers).

e. Ideally, the reinsurers would agree that any such agreement to make payment on the condition that the policyholder is paid modifies the terms of the reinsurance certificate.

Essentially, what I am trying to create is a point-of-claim cut-through agreement whereby the perhaps insolvent insurer is a mere conduit facilitating the transaction between the policyholder and the reinsurers. Usually, cut-throughs are negotiated at the time the policy is originally sold, since the reinsurance backing is integral to the transaction (hence, the logic for the reinsurers allowing a cut through in the first place). The foregoing would obviously (especially after this posting) be intended to insulate the policyholder’s recovery from later recoupment by the liquidator/rehabilitator, i.e., it is an effort to create an enforceable preference. There are good reasons why preferential asset transfers are unwound, as in the Anchor Wate case. But when one’s ox is gored on this basis – when the policyholder has paid a liability claim with the expectation of retaining already agreed insurance recovery – fairness to other creditors of the estate – fairness to other policyholders – is not foremost in mind.

Posted by Marc Mayerson at 1:10 AM | Comments (1) | TrackBack

Now You See It, Now You Don’t: Payments Received from Insolvent Insurers

Insurers collect premiums, invest them, incur overhead, and pay claims. Sometimes this life cycle gets out of whack, leading to the voluntary or forced insolvency of an insurance company. Whenever an insolvency occurs, one job of the rehabilitator or liquidator is to equitably distribute whatever money is available to the policyholders with unpaid claims in the queue. And a policyholder that already received payment from the insurer may be required to disgorge those monies back to the estate if it is found that the claim payment constitutes a preference.

This was the issue in a recent decision of the Utah Supreme Court, Wilcox v. Anchor Wate Co., (Utah Nov. 3, 2006). Anchor Wate was a policyholder of an insurer that soon after making part payment was placed into involuntary liquidation by Utah insurance regulators. The policy at issue provided $5 million of coverage, and the insurer had paid $3 million toward the claim and entered into an agreement to pay the remaining $2 million owed in four equal installments. After the insurer made its initial $3.5 million payment, the order of liquidation was entered (and Anchor Wate submitted a proof of claim for $1.5 million).

Before the liquidation order, the insurer had received the cash to make the payment to Anchor Wate from its reinsurers, which were required under the preexisting reinsurance certificates to make advance payments whenever there was a large loss (as with Anchor Wate). Advancing a number of theories, Anchor Wate sought to fend off the liquidator’s effort to recover the $3.5 million payment as a preference.

The Utah court found that Anchor Wate had no direct rights under the reinsurance agreements: it was not an express third-party beneficiary; there was no “cut through” clause; nor did the reinsurers assume the obligations of the later-insolvent insurer by essentially substituting themselves in discharging the insurer’s obligations. The court did not find any fraud on the part of the insurer that would warrant imposing a constructive trust. And the Utah court found that the “earmarking” doctrine did not apply. Compare In Re Moses, 256 B.R. 641, 6445 (10th Cir. 2000). Accordingly, the Utah court ordered repayment of the $3.5 million in insurance proceeds, plus interest (subject to Anchor Wate’s receiving whatever ratable distribution of the assets to which creditors of its class were entitled).

Of course, this is not a satisfactory result for Anchor Wate, which had received $3.5 million in cash and would have been entitled to a ratable distribution for its claim of $1.5 million against the estate. Instead, Anchor Wate had to disgorge the cash already received and was left with a claim for $5 million against an insolvent estate.

Is there anything a policyholder in Anchor Wate’s position could have done to ensure it received maximal payment? Put more directly, is there a way to structure a preference in favor of one policyholder that will be insulated from claw back by the liquidator?

Where reinsurance policies contain a cut-through clause, the policyholder has direct rights against the reinsurers that it may enforce outside of the insolvent-insurer’s estate, and there has been recent litigation in the Reliance and Legion insolvencies, for example, over whether there a cut through was implied in fact in the circumstances of a particular arrangement covering a policyholder or group of policyholders. Such arrangements are unusual, and typically involve facultative reinsurance (that is, a reinsurance policy or policies issued in connection with the sale of an insurance policy to a particular insured).

In the absence of a cut through, however, probably the best the policyholder can do is to try to shoehorn its way into the earmarking doctrine, whereby money is deemed to pass outside the estate from a debtor of the estate to one of the estate’s creditors. In Anchor Wate’s situation, it might have sought to get its insurer to agree to the following:

a. In consideration of the policyholder’s release of claim, the insurer agrees to obtain all advance payments from its reinsurers to which it is entitled.

b. The insurer will segregate the proceeds so obtained from the reinsurers into a separate account for the purpose of paying the insured.

c. The insurer will notify the reinsurers from which it is obtaining the advance that it will devote the payment to the policyholder’s claim for coverage.

d. The policyholder agrees upon receipt of payment to release the reinsurers from any claims it may have against them (some element of consideration needs to be offered from the policyholder to the reinsurers).

e. Ideally, the reinsurers would agree that any such agreement to make payment on the condition that the policyholder is paid modifies the terms of the reinsurance certificate.

Essentially, what I am trying to create is a point-of-claim cut-through agreement whereby the perhaps insolvent insurer is a mere conduit facilitating the transaction between the policyholder and the reinsurers. Usually, cut-throughs are negotiated at the time the policy is originally sold, since the reinsurance backing is integral to the transaction (hence, the logic for the reinsurers allowing a cut through in the first place). The foregoing would obviously (especially after this posting) be intended to insulate the policyholder’s recovery from later recoupment by the liquidator/rehabilitator, i.e., it is an effort to create an enforceable preference. There are good reasons why preferential asset transfers are unwound, as in the Anchor Wate case. But when one’s ox is gored on this basis – when the policyholder has paid a liability claim with the expectation of retaining already agreed insurance recovery – fairness to other creditors of the estate – fairness to other policyholders – is not foremost in mind.

Posted by Marc Mayerson at 1:10 AM | Comments (1) | TrackBack

October 20, 2006

Berkshire Hath A Way Out for Equitas and Lloyd’s

A long-rumoured transaction between Equitas and Warren Buffett’s Berkshire Hathaway has been announced. This will be a two-step transaction whereby (1) Equitas will be absorbed into a National Indemnity Company subsidiary in exchange for a cash payment and a promise of providing additional reinsurance and (2) a channeling injunction will be obtained cutting off the exposure of Equitas, Lloyd’s, names, and Berkshire beyond the money in the new vehicle. If consummated, the deal will achieve the long-sought finality for names (the individual investors on the responsible pre-1992 syndicate years of account) and for the current Lloyd’s enterprise.

Under the deal, National Indemnity will reinsure all of Equitas’s liabilities and provide a further $7 billion of reinsurance coverage for Equitas. Equitas has reserves presently of $8.7 billion (as of March 31, 2006) and National Indemnity will commit an additional $5.7 billion of reinsurance capacity; Equitas will retain £172 million. National Indemnity gets all of Equitas’s assets, plus £72 million from the Corporation of Lloyd’s.

In Phase II of the deal, National Indemnity will be paid an additional £40 million (£18 million from the Corporation of Lloyd’s), which is to be paid on 31 December 2009. As part of this phase, National Indemnity will commit an additional $1.3 billion of reinsurance cover, for a total of $7 billion of additional reinsurance coverage. The Phase II commitment from National Indemnity, however, is contingent upon the English High Court issuing a channeling injunction directing all claims to the new National Indemnity entity and cutting off all rights of recourse that policyholders otherwise have to seek payment from Equitas or Lloyd’s (and presumably the various trust funds).

So what does all this mean?

1. Let’s start with Lloyd’s. As I have often argued, the Lloyd’s enterprise is the source of ultimate recourse for policyholders that are not paid in full on their claims. While we are shunted over to Equitas in the first instance, policyholders retain the right – pre-Phase II – to seek recompense through the various trust funds in the US backing the Lloyd’s policies and arguably against the current Lloyd’s enterprise, that is, to the current Central Fund and in turn through assessments by Lloyd’s upon the current members. Lloyd’s seems to recognize this exposure by agreeing to commit an additional £90 million to stave off future claims arising from an Equitas shortfall. The principal question here is where is that money coming from? Is it coming from Lloyd’s raiding the existing trust funds or will it come from assessments on the current membership of Lloyd’s? I assume if Phase II does happen, then Lloyd’s will close the existing trust funds and swipe that money.

