Main

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 (2) | 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 (3) | 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 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

February 9, 2006

AIG Settles NY State Charges and Buys Insurance Against Future Liability

AIG has settled New York state charges related to accounting, bid rigging, premium overcharges, and other improprieties. There are many components of this settlement, including admissions of wrongdoing by AIG. One component of interest to corporate policyholders is the $375 million fund being established for the benefit of policyholders that purchased or renewed AIG excess casualty policies between January 1, 2000, and September 30, 2004. Each policyholder within this class will receive a proportionate share of the settlement fund based on the ratio of the premiums it paid to the amount paid by all policyholders in the class.

Ostensibly, this $375 million dollar fund is to make up for the kickback schemes and price manipulation between AIG and the broker Marsh, whereby AIG companies were able to bid on policies with the pricing therefor "validated" through Marsh's solicitation of fake, inflated bids from other insurers. Because of this bid rigging, policyholders paid more in premiums than would have been the case in a competitive, fair market.

Policyholders ripped off in this fashion should be compensated, but Attorney General Spitzer (with all due respect and with due credit for unearthing this scandalous perfidy) has permitted AIG to require that policyholders sign a broad release in exchange for obtaining their share of the settlement pie.

Let's say my neighbor takes my rake and does not give it back. I then demand that he return what is mine, and he refuses to give me my rake unless I sign a release? When he gives me my rake, my damages may then stop, but the notion that AIG stole from policyholders in cahoots with the broker (by bribing the broker and corrupting it through the payment of kickbacks) and overcharged policyholders should result in AIG's returning the overcharged portion (sheepishly and with profuse apology). Once AIG returns the overcharge, then the policyholder may still have a damages claim, but as a practical matter the economics are such that such claims would not be pursued (for what other damages could be shown, other than in exceptional cases?).

Here, however, the "releasor" gives up "any and all claims . . . whatsoever, including known and unknown claims, now existing or hereafter arising, . . . . to the extent any such claims . . . relate to, in whole or in part, (i) any . . . allegations, . . . transactions, events, types of conduct . . . that are the subject of [the AG's] Complaint [or related cases]." Maybe there shouldn't be a release at all. At least, why shouldn't the release be more narrowly drawn to focus only on the amount of damages from the overcharge as opposed to any other damages the policyholder can show or other related misconduct perpetrated on the policyholder? Or, if say the policyholder was overcharged by 100 and the AIG settlement payment is for 60, maybe AIG should just hope the policyholder does not sue it for the remaining 40.

It is mystifying that the Attorney General of the State of New York would help shield AIG from paying full compensation to damaged policyholders. If the damages claims are so overwhelming for AIG -- a situation that is unfathomable -- then bankruptcy is the solution the law provides. If the Attorney General believes that allowing greater damages will harm shareholders who themselves were victimized by AIG's fraudulent accounting, then as between policyholders and shareholders the shareholders should pay the price, since they were ostensibly in the position to control management and the board of directors (or to sue directors and officers for mismanagement, waste, and malfeasance, as is their right).

AIG should establish the settlement fund, send checks to the wronged policyholders, and then hope that it is not sued further. The Attorney General is right to demand a settlement fund in exchange for his curtailing his enforcement powers, but it is puzzling for him to curtail the rights of policyholder victims.

For those interested, some of the source documents are available:

1. New York state Settlement agreement . Note that the Agreement is dated January 18 but is being announced only today, February 9, 2006.
2. SEC complaint
3. NY Attorney General Eliot Spitzer's Press release
4. SEC's press release
5. Prior Insurance Scrawl commentary on the AIG Mess.

Note that this $1.6 billion settlement does not resolve the claims against the individuals, including those against Mr. Maurice "Hank" Greenberg.

Posted by Marc Mayerson at 12:54 PM | Comments (2) | TrackBack

AIG Settles NY State Charges and Buys Insurance Against Future Liability

AIG has settled New York state charges related to accounting, bid rigging, premium overcharges, and other improprieties. There are many components of this settlement, including admissions of wrongdoing by AIG. One component of interest to corporate policyholders is the $375 million fund being established for the benefit of policyholders that purchased or renewed AIG excess casualty policies between January 1, 2000, and September 30, 2004. Each policyholder within this class will receive a proportionate share of the settlement fund based on the ratio of the premiums it paid to the amount paid by all policyholders in the class.

Ostensibly, this $375 million dollar fund is to make up for the kickback schemes and price manipulation between AIG and the broker Marsh, whereby AIG companies were able to bid on policies with the pricing therefor "validated" through Marsh's solicitation of fake, inflated bids from other insurers. Because of this bid rigging, policyholders paid more in premiums than would have been the case in a competitive, fair market.

Policyholders ripped off in this fashion should be compensated, but Attorney General Spitzer (with all due respect and with due credit for unearthing this scandalous perfidy) has permitted AIG to require that policyholders sign a broad release in exchange for obtaining their share of the settlement pie.

Let's say my neighbor takes my rake and does not give it back. I then demand that he return what is mine, and he refuses to give me my rake unless I sign a release? When he gives me my rake, my damages may then stop, but the notion that AIG stole from policyholders in cahoots with the broker (by bribing the broker and corrupting it through the payment of kickbacks) and overcharged policyholders should result in AIG's returning the overcharged portion (sheepishly and with profuse apology). Once AIG returns the overcharge, then the policyholder may still have a damages claim, but as a practical matter the economics are such that such claims would not be pursued (for what other damages could be shown, other than in exceptional cases?).

Here, however, the "releasor" gives up "any and all claims . . . whatsoever, including known and unknown claims, now existing or hereafter arising, . . . . to the extent any such claims . . . relate to, in whole or in part, (i) any . . . allegations, . . . transactions, events, types of conduct . . . that are the subject of [the AG's] Complaint [or related cases]." Maybe there shouldn't be a release at all. At least, why shouldn't the release be more narrowly drawn to focus only on the amount of damages from the overcharge as opposed to any other damages the policyholder can show or other related misconduct perpetrated on the policyholder? Or, if say the policyholder was overcharged by 100 and the AIG settlement payment is for 60, maybe AIG should just hope the policyholder does not sue it for the remaining 40.

It is mystifying that the Attorney General of the State of New York would help shield AIG from paying full compensation to damaged policyholders. If the damages claims are so overwhelming for AIG -- a situation that is unfathomable -- then bankruptcy is the solution the law provides. If the Attorney General believes that allowing greater damages will harm shareholders who themselves were victimized by AIG's fraudulent accounting, then as between policyholders and shareholders the shareholders should pay the price, since they were ostensibly in the position to control management and the board of directors (or to sue directors and officers for mismanagement, waste, and malfeasance, as is their right).

AIG should establish the settlement fund, send checks to the wronged policyholders, and then hope that it is not sued further. The Attorney General is right to demand a settlement fund in exchange for his curtailing his enforcement powers, but it is puzzling for him to curtail the rights of policyholder victims.

For those interested, some of the source documents are available:

1. New York state Settlement agreement . Note that the Agreement is dated January 18 but is being announced only today, February 9, 2006.
2. SEC complaint
3. NY Attorney General Eliot Spitzer's Press release
4. SEC's press release
5. Prior Insurance Scrawl commentary on the AIG Mess.

Note that this $1.6 billion settlement does not resolve the claims against the individuals, including those against Mr. Maurice "Hank" Greenberg.

Posted by Marc Mayerson at 12:54 PM | Comments (2) | TrackBack

January 30, 2006

With Friends (Clients) Like These . . . .

Lawyers working for insurance companies have been exposed to significant pressures from their clients in recent years. While cost-containment billing guidelines and other measures have created significant tensions in those relationships, even the most creative, out-of-the-box management consultant for insurers is unlikely to have dreamt up the facts of a recent Mississippi Supreme Court case.