2. As to the “Names” backing the policies under which assureds are seeking or will seek coverage (these are pre-1993 non-life Lloyd’s policies), while today there is contractual privity between the policyholder and the individual Name, the individual Name is at little risk of any policyholder chasing him or her for the small fractionated share of his/her individual obligation of an specific Lloyd’s policy. It is simply not cost effective for a policyholder to pursue this, nor is there any legal obligation on behalf of policyholders to chase the individual Name in a collection action as opposed to presenting a claim to the “cash window” at Lloyd’s and requiring Lloyd’s then to deal with the accounting/funding through the funds-at-Lloyd’s of the Name and the name’s individual assets more generally (down to the last cufflink, as the saying goes). But if Phase II of this deal goes through, it would appear that the rights of policyholders will be extinguished and a forced novation ordered channeling all claims to the new National Indemnity entity. Moreover, the Names can look forward to a return premium based on roughly the remaining £150 million pounds that will be in Equitas after the deal is done. It seems unlikely that the Names will object to this structure in favor of any of the alternative ways this could possibly play out. Presumably some constituencies will raise a stink in hopes of increasing the size of the return premium, but it is quite difficult to imagine the Names getting together in a fashion to crater this bailout from the nice people in Omaha.

3. The important question is what’s in this for Berkshire Hathaway, and the answer is straightforward: this is just a money bet. To see how the deal works, let start with the money that is presently in Equitas, which as of 31 March 2006 showed a retained surplus of £458 million. The deal in part shows that that “surplus” does not exist (as many of us have long argued), for otherwise why would Equitas and Lloyd’s need to buy an additional $7 billion of assets. If the retained surplus number were right, there is no economically rational need to purchase $7 billion of additional coverage. But hold that to the side, for the moment, and let’s assume that while the surplus number is significantly understated as compared with the entire stream of claims that can be expected to flow into Equitas, assume that the amount of money in Equitas is enough to pay claims for the next 20 years. (Demographers and actuaries tell us that asbestos claims will continue to be asserted for the next 40 years.)

Assuming that there is enough money in Equitas today to handle the next twenty years, the economics of the deal from Berkshire Hathaway’s perspective becomes clear. National Indemnity is taking the back end of the claim stream twenty years out. It is committing to pay up to $7 billion for that back-end portfolio of claims. In exchange for making that commitment, it is getting £286 million today in surplus (a number I derived from taking the current surplus and subtracting the amount that Equitas will retain from that in the deal), plus £90 million in cash from the Corporation of Lloyd’s, plus another £22 million from Equitas. While it gets that money over a couple of years, let’s simplify things and say that Berkshire Hathaway is receiving £398 million in cash today (approximately $746 million) for its $7 billion reinsurance commitment beginning in 2026.

If National Indemnity earns a return of 5.75 percent on that money annually over this period, National Indemnity breaks even on the deal. In other words, in exchange for the cash payment of $746 million, National Indemnity can grow that money to the $7 billion back-end reinsurance commitment as the asbestos claims wind down. What this means of course is that National Indemnity makes money on this deal if any of the following occur:

a. it gets more than 5.75 percent real rate of return (if the return is 6.25, it will make nominally $1.4 billion (with a $123 million present value))

b. the money in Equitas lasts longer than 20 years, allowing National Indemnity to grow its nest egg further

c. the claim stream becomes less than Equitas is currently projecting.

Pursuant to what Albert Einstein supposedly called the greatest mathematical discovery of all time, the miracle of compound interest, tuppence held over a long enough period turns into something of extraordinary value, and Berkshire Hathaway’s taking the long view allows it to enter into a deal like this that others wouldn’t have the stomach for, even though the numbers work on a straightforward basis.

4. How does this proposed deal affect holders of non-life policies issued by underwriters at Lloyd’s prior to 1993, that is, how does this affect those policyholders that today pursue payment of their claims via Equitas?

Phase I of this deal is of course simply a net positive for policyholders. More assets are being made available to Equitas to pay claims. One wonders how the reinsurance policy will work in the sense whether all policies for which Equitas is responsible are reinsured, but one can reasonably assume they all are. If so, then the retained surplus of Equitas improves significantly from £458 million. This is good news for policyholders and for insurance companies that had purchased reinsurance through Lloyd’s and for which Equitas is now the claims handler.

Phase II of the deal is more complicated. If Phase II goes through, the policyholders are benefited by an additional $1.3 billion (really, 1.26 nominally given the Equitas premium), but the policyholders’ recourse will be confined to the new National Indemnity entity, as is the case in approved “solvent runoffs” in the London market. Perhaps this is enough money ultimately to pay all possible claims arising on Equitas-backed policies, but that in part will be the key question in the Phase II court proceedings. In those expected proceedings in the London High Court, policyholders (direct and cedants) need to be prepared to present their own actuarial analyses of the value of the portfolio of claims. The difficulty here will be that no policyholder has enough information to evaluate the entire portfolio of potential claims from anyone who ever purchased a non-life policy through Lloyd’s before 1993. Given the significant politics involved and the absence of compelling proof of a swindle of policyholders, given the gravitas of National Indemnity and the sheer size of the nominal dollars/pounds involved, it seems highly likely that the High Court will approve the cutoff of claims to other assets and parties other than the new National Indemnity/Equitas vehicle.

The constituency that might be less than thrilled with this news are policyholders that liquidated their coverage with Equitas believing the myth that Equitas was the sole recourse and source of funds and fearing for Equitas’s continued solvency. As I have pointed out, of the reported surplus at 31 March 2006, a full 95 percent of that amount was due to policyholders that sold out their coverage for less than the amounts that Equitas had reserved for the claims (and substantially less than the actuarial value of their claims, since most believe that Equitas has systematically underreserved for a variety of reasons). With each passing year, those deals based on erroneous premises look worse and worse, and the Berkshire Hathaway bailout only underscores this.

Note: This analysis was in part quoted in London's Financial Times (Oct. 23, 2006) at 12.

Posted by Marc Mayerson at 1:58 PM | Comments (11) | TrackBack

Berkshire Hath A Way Out for Equitas and Lloyd’s

A long-rumoured transaction between Equitas and Warren Buffett’s Berkshire Hathaway has been announced. This will be a two-step transaction whereby (1) Equitas will be absorbed into a National Indemnity Company subsidiary in exchange for a cash payment and a promise of providing additional reinsurance and (2) a channeling injunction will be obtained cutting off the exposure of Equitas, Lloyd’s, names, and Berkshire beyond the money in the new vehicle. If consummated, the deal will achieve the long-sought finality for names (the individual investors on the responsible pre-1992 syndicate years of account) and for the current Lloyd’s enterprise.

Under the deal, National Indemnity will reinsure all of Equitas’s liabilities and provide a further $7 billion of reinsurance coverage for Equitas. Equitas has reserves presently of $8.7 billion (as of March 31, 2006) and National Indemnity will commit an additional $5.7 billion of reinsurance capacity; Equitas will retain £172 million. National Indemnity gets all of Equitas’s assets, plus £72 million from the Corporation of Lloyd’s.

In Phase II of the deal, National Indemnity will be paid an additional £40 million (£18 million from the Corporation of Lloyd’s), which is to be paid on 31 December 2009. As part of this phase, National Indemnity will commit an additional $1.3 billion of reinsurance cover, for a total of $7 billion of additional reinsurance coverage. The Phase II commitment from National Indemnity, however, is contingent upon the English High Court issuing a channeling injunction directing all claims to the new National Indemnity entity and cutting off all rights of recourse that policyholders otherwise have to seek payment from Equitas or Lloyd’s (and presumably the various trust funds).

So what does all this mean?

1. Let’s start with Lloyd’s. As I have often argued, the Lloyd’s enterprise is the source of ultimate recourse for policyholders that are not paid in full on their claims. While we are shunted over to Equitas in the first instance, policyholders retain the right – pre-Phase II – to seek recompense through the various trust funds in the US backing the Lloyd’s policies and arguably against the current Lloyd’s enterprise, that is, to the current Central Fund and in turn through assessments by Lloyd’s upon the current members. Lloyd’s seems to recognize this exposure by agreeing to commit an additional £90 million to stave off future claims arising from an Equitas shortfall. The principal question here is where is that money coming from? Is it coming from Lloyd’s raiding the existing trust funds or will it come from assessments on the current membership of Lloyd’s? I assume if Phase II does happen, then Lloyd’s will close the existing trust funds and swipe that money.

2. As to the “Names” backing the policies under which assureds are seeking or will seek coverage (these are pre-1993 non-life Lloyd’s policies), while today there is contractual privity between the policyholder and the individual Name, the individual Name is at little risk of any policyholder chasing him or her for the small fractionated share of his/her individual obligation of an specific Lloyd’s policy. It is simply not cost effective for a policyholder to pursue this, nor is there any legal obligation on behalf of policyholders to chase the individual Name in a collection action as opposed to presenting a claim to the “cash window” at Lloyd’s and requiring Lloyd’s then to deal with the accounting/funding through the funds-at-Lloyd’s of the Name and the name’s individual assets more generally (down to the last cufflink, as the saying goes). But if Phase II of this deal goes through, it would appear that the rights of policyholders will be extinguished and a forced novation ordered channeling all claims to the new National Indemnity entity. Moreover, the Names can look forward to a return premium based on roughly the remaining £150 million pounds that will be in Equitas after the deal is done. It seems unlikely that the Names will object to this structure in favor of any of the alternative ways this could possibly play out. Presumably some constituencies will raise a stink in hopes of increasing the size of the return premium, but it is quite difficult to imagine the Names getting together in a fashion to crater this bailout from the nice people in Omaha.

3. The important question is what’s in this for Berkshire Hathaway, and the answer is straightforward: this is just a money bet. To see how the deal works, let start with the money that is presently in Equitas, which as of 31 March 2006 showed a retained surplus of £458 million. The deal in part shows that that “surplus” does not exist (as many of us have long argued), for otherwise why would Equitas and Lloyd’s need to buy an additional $7 billion of assets. If the retained surplus number were right, there is no economically rational need to purchase $7 billion of additional coverage. But hold that to the side, for the moment, and let’s assume that while the surplus number is significantly understated as compared with the entire stream of claims that can be expected to flow into Equitas, assume that the amount of money in Equitas is enough to pay claims for the next 20 years. (Demographers and actuaries tell us that asbestos claims will continue to be asserted for the next 40 years.)

Assuming that there is enough money in Equitas today to handle the next twenty years, the economics of the deal from Berkshire Hathaway’s perspective becomes clear. National Indemnity is taking the back end of the claim stream twenty years out. It is committing to pay up to $7 billion for that back-end portfolio of claims. In exchange for making that commitment, it is getting £286 million today in surplus (a number I derived from taking the current surplus and subtracting the amount that Equitas will retain from that in the deal), plus £90 million in cash from the Corporation of Lloyd’s, plus another £22 million from Equitas. While it gets that money over a couple of years, let’s simplify things and say that Berkshire Hathaway is receiving £398 million in cash today (approximately $746 million) for its $7 billion reinsurance commitment beginning in 2026.

If National Indemnity earns a return of 5.75 percent on that money annually over this period, National Indemnity breaks even on the deal. In other words, in exchange for the cash payment of $746 million, National Indemnity can grow that money to the $7 billion back-end reinsurance commitment as the asbestos claims wind down. What this means of course is that National Indemnity makes money on this deal if any of the following occur:

a. it gets more than 5.75 percent real rate of return (if the return is 6.25, it will make nominally $1.4 billion (with a $123 million present value))

b. the money in Equitas lasts longer than 20 years, allowing National Indemnity to grow its nest egg further

c. the claim stream becomes less than Equitas is currently projecting.

Pursuant to what Albert Einstein supposedly called the greatest mathematical discovery of all time, the miracle of compound interest, tuppence held over a long enough period turns into something of extraordinary value, and Berkshire Hathaway’s taking the long view allows it to enter into a deal like this that others wouldn’t have the stomach for, even though the numbers work on a straightforward basis.

4. How does this proposed deal affect holders of non-life policies issued by underwriters at Lloyd’s prior to 1993, that is, how does this affect those policyholders that today pursue payment of their claims via Equitas?

Phase I of this deal is of course simply a net positive for policyholders. More assets are being made available to Equitas to pay claims. One wonders how the reinsurance policy will work in the sense whether all policies for which Equitas is responsible are reinsured, but one can reasonably assume they all are. If so, then the retained surplus of Equitas improves significantly from £458 million. This is good news for policyholders and for insurance companies that had purchased reinsurance through Lloyd’s and for which Equitas is now the claims handler.

Phase II of the deal is more complicated. If Phase II goes through, the policyholders are benefited by an additional $1.3 billion (really, 1.26 nominally given the Equitas premium), but the policyholders’ recourse will be confined to the new National Indemnity entity, as is the case in approved “solvent runoffs” in the London market. Perhaps this is enough money ultimately to pay all possible claims arising on Equitas-backed policies, but that in part will be the key question in the Phase II court proceedings. In those expected proceedings in the London High Court, policyholders (direct and cedants) need to be prepared to present their own actuarial analyses of the value of the portfolio of claims. The difficulty here will be that no policyholder has enough information to evaluate the entire portfolio of potential claims from anyone who ever purchased a non-life policy through Lloyd’s before 1993. Given the significant politics involved and the absence of compelling proof of a swindle of policyholders, given the gravitas of National Indemnity and the sheer size of the nominal dollars/pounds involved, it seems highly likely that the High Court will approve the cutoff of claims to other assets and parties other than the new National Indemnity/Equitas vehicle.

The constituency that might be less than thrilled with this news are policyholders that liquidated their coverage with Equitas believing the myth that Equitas was the sole recourse and source of funds and fearing for Equitas’s continued solvency. As I have pointed out, of the reported surplus at 31 March 2006, a full 95 percent of that amount was due to policyholders that sold out their coverage for less than the amounts that Equitas had reserved for the claims (and substantially less than the actuarial value of their claims, since most believe that Equitas has systematically underreserved for a variety of reasons). With each passing year, those deals based on erroneous premises look worse and worse, and the Berkshire Hathaway bailout only underscores this.

Note: This analysis was in part quoted in London's Financial Times (Oct. 23, 2006) at 12.

Posted by Marc Mayerson at 1:58 PM | Comments (11) | TrackBack

June 29, 2006

Equitas Financials -- 2006 Version

As part of the Reconstruction and Renewal of Lloyd’s in 1996, various participants in the Lloyd’s enterprise established several companies for the purpose of reinsuring the then-open syndicate years of account and managing the runoff of claims under those and prior years’ insurance policies. In 1997, the liabilities of a Lloyds’ owned-entity called Lioncover were reinsured into Equitas too.

Equitas issues an annual report and accompanying press release that discusses its results to date. Some of the highlights this year:

* 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.

Posted by Marc Mayerson at 2:16 PM | Comments (0) | TrackBack

Equitas Financials -- 2006 Version

As part of the Reconstruction and Renewal of Lloyd’s in 1996, various participants in the Lloyd’s enterprise established several companies for the purpose of reinsuring the then-open syndicate years of account and managing the runoff of claims under those and prior years’ insurance policies. In 1997, the liabilities of a Lloyds’ owned-entity called Lioncover were reinsured into Equitas too.

Equitas issues an annual report and accompanying press release that discusses its results to date. Some of the highlights this year:

* 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.