The Mississippi court nicely summarized the facts giving rise to the contretemps under examination:

"In this case, an insurance company denied coverage to an employee of one of its insureds. When the employee threatened a bad faith lawsuit, the insurance company employed a law firm which advised the insurer that the employee indeed had no coverage. The employee filed a bad faith lawsuit against the insurance company, and the trial judge, believing the employee was covered granted summary judgment to the employee. This unexpected event so shocked the insurance company that it hired new attorneys and settled the bad faith suit by paying the employee $500,000 and assigning to him its potential legal malpractice claim against its former lawyers who advised against coverage. Armed with the assignment, the employee sued the law firm and obtained a judgment."

Baker Donelson Bearman & Caldwell v. Muirhead (Miss. Jan. 26, 2006) at 1 (emphasis added, footnote omitted). Amazingly, this decision was the capper to a decade's worth of litigation involving an employee battery on a third party that raised questions of respondeat superior, the employee's status at the time of the battery as an insured, and expected/intended injury. The poor Baker Donelson firm correctly assessed that under Mississippi law there was no coverage under the insurance policy issued by its client Great River Insurance Company, but found its own client (advised by another firm) selling it out to the opposition by paying cash and assigning the client's (potential) malpractice claim to the plaintiff.

The lawfirm argued that it had not committed malpractice and that public policy barred such bizarre assignments of malpractice claims to the successful opponent in prior litigation (who was the plaintiff in the second litigation against Great River and the defendant in the first litigation with the tort plaintiff). Finding that Baker Donelson had properly advised its client as to the lack of coverage, the Mississippi Supreme Court revised the jury verdict against the lawyers, a verdict comprising $594,000 in compensatory damages (essentially the insurer's payment to the employee (the putative insured) in settlement of the second case), $750,000 in punitive damages, and $300,000 in attorneys' fees. In other words, the plaintiff -- who was the original, alleged insured and tortfeasor -- was (i) made whole for supposedly beating the third party while at work, (ii) paid for that battery claim through the settlement of the bad-faith claim he brought against his (putative) insurance company, (iii) awarded another almost $600,000 being the value of the insurance-company's own "malpractice" claim against the lawyers advising there was no coverage for the original battery claim (advice allegedly so egregiously bad to merit punitive damages too), and (iv)received another $1.15 million in punitives and attorneys' fees. The Mississippi Supreme Court proved why we have appellate courts, thus bringing a welcome end to this pettifoggery.

Posted by Marc Mayerson at 11:37 AM | Comments (5) | TrackBack

With Friends (Clients) Like These . . . .

Lawyers working for insurance companies have been exposed to significant pressures from their clients in recent years. While cost-containment billing guidelines and other measures have created significant tensions in those relationships, even the most creative, out-of-the-box management consultant for insurers is unlikely to have dreamt up the facts of a recent Mississippi Supreme Court case.

The Mississippi court nicely summarized the facts giving rise to the contretemps under examination:

"In this case, an insurance company denied coverage to an employee of one of its insureds. When the employee threatened a bad faith lawsuit, the insurance company employed a law firm which advised the insurer that the employee indeed had no coverage. The employee filed a bad faith lawsuit against the insurance company, and the trial judge, believing the employee was covered granted summary judgment to the employee. This unexpected event so shocked the insurance company that it hired new attorneys and settled the bad faith suit by paying the employee $500,000 and assigning to him its potential legal malpractice claim against its former lawyers who advised against coverage. Armed with the assignment, the employee sued the law firm and obtained a judgment."

Baker Donelson Bearman & Caldwell v. Muirhead (Miss. Jan. 26, 2006) at 1 (emphasis added, footnote omitted). Amazingly, this decision was the capper to a decade's worth of litigation involving an employee battery on a third party that raised questions of respondeat superior, the employee's status at the time of the battery as an insured, and expected/intended injury. The poor Baker Donelson firm correctly assessed that under Mississippi law there was no coverage under the insurance policy issued by its client Great River Insurance Company, but found its own client (advised by another firm) selling it out to the opposition by paying cash and assigning the client's (potential) malpractice claim to the plaintiff.

The lawfirm argued that it had not committed malpractice and that public policy barred such bizarre assignments of malpractice claims to the successful opponent in prior litigation (who was the plaintiff in the second litigation against Great River and the defendant in the first litigation with the tort plaintiff). Finding that Baker Donelson had properly advised its client as to the lack of coverage, the Mississippi Supreme Court revised the jury verdict against the lawyers, a verdict comprising $594,000 in compensatory damages (essentially the insurer's payment to the employee (the putative insured) in settlement of the second case), $750,000 in punitive damages, and $300,000 in attorneys' fees. In other words, the plaintiff -- who was the original, alleged insured and tortfeasor -- was (i) made whole for supposedly beating the third party while at work, (ii) paid for that battery claim through the settlement of the bad-faith claim he brought against his (putative) insurance company, (iii) awarded another almost $600,000 being the value of the insurance-company's own "malpractice" claim against the lawyers advising there was no coverage for the original battery claim (advice allegedly so egregiously bad to merit punitive damages too), and (iv)received another $1.15 million in punitives and attorneys' fees. The Mississippi Supreme Court proved why we have appellate courts, thus bringing a welcome end to this pettifoggery.

Posted by Marc Mayerson at 11:37 AM | Comments (5) | TrackBack

January 28, 2006

Medical-Malpractice Liability and Insurance Myths -- and Reality

Nearly 100,000 killed last year, the same rate as in the ongoing, repellent genocide in Darfur. But this figure is the estimate of the number of Americans who die annually due to medical-malpractice errors.

That’s one of the key points emphasized in the trenchant new book by Professor Tom Baker, The Medical Malpractice Myth (2005). Baker’s slim, accessible, engaging, and well-written volume argues that the prevailing myths concerning medical malpractice and doctors’ liability-insurance premiums are the stuff of urban legend.

One of the key contributions of the book is to assemble in one handy place the current literature about the amount of medical malpractice, the number of med-mal claims, the settlement/judgment costs and transaction costs of these cases, insurance premiums, and ups and downs in insurance markets. Baker argues convincingly that there is an epidemic of medical practice in the United States, nearly 100,000 preventable deaths annually, with only a fraction of claims being pursued (and most nonmeritorious claims are resolved before trial and often are dropped). The number of deaths annually exceeds automobile-related and workplace-related deaths combined, yet the medical-liability insurance premiums in toto are a small fraction of the premiums collected for auto and worker’s comp.

Baker approaches his study with an open mind and transparently – he shows the reader the evidence, the bases for his interpretation of the evidence, and honestly identifies where the data are uncertain, limited or unclear. The book is quite refreshing in this regard, given the jeremiads one usually sees in these discussions. Baker assembles the evidence that the pricing spikes we see in med-mal insurance are straightforward reflections of the insurance cycle and are not driven (much) by the tort-litigation side. As he writes, “the two most recent medical liability insurance crises did not result from sudden or dramatic increases in medical malpractice settlements or jury verdicts.” (p. 53-54) Baker’s analysis of the mechanisms of insurance markets and the insurance cycles is consistent with the analyses of Warren Buffett and Richard Stewart, even though most people seem to uncritically adopt the myth of actuarial pricing of insurance.

The Medical Malpractice Myth discusses the evidence of the impact on the supply of doctors and the costs of defensive medicine, arguing ultimately that med-mal claims have little effect. Baker takes the normative position that medical-malpractice claims are good for the system and that the legal system adequately sifts out nonmeritorious claims. Further, Baker tries to gauge the overall costs of the tort system, arguing ultimately that med-mal victims are undercompensated (especially bearing in mind the large majority of potential plaintiffs that do not seek recompense).

Baker further offers his suggestions for reforming the liability, compensation, and insurance systems for medically caused injury. Baker’s objective is to get the conversation started. The book is a plea – but not for his proposed reforms per se but rather for an evidence-based discussion of the issues.

Professor Baker bravely went into hostile territory recently at a forum sponsored by the American Enterprise Institute to discuss his book. The forum is available online (including video), and Baker’s AEI presentation, the critiques of the discussants, and Baker's rebuttal provide a good overview of the facts, issues, and areas for further research and discussion. I endorse the observation of Professor Martin Grace, one of the AEI “discussants” and a fellow blogger, that it would be profitable to understand better the impact of physician-owned mutual insurance companies on the med-mal insurance market and loss-prevention (i.e., malpractice-injury avoidance) efforts.

Much of Baker’s argument is confirmed by the Insurance Information Institute’s most recent issue update on medical malpractice (December 2005), which to its credit collects much recent data and leavens it only slightly with its political perspective. In what to me seems as ironic understatement, the III cites a recent Missouri study that “found that the leading grounds for malpractice awards in the state in 2004 were medical errors in diagnoses and surgery.” Like Baker, the III cites a study that only one in eight people who suffered from medical-malpractice injury filed a claim. The III further echoes Bush Administration experts who underscored the need to identify and discipline incompetent doctors and encourages risk-management by doctors and hospitals, including requiring doctors to study medical-malpractice prevention and mandating reporting of medical errors (also strongly endorsed by Professor Baker). Furthermore, the III cites a study by an insurance-consulting firm that predicts that the medical-malpractice insurance sector will be profitable in 2006; in 2004 the combined ratio for med-mal insurers was 109.2, meaning that the industry needs an investment return of 9.2 percent on the premiums collected in order to turn a profit. Baker argues that the data show that insurers rarely pay claims that do not substantially indicate malpractice and reports that claims take roughly seven years from premium collection to claim payment, thus giving insurers the opportunity to make their 9 percent investment return (total, not annualized) to be profitable.

It's easy for me to recommend this book, especially to policymakers and their staffs, stakeholders including doctors and their professional organizations, as well as to lawyers, insurers, and laity interested at all in the topic. The Medical Malpractice Myth is iconoclastic but calm and dispassionate in tone. It is informative, easy to read, and short (180 pages). It’s not meant to the be the last word on the subject, but rather aims to start a new conversation, one in which you’ll be equipped to participate once you read Baker's cogent analysis.

Posted by Marc Mayerson at 12:12 PM | Comments (6) | TrackBack

Medical-Malpractice Liability and Insurance Myths -- and Reality

Nearly 100,000 killed last year, the same rate as in the ongoing, repellent genocide in Darfur. But this figure is the estimate of the number of Americans who die annually due to medical-malpractice errors.

That’s one of the key points emphasized in the trenchant new book by Professor Tom Baker, The Medical Malpractice Myth (2005). Baker’s slim, accessible, engaging, and well-written volume argues that the prevailing myths concerning medical malpractice and doctors’ liability-insurance premiums are the stuff of urban legend.

One of the key contributions of the book is to assemble in one handy place the current literature about the amount of medical malpractice, the number of med-mal claims, the settlement/judgment costs and transaction costs of these cases, insurance premiums, and ups and downs in insurance markets. Baker argues convincingly that there is an epidemic of medical practice in the United States, nearly 100,000 preventable deaths annually, with only a fraction of claims being pursued (and most nonmeritorious claims are resolved before trial and often are dropped). The number of deaths annually exceeds automobile-related and workplace-related deaths combined, yet the medical-liability insurance premiums in toto are a small fraction of the premiums collected for auto and worker’s comp.

Baker approaches his study with an open mind and transparently – he shows the reader the evidence, the bases for his interpretation of the evidence, and honestly identifies where the data are uncertain, limited or unclear. The book is quite refreshing in this regard, given the jeremiads one usually sees in these discussions. Baker assembles the evidence that the pricing spikes we see in med-mal insurance are straightforward reflections of the insurance cycle and are not driven (much) by the tort-litigation side. As he writes, “the two most recent medical liability insurance crises did not result from sudden or dramatic increases in medical malpractice settlements or jury verdicts.” (p. 53-54) Baker’s analysis of the mechanisms of insurance markets and the insurance cycles is consistent with the analyses of Warren Buffett and Richard Stewart, even though most people seem to uncritically adopt the myth of actuarial pricing of insurance.

The Medical Malpractice Myth discusses the evidence of the impact on the supply of doctors and the costs of defensive medicine, arguing ultimately that med-mal claims have little effect. Baker takes the normative position that medical-malpractice claims are good for the system and that the legal system adequately sifts out nonmeritorious claims. Further, Baker tries to gauge the overall costs of the tort system, arguing ultimately that med-mal victims are undercompensated (especially bearing in mind the large majority of potential plaintiffs that do not seek recompense).

Baker further offers his suggestions for reforming the liability, compensation, and insurance systems for medically caused injury. Baker’s objective is to get the conversation started. The book is a plea – but not for his proposed reforms per se but rather for an evidence-based discussion of the issues.

Professor Baker bravely went into hostile territory recently at a forum sponsored by the American Enterprise Institute to discuss his book. The forum is available online (including video), and Baker’s AEI presentation, the critiques of the discussants, and Baker's rebuttal provide a good overview of the facts, issues, and areas for further research and discussion. I endorse the observation of Professor Martin Grace, one of the AEI “discussants” and a fellow blogger, that it would be profitable to understand better the impact of physician-owned mutual insurance companies on the med-mal insurance market and loss-prevention (i.e., malpractice-injury avoidance) efforts.

Much of Baker’s argument is confirmed by the Insurance Information Institute’s most recent issue update on medical malpractice (December 2005), which to its credit collects much recent data and leavens it only slightly with its political perspective. In what to me seems as ironic understatement, the III cites a recent Missouri study that “found that the leading grounds for malpractice awards in the state in 2004 were medical errors in diagnoses and surgery.” Like Baker, the III cites a study that only one in eight people who suffered from medical-malpractice injury filed a claim. The III further echoes Bush Administration experts who underscored the need to identify and discipline incompetent doctors and encourages risk-management by doctors and hospitals, including requiring doctors to study medical-malpractice prevention and mandating reporting of medical errors (also strongly endorsed by Professor Baker). Furthermore, the III cites a study by an insurance-consulting firm that predicts that the medical-malpractice insurance sector will be profitable in 2006; in 2004 the combined ratio for med-mal insurers was 109.2, meaning that the industry needs an investment return of 9.2 percent on the premiums collected in order to turn a profit. Baker argues that the data show that insurers rarely pay claims that do not substantially indicate malpractice and reports that claims take roughly seven years from premium collection to claim payment, thus giving insurers the opportunity to make their 9 percent investment return (total, not annualized) to be profitable.

It's easy for me to recommend this book, especially to policymakers and their staffs, stakeholders including doctors and their professional organizations, as well as to lawyers, insurers, and laity interested at all in the topic. The Medical Malpractice Myth is iconoclastic but calm and dispassionate in tone. It is informative, easy to read, and short (180 pages). It’s not meant to the be the last word on the subject, but rather aims to start a new conversation, one in which you’ll be equipped to participate once you read Baker's cogent analysis.

Posted by Marc Mayerson at 12:12 PM | Comments (8) | TrackBack

December 11, 2005

A Slip ‘Twixt the Cup and the Lip: Captive Insurers and Reinsurance Recovery

The price of an insurance policy naturally includes a projection of future payouts under the policy plus a profit margin for the insurer. Rather than giving profit to an insurance company, sometimes corporate policyholders will elect to try to capture that profit by creating a “captive” insurance company. In this way, when the premium is paid to the captive insurance company, the “profit” component is retained on the corporation’s overall balance sheet. There are other reasons to establish a captive: a sense of greater control over the loss-adjustment process; greater certainty of performance; and opportunities for certain tax advantages (not so much from the deductibility of premium expenses as compared to the accrual of reserves but rather from obtaining investment income in a tax-advantaged manner on assets held by (or stuffed into) foreign-domiciled captives).