Posted by Marc Mayerson at 2:16 PM | Comments (0) | TrackBack

May 17, 2006

Taming the Lion(cover): Lioncover, Lloyd's, Equitas, and the Central Fund(s)

W. Mark Felt or Hal Holbrook playing him said to "follow the money," which has proven difficult in the instance of Lloyd's of London, and a task made all the more important as asbestos and environmental liabilities continue to fall upon corporate policyholders in the US that purchased broad insurance in the 1950s, 60s and 70s through the London market. While lawyers and policyholders may be familiar with Equitas, the reinsurance runoff and claims-handling vehicles set up in the late 1990s to deal with liabilities arising under historical Lloyd's policies, I have long believed that a key for litigators is something called Lioncover, a reinsurance vehicle originally set up to bailout important players at Lloyd's who were involved in Peter Cameron Webb "managed" syndicate years of account. Lioncover, which I understand to be a wholly owned subsidiary of the Corporation of Lloyd's and which houses the PCW business, initially was not reinsured into Equitas when Equitas was set up as part of the "Reconstruction and Renewal" of the Lloyd's operation. It was later poured into the Equitas structure but also is explicitly backed by the Lloyd's enterprise itself. Lioncover is a lever one can use to uncover the financial vehicles backing old Lloyd's policies (which contra to popular myth are not backed solely by the assets of Equitas or by the trust funds in the US). Lloyd's annual report for 2005 contains a few interesting crumbs worthy of note for Lloyd's/Equitas watchers.

First, Lioncover's liability payments in 2005 total slightly more than 525 million pounds or roughly $1 billion (US). These principally were attributable to asbestos, environmental, and health-hazard claims. (p. 114; note 14)

Second, this amount is not reflected on Lloyd's net balance sheet because the directors of Lioncover conclude that, because Equitas says it will pay the claims, it can take that reinsurance recoverable as an offset on its balance sheet. (p. 120) As Lloyd's annual report states:

At present, ERL [Equitas Reinsurance Ltd.] and its subsidiary undertaking, Equitas Limited, which is responsible for the run-off of the reinsured business, continue to pay claims in full and the directors of ERL have stated that they believe that the assets should be sufficient to meet all liabilities in full. Accordingly, the directors of Lioncover have considered it appropriate to recognise the amounts recoverable from ERL in full. Should ERL ever cease to meet in full its obligations in respect of the PCW syndicates, Lioncover would be responsible to its policyholders for meeting any amounts remaining unpaid.

The establishment of Lioncover and its reinsurance into Equitas does not cutoff the policyholder's right to make claim under the policy as against the Lloyd's enterprise. (This is consistent with what I have been counseling that one should not look at Equitas' assets alone when evaluating whether to include a credit-risk discount in a deal done with Equitas.)

Third, in the event Equitas does fail to perform, then Lioncover may seek to obtain payment from the "Central Fund," which helps back the policies issued through Lloyd's. As part of the Reconstruction and Renewal process, there is an "old" Central Fund and a "new" Central Fund, and Lioncover can claim under both, though the Council of Lloyd's purports to have discretion not to pay under the new fund unless the current membership agrees. As the report explains:

Following the implementation of ‘Reconstruction and Renewal’, Names underwriting in respect of 1992 and prior years, Lioncover and Centrewrite were reinsured into Equitas. If Equitas were unable to discharge in full the liabilities which it has reinsured, any resulting shortfall in respect of Lioncover or Centrewrite could be met out of both the ‘Old’ Central Fund and the New Central Fund under the terms of their respective Lloyd’s bond. Both the ‘Old’ Central Fund and the New Central Fund would also be available to meet the claims of policyholders of Names who are party to hardship agreements executed before 4 September 1996, to the extent that such an event resulted in a shortfall. However, unless the members of the Society resolve in a general meeting to make the New Central Fund available, only the ‘Old’ Central Fund would be available to meet the claims of policyholders of Names who are not party to hardship agreements executed before 4 September 1996. The Council has determined that any losses resulting from such indemnities will be met by the Lloyd’s Central Fund. (p. 132, note 29)

There certainly is an open question whether there really is discretion not to pay under the new Central Fund, but the reason we care about this is that it is the current membership of Lloyd's that would be responsible for topping up the fund in the event of a shortfall (and that there would be a shortfall is a likely result if the new fund were tapped).

Note that simultaneously Lioncover's liabilities would need to be shown on Lloyd's balance sheet and the capital of the members would be hit, thus doubly impairing the financial ratings of the Lloyd's enterprise.

Fourth, my sense continues to be that, if Equitas stops making payments or determines that it has more mouths to feed than money (or owns up to that reality), following what happened with Lioncover and how it has been intermingled with "new" Lloyd's will be a key focus for discovery and trial when policyholders seek payment on their old Lloyd's policies and are shunted off to the admittedly penurious Equitas. The story of insiders being bailed out through Lioncover and new Lloyd's assumption of those liabilities and seeming manipulation of its own financial statements (by taking the reinsurance recoverable as a full, undiscounted offset while Equitas otherwise is proclaiming its own credit risk) will be the stuff of trial. The promises Lloyd's makes when selling policies are supposed to be backed up by the vaunted "chain of security," which means the assets of the current membership of the Lloyd's enterprise. Compare Industrial Guarantee Corp. v Lloyd's(1924) 19 Lloyd's List Law Reports 78 (Bailhache J).

The Lloyd's enterprise's efforts to "ringfence" the historic liabilities and to protect the current corporate members may yet prove successful -- at least to the extent that policyholderscooperate in obtaining less than the full value of their insurance; the chain of security will back the policies US companies purchased only once those companies bring litigation to force the Lloyd's enterprise to honor the promises made in the broad insurance policies sold to American companies (or in the unlikely event that regulators step in). Certainly, the halcyon days of Cuthbert Heath saying "pay all our policyholders in full" are long, long gone.

A somewhat expanded version of this commentary appears in 17 Mealey's Litigation Reports: Reinsurance (June 15, 2006).

Posted by Marc Mayerson at 12:54 PM | Comments (1) | TrackBack

Taming the Lion(cover): Lioncover, Lloyd's, Equitas, and the Central Fund(s)

W. Mark Felt or Hal Holbrook playing him said to "follow the money," which has proven difficult in the instance of Lloyd's of London, and a task made all the more important as asbestos and environmental liabilities continue to fall upon corporate policyholders in the US that purchased broad insurance in the 1950s, 60s and 70s through the London market. While lawyers and policyholders may be familiar with Equitas, the reinsurance runoff and claims-handling vehicles set up in the late 1990s to deal with liabilities arising under historical Lloyd's policies, I have long believed that a key for litigators is something called Lioncover, a reinsurance vehicle originally set up to bailout important players at Lloyd's who were involved in Peter Cameron Webb "managed" syndicate years of account. Lioncover, which I understand to be a wholly owned subsidiary of the Corporation of Lloyd's and which houses the PCW business, initially was not reinsured into Equitas when Equitas was set up as part of the "Reconstruction and Renewal" of the Lloyd's operation. It was later poured into the Equitas structure but also is explicitly backed by the Lloyd's enterprise itself. Lioncover is a lever one can use to uncover the financial vehicles backing old Lloyd's policies (which contra to popular myth are not backed solely by the assets of Equitas or by the trust funds in the US). Lloyd's annual report for 2005 contains a few interesting crumbs worthy of note for Lloyd's/Equitas watchers.

First, Lioncover's liability payments in 2005 total slightly more than 525 million pounds or roughly $1 billion (US). These principally were attributable to asbestos, environmental, and health-hazard claims. (p. 114; note 14)

Second, this amount is not reflected on Lloyd's net balance sheet because the directors of Lioncover conclude that, because Equitas says it will pay the claims, it can take that reinsurance recoverable as an offset on its balance sheet. (p. 120) As Lloyd's annual report states:

At present, ERL [Equitas Reinsurance Ltd.] and its subsidiary undertaking, Equitas Limited, which is responsible for the run-off of the reinsured business, continue to pay claims in full and the directors of ERL have stated that they believe that the assets should be sufficient to meet all liabilities in full. Accordingly, the directors of Lioncover have considered it appropriate to recognise the amounts recoverable from ERL in full. Should ERL ever cease to meet in full its obligations in respect of the PCW syndicates, Lioncover would be responsible to its policyholders for meeting any amounts remaining unpaid.