It is uncommon to find that a company only has a captive program: typically, there is commercial insurance market involvement through excess-layer insurance above the captive or through reinsurance of the captive. (Sometimes the reinsurance relationship is the converse where the insured has commercial insurance that is reinsured into the captive.) When a corporation taps reinsurance markets, what it wants most assuredly is the seamless flow of loss and coverage through the captive to the reinsurer once the retention is exceeded. In this regard, a recent High Court decision in London is important to note, because the decision creates a gap in this flow stemming from of all things a difference in “choice of law” as between the captive-issued policy and the reinsurance policy backing it.

In CGU Int’l Ins. PLC v. AstraZeneca Ins. Co. Ltd., [2005] EWHC 2755 (Dec. 1, 2005), Mr. Justice Cresswell held that a captive insurer might not obtain recovery due to a disjunction between the interpretation of the identical words between English and US state law. In CGU, the captive faced a loss from an affiliate; that affiliate submitted a claim for coverage that the captive evaluated at arms’ length and paid. The reinsurers had been apprised of the claim and the possibility of settlement in advance, and they did not dispute that all procedural duties pertaining to the perfecting of the reinsurance claim had been satisfied by the captive/cedent.

It was common ground as between the captive and its reinsurers that, had the claim not been paid, the affiliate would have sued the captive for coverage in state court in the US and that the US court, properly applying its own choice-of-law rules, would have applied US state law to the loss in question. Faced with that inevitability, the captive paid the claim guided by that state’s law and turned to its reinsurers for indemnification.

The reinsurers denied recovery for most of the claim by advancing the curious argument that assuming ex hypothesi that the captive’s payment was validly compelled with respect to the US state law the scope of coverage under English law for the same loss was narrower. In other words, the reinsurers argued that one must take the identical words and identical loss and run them through English law, even though the underlying loss would have been litigated and resolved under US law.

The CGU court construed the placing slip – providing coverage “as original” – to mean, as a practical matter, that one takes the words from the original contract being reinsured and retypes them into a new document containing the identical words. Instead of confirming an intention that there be no gap between the terms afforded under the original policy and the reinsurance, “as original” in fact will create a disjunction to the extent the original policy will be construed under a different set of laws from those applying to the retyped policy. As the court states: “Where the reinsurance incorporates the terms of the underlying, the coverage terms of the underlying insurance are treated as incorporated in a contract which is expressly governed by English law. That incorporation took place at the outset, and the coverage terms bore, from the outset, the meaning attached to them applying English rules of construction.” Id. at [126].

In CGU, therefore, the result of the court’s ruling is to put the captive in the following position: having a full obligation to perform vis-à-vis its own insured guided by the applicable US state’s law and having its reinsurance recovery decided by a different jurisdiction’s law with a more parsimonious view of the coverage afforded under the identical words. While recognizing implicitly that the captive’s payment of its insured was compelled (and so was not an ex gratia payment or voluntary), the High Court ruled that unacceptable commercial uncertainty otherwise would result were the reinsurers bound to pay according to the legal obligations of the cedent/captive. Id. at [118], [128].

One lesson of the CGU case is that, when placing reinsurance in the London market for a worldwide program, the company needs to be prepared to incur a substantial additional retention stemming from the disjunction in the coverage afforded under the local law governing a dispute with one of the captive’s insureds and the same words as construed with an English-law gloss. Placing coverage “as original” will not ensure that coverage flows seamlessly – to the contrary, “as original” will create a disjunction in a worldwide policy.

Accordingly, captives placing reinsurance through the London market in particular need to make express the hitherto assumed expectation that the reinsurance will be back-to-back to the captive’s coverage. The captive needs either (i) to issue a policy with the same choice of law (and preferably choice of forum) as that governing its reinsurance or (ii) to craft language in its reinsurance contracts that compels the reinsurers to follow the coverage as it will be construed under the law governing a claim under the captive-issued policy.

Posted by Marc Mayerson at 6:05 PM | Comments (1) | TrackBack

A Slip ‘Twixt the Cup and the Lip: Captive Insurers and Reinsurance Recovery

The price of an insurance policy naturally includes a projection of future payouts under the policy plus a profit margin for the insurer. Rather than giving profit to an insurance company, sometimes corporate policyholders will elect to try to capture that profit by creating a “captive” insurance company. In this way, when the premium is paid to the captive insurance company, the “profit” component is retained on the corporation’s overall balance sheet. There are other reasons to establish a captive: a sense of greater control over the loss-adjustment process; greater certainty of performance; and opportunities for certain tax advantages (not so much from the deductibility of premium expenses as compared to the accrual of reserves but rather from obtaining investment income in a tax-advantaged manner on assets held by (or stuffed into) foreign-domiciled captives).

It is uncommon to find that a company only has a captive program: typically, there is commercial insurance market involvement through excess-layer insurance above the captive or through reinsurance of the captive. (Sometimes the reinsurance relationship is the converse where the insured has commercial insurance that is reinsured into the captive.) When a corporation taps reinsurance markets, what it wants most assuredly is the seamless flow of loss and coverage through the captive to the reinsurer once the retention is exceeded. In this regard, a recent High Court decision in London is important to note, because the decision creates a gap in this flow stemming from of all things a difference in “choice of law” as between the captive-issued policy and the reinsurance policy backing it.

In CGU Int’l Ins. PLC v. AstraZeneca Ins. Co. Ltd., [2005] EWHC 2755 (Dec. 1, 2005), Mr. Justice Cresswell held that a captive insurer might not obtain recovery due to a disjunction between the interpretation of the identical words between English and US state law. In CGU, the captive faced a loss from an affiliate; that affiliate submitted a claim for coverage that the captive evaluated at arms’ length and paid. The reinsurers had been apprised of the claim and the possibility of settlement in advance, and they did not dispute that all procedural duties pertaining to the perfecting of the reinsurance claim had been satisfied by the captive/cedent.

It was common ground as between the captive and its reinsurers that, had the claim not been paid, the affiliate would have sued the captive for coverage in state court in the US and that the US court, properly applying its own choice-of-law rules, would have applied US state law to the loss in question. Faced with that inevitability, the captive paid the claim guided by that state’s law and turned to its reinsurers for indemnification.

The reinsurers denied recovery for most of the claim by advancing the curious argument that assuming ex hypothesi that the captive’s payment was validly compelled with respect to the US state law the scope of coverage under English law for the same loss was narrower. In other words, the reinsurers argued that one must take the identical words and identical loss and run them through English law, even though the underlying loss would have been litigated and resolved under US law.

The CGU court construed the placing slip – providing coverage “as original” – to mean, as a practical matter, that one takes the words from the original contract being reinsured and retypes them into a new document containing the identical words. Instead of confirming an intention that there be no gap between the terms afforded under the original policy and the reinsurance, “as original” in fact will create a disjunction to the extent the original policy will be construed under a different set of laws from those applying to the retyped policy. As the court states: “Where the reinsurance incorporates the terms of the underlying, the coverage terms of the underlying insurance are treated as incorporated in a contract which is expressly governed by English law. That incorporation took place at the outset, and the coverage terms bore, from the outset, the meaning attached to them applying English rules of construction.” Id. at [126].

In CGU, therefore, the result of the court’s ruling is to put the captive in the following position: having a full obligation to perform vis-à-vis its own insured guided by the applicable US state’s law and having its reinsurance recovery decided by a different jurisdiction’s law with a more parsimonious view of the coverage afforded under the identical words. While recognizing implicitly that the captive’s payment of its insured was compelled (and so was not an ex gratia payment or voluntary), the High Court ruled that unacceptable commercial uncertainty otherwise would result were the reinsurers bound to pay according to the legal obligations of the cedent/captive. Id. at [118], [128].

One lesson of the CGU case is that, when placing reinsurance in the London market for a worldwide program, the company needs to be prepared to incur a substantial additional retention stemming from the disjunction in the coverage afforded under the local law governing a dispute with one of the captive’s insureds and the same words as construed with an English-law gloss. Placing coverage “as original” will not ensure that coverage flows seamlessly – to the contrary, “as original” will create a disjunction in a worldwide policy.

Accordingly, captives placing reinsurance through the London market in particular need to make express the hitherto assumed expectation that the reinsurance will be back-to-back to the captive’s coverage. The captive needs either (i) to issue a policy with the same choice of law (and preferably choice of forum) as that governing its reinsurance or (ii) to craft language in its reinsurance contracts that compels the reinsurers to follow the coverage as it will be construed under the law governing a claim under the captive-issued policy.

Posted by Marc Mayerson at 6:05 PM | Comments (1) | TrackBack

November 21, 2005

More Alchemy than Chemistry: Corporate Purchases of Liability Insurance 2005

Purchasing the “right” amount of coverage is not possible. There is a tradeoff among the availability of coverage, the price of coverage, the company’s other financial resources, projections of how much a single claim and accumulation of claims might cost, and a number of other factors. Learning what one’s peers are doing can be helpful, and the broker Marsh annually publishes a study, most recently “Limits of Liability 2005: Balancing Price Against Need,” that reports on insurance-purchasing trends of businesses.

Among the nearly 3000 companies surveyed, the average amount of liability limits purchased was $75 million. According to Marsh, one significant factor that correlates to the amount of limits purchased is whether the insured previously has suffered a $5+ million loss. For this group, the average limit purchased was $199 million compared to $64 million for companies that haven’t experienced such a loss within the last five years. (p. 5)

Companies with revenues of less than $200 million purchased on average $33 million in limits; companies with more than $10 billion revenues purchased $262 million (p. 16). By industry sector, the chemical and pharmaceutical industry purchased $112 million in limits; transportation $90 million; rubber/plastic $46 million; construction $46 million; and health care $37 million. The attachment point for excess coverage purchased by companies with $1 billion of sales averaged $3.7 million (that is, below that figure companies have primary coverage and retentions/deductibles).

Another way to look at liability limits is to gauge the cost of insurance as a percentage of revenue. Chemical and pharmaceutical companies paid 94¢ per $1000 of revenue (which ignores the quite substantial availability problem in this sector for product-liability insurance), whereas food producers pay 22¢, and retailers 15¢. In contrast, health-care companies paid $1.47, transportation companies $1.44, and construction companies $2.37. In 2005, the average cost per $1000 of revenue was 39¢. Flipping the question around, the cost of $1 million of coverage was $22,852 for chemical and pharmaceutical companies, $29,895 for construction companies, $52,004 for health-care companies, and $5,684 for printing and publishing companies. In 2005, the average cost of $1 million of coverage was $13,222 (p. 17, 21).

Based on Marsh’s analysis, a lot of action is occurring on the motor-vehicle side, with jury verdicts increasing substantially (of the top 100 verdicts in 2004 according to the National Law Journal, 14 were motor-vehicle incidents, up from 4 the year before). Vehicular liability accounted for 5 percent of all liability cases in which $1 million or more was awarded, and 23 percent of cases where punitive damages were awarded. (p. 6) Companies with larger number of vehicles purchased higher (aggregate) policy limits, with companies having more than 5000 vehicles purchasing (on average) $309 million in limits at the cost of $23,093 per million and companies having 100 or fewer vehicles maintaining $47 million in limits at the cost of $7396 per million. (p. 7)

For all tort claims, a wrongful-death verdict involving an adult male produced damages on average (in 2003) of $3,628,830 and with a woman, $2,711,639. (p.8)

This information all is descriptive, not prescriptive; these data do not answer the question what a particular company should do – how much coverage and what type it should purchase. Companies have different appetites for risk and different sensitivities to price changes. Some companies value the reputation of the insurer on the claims side at the expense of the cheapest price today. Some companies value longstanding relationships with their carriers; others view insurance as a pure commodity to be rebid. The long-tail on claims can make the long-term financial strength of the insurer an important factor, and the cheapest carrier today may not still be around when the bill comes due to pay. As Marsh emphasizes, striking a balance “between the cost of excess liability insurance and their specific coverage needs” involves a fair degree of “art” and not just science. (p. 3).

The other aspect that Marsh’s study cannot track is the suitability of coverage to the loss exposures. When companies ask me as a policyholder lawyer to review the terms of a policy or policies they are considering purchasing, I often see that the language is not well tailored to their needs. For me, the key question is not coopering up new language necessarily but ensuring that management understands what types of risks it faces that the policies might not cover. Certainty is what is key, and knowing what is and is not covered allows a company to plan – and for managers to be accountable. It’s easy to buy a policy with a lot of limits – even for a cheap price. The trick is to purchase policies both at reasonable price points and that are more likely to perform when the company needs its coverage most.

Posted by Marc Mayerson at 6:52 PM | Comments (1) | TrackBack

More Alchemy than Chemistry: Corporate Purchases of Liability Insurance 2005

Purchasing the “right” amount of coverage is not possible. There is a tradeoff among the availability of coverage, the price of coverage, the company’s other financial resources, projections of how much a single claim and accumulation of claims might cost, and a number of other factors. Learning what one’s peers are doing can be helpful, and the broker Marsh annually publishes a study, most recently “Limits of Liability 2005: Balancing Price Against Need,” that reports on insurance-purchasing trends of businesses.

Among the nearly 3000 companies surveyed, the average amount of liability limits purchased was $75 million. According to Marsh, one significant factor that correlates to the amount of limits purchased is whether the insured previously has suffered a $5+ million loss. For this group, the average limit purchased was $199 million compared to $64 million for companies that haven’t experienced such a loss within the last five years. (p. 5)

Companies with revenues of less than $200 million purchased on average $33 million in limits; companies with more than $10 billion revenues purchased $262 million (p. 16). By industry sector, the chemical and pharmaceutical industry purchased $112 million in limits; transportation $90 million; rubber/plastic $46 million; construction $46 million; and health care $37 million. The attachment point for excess coverage purchased by companies with $1 billion of sales averaged $3.7 million (that is, below that figure companies have primary coverage and retentions/deductibles).

Another way to look at liability limits is to gauge the cost of insurance as a percentage of revenue. Chemical and pharmaceutical companies paid 94¢ per $1000 of revenue (which ignores the quite substantial availability problem in this sector for product-liability insurance), whereas food producers pay 22¢, and retailers 15¢. In contrast, health-care companies paid $1.47, transportation companies $1.44, and construction companies $2.37. In 2005, the average cost per $1000 of revenue was 39¢. Flipping the question around, the cost of $1 million of coverage was $22,852 for chemical and pharmaceutical companies, $29,895 for construction companies, $52,004 for health-care companies, and $5,684 for printing and publishing companies. In 2005, the average cost of $1 million of coverage was $13,222 (p. 17, 21).

Based on Marsh’s analysis, a lot of action is occurring on the motor-vehicle side, with jury verdicts increasing substantially (of the top 100 verdicts in 2004 according to the National Law Journal, 14 were motor-vehicle incidents, up from 4 the year before). Vehicular liability accounted for 5 percent of all liability cases in which $1 million or more was awarded, and 23 percent of cases where punitive damages were awarded. (p. 6) Companies with larger number of vehicles purchased higher (aggregate) policy limits, with companies having more than 5000 vehicles purchasing (on average) $309 million in limits at the cost of $23,093 per million and companies having 100 or fewer vehicles maintaining $47 million in limits at the cost of $7396 per million. (p. 7)

For all tort claims, a wrongful-death verdict involving an adult male produced damages on average (in 2003) of $3,628,830 and with a woman, $2,711,639. (p.8)

This information all is descriptive, not prescriptive; these data do not answer the question what a particular company should do – how much coverage and what type it should purchase. Companies have different appetites for risk and different sensitivities to price changes. Some companies value the reputation of the insurer on the claims side at the expense of the cheapest price today. Some companies value longstanding relationships with their carriers; others view insurance as a pure commodity to be rebid. The long-tail on claims can make the long-term financial strength of the insurer an important factor, and the cheapest carrier today may not still be around when the bill comes due to pay. As Marsh emphasizes, striking a balance “between the cost of excess liability insurance and their specific coverage needs” involves a fair degree of “art” and not just science. (p. 3).