The establishment of Lioncover and its reinsurance into Equitas does not cutoff the policyholder's right to make claim under the policy as against the Lloyd's enterprise. (This is consistent with what I have been counseling that one should not look at Equitas' assets alone when evaluating whether to include a credit-risk discount in a deal done with Equitas.)

Third, in the event Equitas does fail to perform, then Lioncover may seek to obtain payment from the "Central Fund," which helps back the policies issued through Lloyd's. As part of the Reconstruction and Renewal process, there is an "old" Central Fund and a "new" Central Fund, and Lioncover can claim under both, though the Council of Lloyd's purports to have discretion not to pay under the new fund unless the current membership agrees. As the report explains:

Following the implementation of ‘Reconstruction and Renewal’, Names underwriting in respect of 1992 and prior years, Lioncover and Centrewrite were reinsured into Equitas. If Equitas were unable to discharge in full the liabilities which it has reinsured, any resulting shortfall in respect of Lioncover or Centrewrite could be met out of both the ‘Old’ Central Fund and the New Central Fund under the terms of their respective Lloyd’s bond. Both the ‘Old’ Central Fund and the New Central Fund would also be available to meet the claims of policyholders of Names who are party to hardship agreements executed before 4 September 1996, to the extent that such an event resulted in a shortfall. However, unless the members of the Society resolve in a general meeting to make the New Central Fund available, only the ‘Old’ Central Fund would be available to meet the claims of policyholders of Names who are not party to hardship agreements executed before 4 September 1996. The Council has determined that any losses resulting from such indemnities will be met by the Lloyd’s Central Fund. (p. 132, note 29)

There certainly is an open question whether there really is discretion not to pay under the new Central Fund, but the reason we care about this is that it is the current membership of Lloyd's that would be responsible for topping up the fund in the event of a shortfall (and that there would be a shortfall is a likely result if the new fund were tapped).

Note that simultaneously Lioncover's liabilities would need to be shown on Lloyd's balance sheet and the capital of the members would be hit, thus doubly impairing the financial ratings of the Lloyd's enterprise.

Fourth, my sense continues to be that, if Equitas stops making payments or determines that it has more mouths to feed than money (or owns up to that reality), following what happened with Lioncover and how it has been intermingled with "new" Lloyd's will be a key focus for discovery and trial when policyholders seek payment on their old Lloyd's policies and are shunted off to the admittedly penurious Equitas. The story of insiders being bailed out through Lioncover and new Lloyd's assumption of those liabilities and seeming manipulation of its own financial statements (by taking the reinsurance recoverable as a full, undiscounted offset while Equitas otherwise is proclaiming its own credit risk) will be the stuff of trial. The promises Lloyd's makes when selling policies are supposed to be backed up by the vaunted "chain of security," which means the assets of the current membership of the Lloyd's enterprise. Compare Industrial Guarantee Corp. v Lloyd's(1924) 19 Lloyd's List Law Reports 78 (Bailhache J).

The Lloyd's enterprise's efforts to "ringfence" the historic liabilities and to protect the current corporate members may yet prove successful -- at least to the extent that policyholderscooperate in obtaining less than the full value of their insurance; the chain of security will back the policies US companies purchased only once those companies bring litigation to force the Lloyd's enterprise to honor the promises made in the broad insurance policies sold to American companies (or in the unlikely event that regulators step in). Certainly, the halcyon days of Cuthbert Heath saying "pay all our policyholders in full" are long, long gone.

A somewhat expanded version of this commentary appears in 17 Mealey's Litigation Reports: Reinsurance (June 15, 2006).

Posted by Marc Mayerson at 12:54 PM | Comments (1) | TrackBack

April 27, 2006

ACE's "Plea Agreement" with Law Enforcement and Regulators

Law enforcement, insurance regulators, and insurance-industry participants continue to collide regarding "contingent commissions" and bid rigging that occurred in US insurance markets in the 1990s and '00s. One insurer, Liberty Mutual, says it would rather fight than switch, and it has announced it will defend litigation brought by state attorneys general and insurance regulators. Most other insurers have sought to put the matter behind them.

For example, ACE Ltd. recently reached accord with the New York Attorney General's office and New York's insurance commissioner regarding its conduct principally regarding the broker Marsh and ACE's effort to expand its excess general-liability insurance business. (Illinois and Connecticut signed on, too). In a document whose title is rich in irony -- an "Assurance of Discontinuance and Voluntary Compliance" -- ACE undertakes to set up a compensation fund and to conform its future business practices. Review of the "Assurance of Discontinuance" provides rich, indeed stunning, detail into how business was done at the expense of corporate policyholders in particular whose premiums were sufficiently large as to make bid-rigging, kickbacks, lying, and cheating lucrative for the participants -- both the individuals whose bonuses and power reflected their success in business and the companies that employed them that generated large premiums from the widespread conspiracy and corruption endemic to the top-tier of the insurance brokerage industry and the insurers that paid them.

ACE craftily negotiated the wording of the apology demanded by the state enforcement officials wherein the regulators affirm that ACE's standards of business conduct -- as did the law in its majesty -- prohibited the conduct that its employees engaged in (without the apology's quite coming to grips with that this was no mailroom operation but involved among other things the creation of fraudulent documentation by ACE's North American president and ACE's president of casualty risk).

ACE's two paragraph apology says:

As part of today's settlement with the Attorneys General and the Superintendent, ACE acknowledges that certain of its employees violated both acceptable business practices and ACE's own standards of conduct by engaging in behavior that included improper bidding practices and certain 'finite reinsurance' transactions. ACE apologizes for this conduct. It has reformed its business practices and is satisfied that this behavior will not be repeated.

In order to promote transparency and reduce the potential for conflicts of interest, ACE has supported legislation in the US to eliminate contingent compensation and through this agreement pledges to continue to do so.

ACE will be able to argue that the law enforcement officials have signed off on its internal reforms but also with the idea that only certain individuals were misguided as opposed to the company's (if you will) soul. ACE accomplished quite a lot for itself in the agreement, for which it and its general counsel should receive great kudos from its shareholders. Whether the citizens of this nation, insurance policyholders, insurance brokers, and competitors should respond as positively is perhaps a different matter.

But let's review the bidding, er, an unfortunate turn of phrase in this context, so shall we say, let's review how we got here as set forth in the Assurance of Discontinuance and Voluntary Compliance. Here are the findings agreed to by ACE (the numbered paragraphs quote the stipulated wrongdoing by ACE (with elisions indicated "[ ]" and the material in brackets "{ }" are my comments):

1. Since at least the mid-1990s ACE and other insurers have paid hundreds of millions of dollars in so-called 'contingent commissions' to the world's largest insurance brokers . . . as well as tens of thousands of smaller brokers and independent agents.

2. ACE entered into a number of contingent commission agreements . . . to pay compensation to [brokers] as a result of which they steered insurance policies to ACE to increase the volume of policies written by ACE . . . and to direct policies to ACE.

3. Under these agreements, when Marsh, for exampled, helped ACE retain its existing business at renewal time, ACE paid Marsh higher contingent commissions. . . . These contingent compensation payments were passed on to ACE's customers in the form of higher premiums. {Note: these higher prices would have floated up the market price for all carriers, so all policyholders were adversely affected.}

4. In 2002, ACE decided to greatly expand its position in the potentially lucrative excess casualty market . . . . Previously, ACE had maintained only a small presence in this market. . . . ACE [then] signed a lucrative placement service agreement [with Marsh]. In addition, ACE agreed to join other insurers and Marsh in rigging the process of bidding for insurance policies and actively deceiving clients. ACE participated in the scheme in two ways: (1) where ACE was the incumbent on the lead layer of business, Marsh generally sought to protect ACE's incumbency and gave ACE an unfair competitive advantage by seeking out non-competitive bids from other insurers; and (2) where ACE was not the incumbent on the lead layer, Ace agreed to provide quotes to protect the incumbent, with the understanding that ACE would receive business on an excess layer without competition, thereby allowing it to enter the market. These practices were to the detriment of the insured, whose best interests Marsh was supposed to be serving. {And at least when ACE was an "incumbent," ACE had a contractual duty of good faith and fair dealing to the insured.}

5. The details of the scheme were as follow: when ACE was the incumbent carrier on the lead layer, or was otherwise chosen by Marsh to win a client's excess layer business, Marsh set a target for ACE which included proposed premium and policy terms for ACE's bid. If ACE met this target, Marsh generally arranged for ACE to win the business, regardless of whether ACE, or any other insurance company, could have quoted better terms for the client.