The other aspect that Marsh’s study cannot track is the suitability of coverage to the loss exposures. When companies ask me as a policyholder lawyer to review the terms of a policy or policies they are considering purchasing, I often see that the language is not well tailored to their needs. For me, the key question is not coopering up new language necessarily but ensuring that management understands what types of risks it faces that the policies might not cover. Certainty is what is key, and knowing what is and is not covered allows a company to plan – and for managers to be accountable. It’s easy to buy a policy with a lot of limits – even for a cheap price. The trick is to purchase policies both at reasonable price points and that are more likely to perform when the company needs its coverage most.

Posted by Marc Mayerson at 6:52 PM | Comments (1) | TrackBack

September 30, 2005

Good Deeds, Smart Business, Corporate Waste, and Ex Gratia Payments

Americans in the Gulf States have endured Katrina and Rita in close succession, similar to how their Florida neighbors suffered through a series of hurricanes last year. Those who have been affected by these hurricanes naturally turn to their insurers for help. When losses stem from both of the recent hurricanes, however, insurers can compound their insureds' financial woes by requiring them to absorb separate deductibles for each storm.

Some insurers have responded by saying that only one deductible will be required in these circumstances. That decision, however, potentially exposes those insurers on the reinsurance and shareholder fronts.

Of course, responding by "waiving" the second deductible reflects the aspiration of insurers genuinely to help their assureds in their time of need. It also enhances goodwill and helps cement their relationship with their policyholders (the source of their premiums). I know from personal experience with my auto insurer that when our two cars kissed each other one day damaging both our insurance policy waives deductibles completely -- we didn't even pay one, let alone two (i.e., a deductible each for each damaged car). I can't quite say that because of that alone we're still premium-payers ten years later, but it certainly helps ensure the continuation of the income flow from my family to that insurance company.

One key difference between my experience and that of the Katrina/Rita policyholders is that my insurance policy had a provision on point saying that no deductibles are owed in the circumstances. Here, the insurers ostensibly are waiving deductibles at the point of claim or retroactively (whereas in my case the insurer waived what would otherwise be the right to two deductibles in advance, that is, in the policy).

In addition to fostering customer loyalty, waiving the second deductible reduces the transaction costs of adjusting the claim (since the adjuster need not unscramble the omelet to see which particular damage was caused by one hurricane or the other). This practical point then goes to the legal question of who bears the burden of proof against the unscrambling problem: if the insurance company bears the burden of differentiating the damage before the second deductible applies, in the absence of adequate evidence the insurer not only would lose that case but potentially risks bad faith (if it did not have a reasonable basis to believe that part of the particular loss was attributable to the second storm). Issues of causation arise, too, for if my roof would need to be replaced from the first storm, that it was further damaged from the second storm is irrelevant (other than that the policyholder cannot collect twice for the roof). Against the potential complexities of these legal questions of burden of proof and causation as well as the increased costs of ascertaining the information needed to refine the determination of what was caused by one storm or the other, those insurers that have "waived" the second deductible may be taking a practical problem and turning it into a PR victory (at no additional cost to them).

In life, it sometimes seems that no good deed goes unpunished, so here's the consequences to these "enlightened" insurance companies.

First, if the experience of the Florida hurricanes holds true, the reinsurers will not similarly allow the insurance companies to aggregate the two storm-related losses together. Last year, reinsurers said publicly that, while waiving the second (or third or fourth) deductible may be sound public relations, they would require in effect the insurers to offset their reinsurance claims by the amount of deductible that was not collected. The ground for this position is that the insurer's expenditure of money within the amount of the additional deductible is a gratuitous (ex gratia) payment, so the reinsurer does not have an obligation to reimburse. Whether this is a winning point for the reinsurers largely depends on the language of the reinsurance policy and on whether the reinsurance contact is governed by English or US law, for English law is much more rigid (and uncommercial) on the issue than is the law in US jurisdictions. When one considers the number of deductibles a major carrier like Fireman's Fund may be giving up, the amount of money at stake could be considerable.

The rejoinder to the ex gratia point is the same as indicated above regarding the legal and practical difficulties regarding the second deductible, which is not a "reinsurance" point as such but rather a question whether under the insurance policy that was issued would the insurer even have had the right to the second deductible. Even if the insurer might have been able to collect the second deductible, the reinsurance policy may contain various follow-the-settlements, follow-the-fortunes, and loss-adjustment clauses that may vest in the insurance company (cedant) the power to make this decision, so long as it does so in good faith and acts as if it is playing with its own money (i.e., as a prudent unreinsured).

Second, the same structure of argument, or criticism, might well be leveled by shareholders of the insurers who elect not to pursue the second deductible. The argument here is that by not pursuing the second deductible (especially without reinsurance recovery) the company has engaged in corporate waste. The burden of demonstrating waste is a high one. In Re Walt Disney Co. Derivative Litigation (Del. Ch. Aug. 9, 2005), slip op. at 111 ("[W]aste is a rare, 'unconscionable case() where directors irrationally squander or give away corporate assets.'") (citation omitted). One also wonders how Wall Street will react to insurers' election not to collect the second deductible and whether the trading value of those stocks actually will go up in recognition of the future return (in terms of customer loyalty -- and future premium streams) on the investment of not pursuing the second deductible. Depending on how Wall Street reacts, there may be no damages suffered by shareholders. (Insurers might consider adopting internal corporate resolutions, however, recognizing that there may be circumstances where the company will waive deductibles, which would help insulate the board from challenges by future shareholders re future disasters.)

At all events, "waiving" or not pressing the question of the second deductible is the right thing to do. There is a sound business and legal case for doing so, so one expects that corporate directors and officers (and their insurers) should be insulated from liability from making this business judgment. And one further hopes that the reinsurers likewise recognize that the legal case for contending that performance is owed without regard to the second deductible is substantial, so that the insurers obtain reinsurance recovery without need to resort to arbitration or litigation on the question.

Posted by Marc Mayerson at 10:04 AM | Comments (0)

Good Deeds, Smart Business, Corporate Waste, and Ex Gratia Payments

Americans in the Gulf States have endured Katrina and Rita in close succession, similar to how their Florida neighbors suffered through a series of hurricanes last year. Those who have been affected by these hurricanes naturally turn to their insurers for help. When losses stem from both of the recent hurricanes, however, insurers can compound their insureds' financial woes by requiring them to absorb separate deductibles for each storm.

Some insurers have responded by saying that only one deductible will be required in these circumstances. That decision, however, potentially exposes those insurers on the reinsurance and shareholder fronts.

Of course, responding by "waiving" the second deductible reflects the aspiration of insurers genuinely to help their assureds in their time of need. It also enhances goodwill and helps cement their relationship with their policyholders (the source of their premiums). I know from personal experience with my auto insurer that when our two cars kissed each other one day damaging both our insurance policy waives deductibles completely -- we didn't even pay one, let alone two (i.e., a deductible each for each damaged car). I can't quite say that because of that alone we're still premium-payers ten years later, but it certainly helps ensure the continuation of the income flow from my family to that insurance company.

One key difference between my experience and that of the Katrina/Rita policyholders is that my insurance policy had a provision on point saying that no deductibles are owed in the circumstances. Here, the insurers ostensibly are waiving deductibles at the point of claim or retroactively (whereas in my case the insurer waived what would otherwise be the right to two deductibles in advance, that is, in the policy).

In addition to fostering customer loyalty, waiving the second deductible reduces the transaction costs of adjusting the claim (since the adjuster need not unscramble the omelet to see which particular damage was caused by one hurricane or the other). This practical point then goes to the legal question of who bears the burden of proof against the unscrambling problem: if the insurance company bears the burden of differentiating the damage before the second deductible applies, in the absence of adequate evidence the insurer not only would lose that case but potentially risks bad faith (if it did not have a reasonable basis to believe that part of the particular loss was attributable to the second storm). Issues of causation arise, too, for if my roof would need to be replaced from the first storm, that it was further damaged from the second storm is irrelevant (other than that the policyholder cannot collect twice for the roof). Against the potential complexities of these legal questions of burden of proof and causation as well as the increased costs of ascertaining the information needed to refine the determination of what was caused by one storm or the other, those insurers that have "waived" the second deductible may be taking a practical problem and turning it into a PR victory (at no additional cost to them).

In life, it sometimes seems that no good deed goes unpunished, so here's the consequences to these "enlightened" insurance companies.

First, if the experience of the Florida hurricanes holds true, the reinsurers will not similarly allow the insurance companies to aggregate the two storm-related losses together. Last year, reinsurers said publicly that, while waiving the second (or third or fourth) deductible may be sound public relations, they would require in effect the insurers to offset their reinsurance claims by the amount of deductible that was not collected. The ground for this position is that the insurer's expenditure of money within the amount of the additional deductible is a gratuitous (ex gratia) payment, so the reinsurer does not have an obligation to reimburse. Whether this is a winning point for the reinsurers largely depends on the language of the reinsurance policy and on whether the reinsurance contact is governed by English or US law, for English law is much more rigid (and uncommercial) on the issue than is the law in US jurisdictions. When one considers the number of deductibles a major carrier like Fireman's Fund may be giving up, the amount of money at stake could be considerable.

The rejoinder to the ex gratia point is the same as indicated above regarding the legal and practical difficulties regarding the second deductible, which is not a "reinsurance" point as such but rather a question whether under the insurance policy that was issued would the insurer even have had the right to the second deductible. Even if the insurer might have been able to collect the second deductible, the reinsurance policy may contain various follow-the-settlements, follow-the-fortunes, and loss-adjustment clauses that may vest in the insurance company (cedant) the power to make this decision, so long as it does so in good faith and acts as if it is playing with its own money (i.e., as a prudent unreinsured).

Second, the same structure of argument, or criticism, might well be leveled by shareholders of the insurers who elect not to pursue the second deductible. The argument here is that by not pursuing the second deductible (especially without reinsurance recovery) the company has engaged in corporate waste. The burden of demonstrating waste is a high one. In Re Walt Disney Co. Derivative Litigation (Del. Ch. Aug. 9, 2005), slip op. at 111 ("[W]aste is a rare, 'unconscionable case() where directors irrationally squander or give away corporate assets.'") (citation omitted). One also wonders how Wall Street will react to insurers' election not to collect the second deductible and whether the trading value of those stocks actually will go up in recognition of the future return (in terms of customer loyalty -- and future premium streams) on the investment of not pursuing the second deductible. Depending on how Wall Street reacts, there may be no damages suffered by shareholders. (Insurers might consider adopting internal corporate resolutions, however, recognizing that there may be circumstances where the company will waive deductibles, which would help insulate the board from challenges by future shareholders re future disasters.)

At all events, "waiving" or not pressing the question of the second deductible is the right thing to do. There is a sound business and legal case for doing so, so one expects that corporate directors and officers (and their insurers) should be insulated from liability from making this business judgment. And one further hopes that the reinsurers likewise recognize that the legal case for contending that performance is owed without regard to the second deductible is substantial, so that the insurers obtain reinsurance recovery without need to resort to arbitration or litigation on the question.

Posted by Marc Mayerson at 10:04 AM | Comments (0)

July 26, 2005

Dissolving Solvent Schemes of Arrangement

Bankruptcy is one option for insolvent companies to manage their obligations to creditors and to provide an efficient mechanism to marshall assets for their benefit; an insolvent insurance company similarly may enter a bankruptcy-like process and pay the claims of its creditors – its policyholders – and marshall its assets (typically reinsurance). Over the past few years, however, we have seen increasing numbers of solvent insurance companies seek to ring fence their liabilities – and lock in profits or at least circumscribe losses – by entering into bankruptcy-like processes by which they forcibly commute their obligations to their policyholders. In 2002, Rhode Island established legislation permitting this type of solvent runoff, but most of the action in this area has been in England for London-market insurers that wrote substantial North American (especially US) risks under broad occurrence policy forms and that now wish to extinguish the long-tail liabilities that naturally follow. Because of a new English decision, however, the ability of London market insurance companies to forcibly terminate their obligations to their policyholders is now in substantial doubt.

London market insurance companies enter what are called “schemes of arrangement” – akin to US Chapter 11 proceedings – in which they seek to reorganize their debts (that is, obligations to policyholders). The advantages for the insurance company from such a scheme are obvious: they achieve finality and potentially release capital back to the company or its parent. The process involves formal application with courts and the division of creditors into classes who have meetings and vote on the proposed scheme. Usually, an application will be made in US bankruptcy court for a section 304 injunction (11 USC § 304), which enjoins US litigation against the company, notwithstanding service-of-suit clauses, and funnels all claims to the English reorganization proceeding. Creditors such as policyholders submit claims by a set bar date, which is the basis for a liquidation of their coverage rights.

Claims of policyholders fall into three basic categories: mature, unpaid claims where the amount of loss is known; mature claims where the policyholder’s liability has yet to be established; and incurred-but-not-reported (“IBNR”) claims which involve injury occurring in the period of the carrier’s coverage but which have yet to be asserted against the policyholder. This all echoes Donald Rumsfield’s famous quatrain:

As we know,

There are known knowns.
There are things we know we know.

We also know
There are known unknowns.
That is to say
We know there are some things
We do not know.

But there are also unknown unknowns,
The ones we don't know
We don't know.

(Feb. 12, 2002, Department of Defense news briefing) The Secretary’s trenchant categorization applies with equal force to characterizing the nature of claims against policyholders covered by occurrence coverage and that are unasserted and unliquidated. Guarding against the risk of future of liability of course is the purpose of the policyholder’s purchase of insurance, and one crucial advantage of occurrence-based coverage is that it applies no matter when the claim is eventually asserted against the policyholder, so long as injury or damage occurred in the period of the carrier’s coverage.

Solvent schemes of arrangement seek to cut off the “inconvenience” of the long tail of claims under occurrence policies by forcing the policyholder into a compulsory commutation (buy-back) of its coverage. Therein lies their vice (from the perspective of policyholders), and the High Court of Justice recently invalidated a solvent scheme of arrangement. The case, In the Matter of the British Aviation Insurance Company Ltd., 2005 EWHC 1621 (Ch.), invalidates the scheme on various technical grounds, such how the voting classes were constituted (see paragraphs 83, 92, 93), and thus the court found itself without jurisdiction to uphold the scheme. More significant, however, is its ruling refusing to sanction solvent schemes of arrangement more broadly on the ground that they unfairly force policyholders to liquidate unknown asbestos and other health hazard claims that may or may not come to fruition. (One remains free always to commute policies voluntarily with an insurer for the known-unknowns and the unknown-unknowns; in a solvent scheme, policyholders are forced to liquidate coverage for their IBNR claims.)

In refusing to uphold the scheme essentially on the grounds of fundamental unfairness, Mr. Justice Lewison distinguished the situation of ordinary policyholders from that of insurance companies that may have inwards and outwards reinsurance with British Aviation Insurance Company (BAIC).