6. In order to control the market, Marsh instructed other insurance companies to provide intentionally losing bids that were inferior to those provided by the incumbent or its chosen winner for the excess layer. . . . They were also known as "B Quotes." . . Once it has secured such quotes, Marsh would present them to clients [policyholders] as bids obtained through a competitive process. This pretense of competition was intended to, and did, give clients the impression that ACE's bid was the best available. It also had the effect of directing business to ACE, not at terms best for the client, but rather at terms advantageous to ACE.

8. The arrangement with Marsh allowed ACE to become a major competitor in the excess casualty market with phenomenal speed. In 2001, before entering the scheme, ACE received only $5 million in Excess Casualty premiums in the United States from Marsh [the largest broker]. This number increased in 2002 to $41 million, $98.6 million in 2003 and $93.5 million in 2004. These premiums placed ACE . . . as the third largest carrier of excess casualty with Marsh. . . . {Note that ACE's premium had an eight-fold increase once it started acting in cahoots to the policyholders' detriment and then doubled against the next year; in other words, its business exploded 1600% in two years!}

8a. In or about December of 2002, Client A approached Marsh to help Client A obtain excess casualty insurance. In response to the ensuing quote request from Marsh, an ACE assistant vice president sent a fax to Greg Doherty, a Senior vice president in Marsh Global Broking Excess Casualty division, quoting an annual premium of $990,000 for the policy. Later that day, ACE revised its bid upward to $1,100,000. . . . An e-mail the next day from the assistant vice president to an ACE vice president of underwriting explained the revision as follows: 'Original quote $990,000. . . . We were more competitive than AIG in price and terms. [Marsh] requested we increase premium to $1.1M to be less competitive, so AIG does not [lose] the business. . . .'

9. In addition to participating in the bid-rigging scheme with Marsh, ACE engaged in a variety of other improper activities to ensure that brokers gave ACE preferential treatment in the placement of contracts. These activities included: (1) compensating brokers for business steered to ACE by agreeing to obtain ACE's own reinsurance through the same broker, and (2) sending fraudulent e-mails to a broker misrepresenting ACE's payments to help the broker meet its targeted performance goal.

12. To promote its relationship with a broker and receive more business, ACE also provided false documentation that would improve the appearance of the broker's year end results. . . .

13. ACE also used non-traditional and finite reinsurance to improperly enhance both its own earnings and those of its clients. In at least six separate deals, ACE created the false appearance of risk transfer, utilizing methods such as secret side agreements, to negate the wording of written contracts that did not accurately characterize the agreement reached between the parties. . .

a. In 1998, Hiscox Syndicates . . . . was seeking a reinsurance contract for a policy it had insured with a $45 million dollar limit on which $40.8 million of losses had already occurred. . . . . [T]he contract on its face would appear to have sufficient risk of loss to any auditor or regulator who examined the contract. Both ACE and Hiscox, however, believed that it was likely that the losses would reach at least the [policy limit]. Accordingly, the parties negotiated a secret side agreement providing that ACE would not have to pay any claims [until 4 years later]. . . . ACE inadvertently showed a copy of the side agreement to its outside auditing firm which, as a result, refused to authorize the deal as reinsurance. Rather than simply abandoning the deal, however, ACE falsely told its auditor that the transaction would proceed without the side agreement. In reality, ACE and Hiscox simply reached a verbal agreement for the same terms as the previous side agreement. The verbal side agreement was followed by the parties. . . .

c. ACE also used finite insurance to improperly shift losses among its subsidiaries, accounting for inter-company transfers as 'reinsurance.' [ACE Tempest Re and ACE Bermuda] entered into a sham transaction that appeared to involve Tempest Re paying $70 million for $120 million in reinsurance . . . . The substance of the deal as it appeared n paper, however, was overridden by a secret side agreement. . . . Despite the lack of risk, both parties accounted for the deal as 'reinsurance.'

14. Based on these allegations, the Attorneys General and the Superintendent allege that ACE unlawfully deceived policyholders, regulators and other authorities and shareholders by: (a) participating in scheme to steer business; (b) participating in rigging of bids for excess casualty insurance through Marsh; and (c) improperly using insurance transactions to bolster the quality, quantity and stability of their clients' and ACE's earnings.

21. Without admitting or denying any of the above allegations, ACE is entering into this Assurance and the Stipulation.

I spend the space here quoting these allegations directly because I believe that summarizing them does not capture their full impact. (Maybe the way to state this is that this is a story that writes itself.)

In the acknowledgement of its avarice, ACE agrees to set up a compensation fund to the policyholders who were overcharged for their insurance sold by ACE. Like the AIG fund before it, the ACE fund ($40 million) will be paid out to policyholders based on qualifying policyholders' percentage premium share of the overall premiums collected by ACE. Policyholders must tender a broad release (ee Exhibit 2 to the Assurance of Discontinuance and Voluntary Compliance)
as a condition of payment (a structure that I criticized in discussing the AIG settlement so I won't repeat those points here) and must do so on or before January 26, 2007. If policyholders don't drain the fund because some do not step forward, then the settling policyholders will receive further proportional payment from the fund by early 2008.

The settlement agreement does not prohibit contingent commissions evermore: first, their payment is barred for excess casualty through 2008; and second, the regulators allow for their return after 2008 if the insurers that do not pay contingent commissions henceforth find themselves at an undue competitive disadvantage. If ACE and other insurers that do not pay contingent commissions lose market share (below 60 percent), then ACE can notify the attorneys general it intends to commence paying such commissions and, if they don't object, ACE can start paying such kickbacks again.

Posted by Marc Mayerson at 11:37 PM | Comments (0) | TrackBack

ACE's "Plea Agreement" with Law Enforcement and Regulators

Law enforcement, insurance regulators, and insurance-industry participants continue to collide regarding "contingent commissions" and bid rigging that occurred in US insurance markets in the 1990s and '00s. One insurer, Liberty Mutual, says it would rather fight than switch, and it has announced it will defend litigation brought by state attorneys general and insurance regulators. Most other insurers have sought to put the matter behind them.

For example, ACE Ltd. recently reached accord with the New York Attorney General's office and New York's insurance commissioner regarding its conduct principally regarding the broker Marsh and ACE's effort to expand its excess general-liability insurance business. (Illinois and Connecticut signed on, too). In a document whose title is rich in irony -- an "Assurance of Discontinuance and Voluntary Compliance" -- ACE undertakes to set up a compensation fund and to conform its future business practices. Review of the "Assurance of Discontinuance" provides rich, indeed stunning, detail into how business was done at the expense of corporate policyholders in particular whose premiums were sufficiently large as to make bid-rigging, kickbacks, lying, and cheating lucrative for the participants -- both the individuals whose bonuses and power reflected their success in business and the companies that employed them that generated large premiums from the widespread conspiracy and corruption endemic to the top-tier of the insurance brokerage industry and the insurers that paid them.

ACE craftily negotiated the wording of the apology demanded by the state enforcement officials wherein the regulators affirm that ACE's standards of business conduct -- as did the law in its majesty -- prohibited the conduct that its employees engaged in (without the apology's quite coming to grips with that this was no mailroom operation but involved among other things the creation of fraudulent documentation by ACE's North American president and ACE's president of casualty risk).

ACE's two paragraph apology says:

As part of today's settlement with the Attorneys General and the Superintendent, ACE acknowledges that certain of its employees violated both acceptable business practices and ACE's own standards of conduct by engaging in behavior that included improper bidding practices and certain 'finite reinsurance' transactions. ACE apologizes for this conduct. It has reformed its business practices and is satisfied that this behavior will not be repeated.

In order to promote transparency and reduce the potential for conflicts of interest, ACE has supported legislation in the US to eliminate contingent compensation and through this agreement pledges to continue to do so.

ACE will be able to argue that the law enforcement officials have signed off on its internal reforms but also with the idea that only certain individuals were misguided as opposed to the company's (if you will) soul. ACE accomplished quite a lot for itself in the agreement, for which it and its general counsel should receive great kudos from its shareholders. Whether the citizens of this nation, insurance policyholders, insurance brokers, and competitors should respond as positively is perhaps a different matter.

But let's review the bidding, er, an unfortunate turn of phrase in this context, so shall we say, let's review how we got here as set forth in the Assurance of Discontinuance and Voluntary Compliance. Here are the findings agreed to by ACE (the numbered paragraphs quote the stipulated wrongdoing by ACE (with elisions indicated "[ ]" and the material in brackets "{ }" are my comments):

1. Since at least the mid-1990s ACE and other insurers have paid hundreds of millions of dollars in so-called 'contingent commissions' to the world's largest insurance brokers . . . as well as tens of thousands of smaller brokers and independent agents.

2. ACE entered into a number of contingent commission agreements . . . to pay compensation to [brokers] as a result of which they steered insurance policies to ACE to increase the volume of policies written by ACE . . . and to direct policies to ACE.

3. Under these agreements, when Marsh, for exampled, helped ACE retain its existing business at renewal time, ACE paid Marsh higher contingent commissions. . . . These contingent compensation payments were passed on to ACE's customers in the form of higher premiums. {Note: these higher prices would have floated up the market price for all carriers, so all policyholders were adversely affected.}

4. In 2002, ACE decided to greatly expand its position in the potentially lucrative excess casualty market . . . . Previously, ACE had maintained only a small presence in this market. . . . ACE [then] signed a lucrative placement service agreement [with Marsh]. In addition, ACE agreed to join other insurers and Marsh in rigging the process of bidding for insurance policies and actively deceiving clients. ACE participated in the scheme in two ways: (1) where ACE was the incumbent on the lead layer of business, Marsh generally sought to protect ACE's incumbency and gave ACE an unfair competitive advantage by seeking out non-competitive bids from other insurers; and (2) where ACE was not the incumbent on the lead layer, Ace agreed to provide quotes to protect the incumbent, with the understanding that ACE would receive business on an excess layer without competition, thereby allowing it to enter the market. These practices were to the detriment of the insured, whose best interests Marsh was supposed to be serving. {And at least when ACE was an "incumbent," ACE had a contractual duty of good faith and fair dealing to the insured.}

5. The details of the scheme were as follow: when ACE was the incumbent carrier on the lead layer, or was otherwise chosen by Marsh to win a client's excess layer business, Marsh set a target for ACE which included proposed premium and policy terms for ACE's bid. If ACE met this target, Marsh generally arranged for ACE to win the business, regardless of whether ACE, or any other insurance company, could have quoted better terms for the client.

6. In order to control the market, Marsh instructed other insurance companies to provide intentionally losing bids that were inferior to those provided by the incumbent or its chosen winner for the excess layer. . . . They were also known as "B Quotes." . . Once it has secured such quotes, Marsh would present them to clients [policyholders] as bids obtained through a competitive process. This pretense of competition was intended to, and did, give clients the impression that ACE's bid was the best available. It also had the effect of directing business to ACE, not at terms best for the client, but rather at terms advantageous to ACE.

8. The arrangement with Marsh allowed ACE to become a major competitor in the excess casualty market with phenomenal speed. In 2001, before entering the scheme, ACE received only $5 million in Excess Casualty premiums in the United States from Marsh [the largest broker]. This number increased in 2002 to $41 million, $98.6 million in 2003 and $93.5 million in 2004. These premiums placed ACE . . . as the third largest carrier of excess casualty with Marsh. . . . {Note that ACE's premium had an eight-fold increase once it started acting in cahoots to the policyholders' detriment and then doubled against the next year; in other words, its business exploded 1600% in two years!}

8a. In or about December of 2002, Client A approached Marsh to help Client A obtain excess casualty insurance. In response to the ensuing quote request from Marsh, an ACE assistant vice president sent a fax to Greg Doherty, a Senior vice president in Marsh Global Broking Excess Casualty division, quoting an annual premium of $990,000 for the policy. Later that day, ACE revised its bid upward to $1,100,000. . . . An e-mail the next day from the assistant vice president to an ACE vice president of underwriting explained the revision as follows: 'Original quote $990,000. . . . We were more competitive than AIG in price and terms. [Marsh] requested we increase premium to $1.1M to be less competitive, so AIG does not [lose] the business. . . .'

9. In addition to participating in the bid-rigging scheme with Marsh, ACE engaged in a variety of other improper activities to ensure that brokers gave ACE preferential treatment in the placement of contracts. These activities included: (1) compensating brokers for business steered to ACE by agreeing to obtain ACE's own reinsurance through the same broker, and (2) sending fraudulent e-mails to a broker misrepresenting ACE's payments to help the broker meet its targeted performance goal.

12. To promote its relationship with a broker and receive more business, ACE also provided false documentation that would improve the appearance of the broker's year end results. . . .

13. ACE also used non-traditional and finite reinsurance to improperly enhance both its own earnings and those of its clients. In at least six separate deals, ACE created the false appearance of risk transfer, utilizing methods such as secret side agreements, to negate the wording of written contracts that did not accurately characterize the agreement reached between the parties. . .

a. In 1998, Hiscox Syndicates . . . . was seeking a reinsurance contract for a policy it had insured with a $45 million dollar limit on which $40.8 million of losses had already occurred. . . . . [T]he contract on its face would appear to have sufficient risk of loss to any auditor or regulator who examined the contract. Both ACE and Hiscox, however, believed that it was likely that the losses would reach at least the [policy limit]. Accordingly, the parties negotiated a secret side agreement providing that ACE would not have to pay any claims [until 4 years later]. . . . ACE inadvertently showed a copy of the side agreement to its outside auditing firm which, as a result, refused to authorize the deal as reinsurance. Rather than simply abandoning the deal, however, ACE falsely told its auditor that the transaction would proceed without the side agreement. In reality, ACE and Hiscox simply reached a verbal agreement for the same terms as the previous side agreement. The verbal side agreement was followed by the parties. . . .

c. ACE also used finite insurance to improperly shift losses among its subsidiaries, accounting for inter-company transfers as 'reinsurance.' [ACE Tempest Re and ACE Bermuda] entered into a sham transaction that appeared to involve Tempest Re paying $70 million for $120 million in reinsurance . . . . The substance of the deal as it appeared n paper, however, was overridden by a secret side agreement. . . . Despite the lack of risk, both parties accounted for the deal as 'reinsurance.'

14. Based on these allegations, the Attorneys General and the Superintendent allege that ACE unlawfully deceived policyholders, regulators and other authorities and shareholders by: (a) participating in scheme to steer business; (b) participating in rigging of bids for excess casualty insurance through Marsh; and (c) improperly using insurance transactions to bolster the quality, quantity and stability of their clients' and ACE's earnings.

21. Without admitting or denying any of the above allegations, ACE is entering into this Assurance and the Stipulation.

I spend the space here quoting these allegations directly because I believe that summarizing them does not capture their full impact. (Maybe the way to state this is that this is a story that writes itself.)

In the acknowledgement of its avarice, ACE agrees to set up a compensation fund to the policyholders who were overcharged for their insurance sold by ACE. Like the AIG fund before it, the ACE fund ($40 million) will be paid out to policyholders based on qualifying policyholders' percentage premium share of the overall premiums collected by ACE. Policyholders must tender a broad release (ee Exhibit 2 to the Assurance of Discontinuance and Voluntary Compliance)
as a condition of payment (a structure that I criticized in discussing the AIG settlement so I won't repeat those points here) and must do so on or before January 26, 2007. If policyholders don't drain the fund because some do not step forward, then the settling policyholders will receive further proportional payment from the fund by early 2008.

The settlement agreement does not prohibit contingent commissions evermore: first, their payment is barred for excess casualty through 2008; and second, the regulators allow for their return after 2008 if the insurers that do not pay contingent commissions henceforth find themselves at an undue competitive disadvantage. If ACE and other insurers that do not pay contingent commissions lose market share (below 60 percent), then ACE can notify the attorneys general it intends to commence paying such commissions and, if they don't object, ACE can start paying such kickbacks again.

Posted by Marc Mayerson at 11:37 PM | Comments (0) | TrackBack

February 19, 2006

The Risks of the Seas and of Federal Courts Seizing -- or Being Seised of -- Jurisdiction

Insurance contracts typically are creatures of state law. As a result, unlike other kinds of complex litigation, insurance-coverage disputes often are litigated in state, not federal, court. There are exceptions to this where there is diversity jurisdiction, though in complex, multiparty coverage cases it is often unusual for there to be complete diversity between and among all the parties.

Insurance disputes can end up in federal court under admiralty jurisdiction, which provides a jurisdictional hook to get into federal court where the insurance is maritime in character – or what is sometimes referred to as “salty.” There are traditional forms of maritime insurance that are subject to federal jurisdiction, such as hull, protection and indemnity, and cargo. Other forms of coverage may have a relationship to maritime risks, and parties may fight over getting into federal court and having federal admiralty law apply.

Where policies are not expressly maritime – or are combination policies with some maritime and traditional non-maritime coverage parts – there is a fair amount of uncertainty as to whether a case should be in federal court. The Second Circuit confronted these issues in Folksamerica Reinsurance Co. v. Clean Water of New York Inc. (2d Cir. June 30, 2005), a case that may well have impact on whether disputes associated with hurricane Katrina will be subject to federal-court jurisdiction, even though the particular facts concerned a bodily injury claim brought by a worker cleaning a vessel.

Clean Water was one of several entities covered under the policy at issue, which contained both a “Shiprepairers Legal Liability” section and a Comprehensive General Liability section. This package policy had combined limits for both sections, and a single premium for the policy as a whole. It was the insurer that argued for admiralty jurisdiction, arguing that it had a stronger basis for a misrepresentation defense under the standards of federal admiralty law.

The Second Circuit’s opinion is a lengthy tour of the issues concerning the standards for divining which types of contracts are sufficiently salty as to qualify for admiralty jurisdiction. The court characterized the question before it as a seemingly “simple inquiry: Is the Policy a maritime contract giving rise to admiralty jurisdiction?” Slip op. at 5. The federal courts possess a unique lawmaking authority under Article III for admiralty matters, with the essential idea being that it is important to have a uniform law for maritime matters even in the absence of Congressional action. This power stems from the need to “protect maritime commerce,” (p. 6). In the case before it, the dispute concerned “an insurance claim based on a ship-maintenance-related injury sustained by a ship oil-tank cleaner aboard an ocean-going vessel in navigable waters.” (p. 8)

Nevertheless, the coverage had little to do with maritime issues: the question concerned ordinary CGL coverage. While a portion of the package policy unquestionably was maritime in character, the coverage under which the dispute arose was the general-liability section, and on this basis the district court found the policy to be divisible and that the nonmaritime aspects predominated (and thus there was no jurisdiction).

The Second Circuit reviewed recent Supreme Court jurisprudence that it believed undermined aspects the prior Second Circuit precedent. In general, “admiralty jurisdiction will exist over an insurance contract where the primary or principal objective of the contract is the establishment of ‘policies of marine insurance,’” (p. 12) but positing the issue this way obviously is circular.

Courts typically have looked at whether the maritime aspects predominate or whether they are incidental. The Second Circuit here found there was “nothing intrinsically ‘shore side’ about a CGL policy.” (p. 15). Instead, the keys are the terms of the insurance and the nature of the business insured, with the label or form of the policy not being determinative. (p. 16-17)

In the case at hand, the policy excluded typical or traditional maritime risks, though the court found ultimately an overlap in the coverage provided for premises/operations, products, completed-operations, pollution, and incidental-contract coverage. While concluding that the contracts coverage was not maritime, the Second Circuit found that the other portions were in the circumstances maritime in nature.

In Clean Water, the insured’s repair and maintenance operations on seagoing vessels implicated marine issues, and the insured’s replacement of parts on the ship in its maintenance activities similarly were maritime. As the court stated, “[t]he risk of injuries from, and damage to, a ship after defective or faulty repair or maintenance is a ‘maritime risk’ that includes the risk of ‘the loss of the ship or goods.’” (p. 22) While this coverage overlapped with P&I coverage, that confirmed rather than confuted admiralty jurisdiction.

In finding that disputes under the policy to be subject to admiralty jurisdiction, the court summarized:

In the circumstances of this case – a contract with two sections, one of which provides fully marine insurance [the shiprepairers legal liability], and the other specifically modified to cover maritime risks – we conclude that the Policy is marine in nature . . . [and that] the primary objective of the policy is to establish marine insurance. (p. 29)

The Second Circuit conceded that part of the policy unquestionably was nonmarine and that the policy did not fall within the traditional categories of marine insurance, yet it found there was a sufficient nexus to the risks of the sea as to merit the exercise of admiralty jurisdiction. The court’s lengthy opinion is not altogether satisfactory in guiding litigants on the question of how much of the policy needs to be maritime in nature and the required nexus between the dispute at issue and the maritime portions of the coverage for federal-court lawmaking to govern and for the federal court to be seised of jurisdiction under 28 USC § 1333(1).

Posted by Marc Mayerson at 3:34 PM | Comments (0) | TrackBack

The Risks of the Seas and of Federal Courts Seizing -- or Being Seised of -- Jurisdiction

Insurance contracts typically are creatures of state law. As a result, unlike other kinds of complex litigation, insurance-coverage disputes often are litigated in state, not federal, court. There are exceptions to this where there is diversity jurisdiction, though in complex, multiparty coverage cases it is often unusual for there to be complete diversity between and among all the parties.

Insurance disputes can end up in federal court under admiralty jurisdiction, which provides a jurisdictional hook to get into federal court where the insurance is maritime in character – or what is sometimes referred to as “salty.” There are traditional forms of maritime insurance that are subject to federal jurisdiction, such as hull, protection and indemnity, and cargo. Other forms of coverage may have a relationship to maritime risks, and parties may fight over getting into federal court and having federal admiralty law apply.

Where policies are not expressly maritime – or are combination policies with some maritime and traditional non-maritime coverage parts – there is a fair amount of uncertainty as to whether a case should be in federal court. The Second Circuit confronted these issues in Folksamerica Reinsurance Co. v. Clean Water of New York Inc. (2d Cir. June 30, 2005), a case that may well have impact on whether disputes associated with hurricane Katrina will be subject to federal-court jurisdiction, even though the particular facts concerned a bodily injury claim brought by a worker cleaning a vessel.

Clean Water was one of several entities covered under the policy at issue, which contained both a “Shiprepairers Legal Liability” section and a Comprehensive General Liability section. This package policy had combined limits for both sections, and a single premium for the policy as a whole. It was the insurer that argued for admiralty jurisdiction, arguing that it had a stronger basis for a misrepresentation defense under the standards of federal admiralty law.

The Second Circuit’s opinion is a lengthy tour of the issues concerning the standards for divining which types of contracts are sufficiently salty as to qualify for admiralty jurisdiction. The court characterized the question before it as a seemingly “simple inquiry: Is the Policy a maritime contract giving rise to admiralty jurisdiction?” Slip op. at 5. The federal courts possess a unique lawmaking authority under Article III for admiralty matters, with the essential idea being that it is imp