“Unlike the direct insureds, the insurers are in the risk business. Given the uncertainties of the extent of potential exposure to asbestos and other long-tail claims, it makes perfect sense for them to be keen to cap their liabilities. If the Company’s liabilities are capped, so are their liabilities as reinsurers. Their mutual liabilities are set off under the scheme. This does not apply to the direct insureds, who remain liable to those who contract asbestos-related diseases.”

(Paragraph 121) The direct insureds, the policyholders, thus face the prospect (were the scheme approved) of facing greater liabilities than were the basis for the claims estimation, yielding a gap in coverage to which they otherwise would have been entitled had the insurer simply continued in its solvent runoff. As the court explains, “So far as policyholders with IBNR claims are concerned, their right in a solvent run-off is to wait and see whether a claim materializes, and if it does, to have full indemnity against the claim. They have already paid their premiums for the insurance cover, so they are at risk of no further expenditure in relation to a valid claim.” (Paragraph 90). There is no risk of the insureds receiving less than that to which they are entitled if the insurance company simply pays claims as they come due.

In contrast, in the proposed solvent scheme of arrangement, in which the policyholders’ rights are cut off and liquidated, the very risk transfer the policyholder sought to achieve may be turned back to the policyholder involuntarily. As Mr. Justice Lewison explains:

“[It is] unfair to require the manufacturers who have bought insurance policies designed to cast the risk of exposure to asbestos claims on insurers to have that risk compulsorily retransferred to them. The Company is in the risk business; and they are not. This is not a case of an insolvent company to which quite different considerations apply. . . .[T]he Company is able to meet its liabilities under such policies as and when they fall due. The purpose of the scheme is to allow surplus funds to be returned to shareholders in preference to satisfying the legitimate claims of creditors. No matter how useable and reasonable [a claims] estimate may be, the very fact that it is an estimate is likely to make it an inaccurate forecast of the actual liabilities of policyholders. If individual policyholders wish to compound the Company’s contingent liabilities to them, and to accept payment in full of an estimate of their claims, there is nothing to stop them doing so. But to compel dissentients to do so would . . . require them to do that which it is unreasonable to require them to do.”

(Paragraph 143) Although the discussion of the fundamental unfairness of solvent schemes technically may be an alternative holding of the court, the breadth and power of the court’s analysis surely casts a pall on their continued popularity. On a going-forward basis, policyholders receiving notice of a solvent scheme of arrangement should arrange to vote in the creditors’ meeting and object on grounds of fundamental unfairness (and consider whether it is appropriate to object to the constitution of the creditor classes). For those solvent schemes that have been approved by a majority, the court retains continuing jurisdiction, and previous objectors presumably may be able to renew their objections. (For a recommended treatise about the English insurance insolvency process, see here.)

A solvent scheme is a mechanism that is too clever by half. Mr. Justice Lewison's decision has become final, and no appeal was taken. Time will tell whether we’ll continue to see this particular form of scheming by solvent companies to cauterize their liabilities under the very broad coverage they sold to US policyholders.

A version of this article was published in 22 Tolley's Insolvency Law & Practice 23(London 2006).

Posted by Marc Mayerson at 5:29 PM | Comments (3) | TrackBack

Dissolving Solvent Schemes of Arrangement

Bankruptcy is one option for insolvent companies to manage their obligations to creditors and to provide an efficient mechanism to marshall assets for their benefit; an insolvent insurance company similarly may enter a bankruptcy-like process and pay the claims of its creditors – its policyholders – and marshall its assets (typically reinsurance). Over the past few years, however, we have seen increasing numbers of solvent insurance companies seek to ring fence their liabilities – and lock in profits or at least circumscribe losses – by entering into bankruptcy-like processes by which they forcibly commute their obligations to their policyholders. In 2002, Rhode Island established legislation permitting this type of solvent runoff, but most of the action in this area has been in England for London-market insurers that wrote substantial North American (especially US) risks under broad occurrence policy forms and that now wish to extinguish the long-tail liabilities that naturally follow. Because of a new English decision, however, the ability of London market insurance companies to forcibly terminate their obligations to their policyholders is now in substantial doubt.

London market insurance companies enter what are called “schemes of arrangement” – akin to US Chapter 11 proceedings – in which they seek to reorganize their debts (that is, obligations to policyholders). The advantages for the insurance company from such a scheme are obvious: they achieve finality and potentially release capital back to the company or its parent. The process involves formal application with courts and the division of creditors into classes who have meetings and vote on the proposed scheme. Usually, an application will be made in US bankruptcy court for a section 304 injunction (11 USC § 304), which enjoins US litigation against the company, notwithstanding service-of-suit clauses, and funnels all claims to the English reorganization proceeding. Creditors such as policyholders submit claims by a set bar date, which is the basis for a liquidation of their coverage rights.

Claims of policyholders fall into three basic categories: mature, unpaid claims where the amount of loss is known; mature claims where the policyholder’s liability has yet to be established; and incurred-but-not-reported (“IBNR”) claims which involve injury occurring in the period of the carrier’s coverage but which have yet to be asserted against the policyholder. This all echoes Donald Rumsfield’s famous quatrain:

As we know,

There are known knowns.
There are things we know we know.

We also know
There are known unknowns.
That is to say
We know there are some things
We do not know.

But there are also unknown unknowns,
The ones we don't know
We don't know.

(Feb. 12, 2002, Department of Defense news briefing) The Secretary’s trenchant categorization applies with equal force to characterizing the nature of claims against policyholders covered by occurrence coverage and that are unasserted and unliquidated. Guarding against the risk of future of liability of course is the purpose of the policyholder’s purchase of insurance, and one crucial advantage of occurrence-based coverage is that it applies no matter when the claim is eventually asserted against the policyholder, so long as injury or damage occurred in the period of the carrier’s coverage.

Solvent schemes of arrangement seek to cut off the “inconvenience” of the long tail of claims under occurrence policies by forcing the policyholder into a compulsory commutation (buy-back) of its coverage. Therein lies their vice (from the perspective of policyholders), and the High Court of Justice recently invalidated a solvent scheme of arrangement. The case, In the Matter of the British Aviation Insurance Company Ltd., 2005 EWHC 1621 (Ch.), invalidates the scheme on various technical grounds, such how the voting classes were constituted (see paragraphs 83, 92, 93), and thus the court found itself without jurisdiction to uphold the scheme. More significant, however, is its ruling refusing to sanction solvent schemes of arrangement more broadly on the ground that they unfairly force policyholders to liquidate unknown asbestos and other health hazard claims that may or may not come to fruition. (One remains free always to commute policies voluntarily with an insurer for the known-unknowns and the unknown-unknowns; in a solvent scheme, policyholders are forced to liquidate coverage for their IBNR claims.)

In refusing to uphold the scheme essentially on the grounds of fundamental unfairness, Mr. Justice Lewison distinguished the situation of ordinary policyholders from that of insurance companies that may have inwards and outwards reinsurance with British Aviation Insurance Company (BAIC).

“Unlike the direct insureds, the insurers are in the risk business. Given the uncertainties of the extent of potential exposure to asbestos and other long-tail claims, it makes perfect sense for them to be keen to cap their liabilities. If the Company’s liabilities are capped, so are their liabilities as reinsurers. Their mutual liabilities are set off under the scheme. This does not apply to the direct insureds, who remain liable to those who contract asbestos-related diseases.”

(Paragraph 121) The direct insureds, the policyholders, thus face the prospect (were the scheme approved) of facing greater liabilities than were the basis for the claims estimation, yielding a gap in coverage to which they otherwise would have been entitled had the insurer simply continued in its solvent runoff. As the court explains, “So far as policyholders with IBNR claims are concerned, their right in a solvent run-off is to wait and see whether a claim materializes, and if it does, to have full indemnity against the claim. They have already paid their premiums for the insurance cover, so they are at risk of no further expenditure in relation to a valid claim.” (Paragraph 90). There is no risk of the insureds receiving less than that to which they are entitled if the insurance company simply pays claims as they come due.

In contrast, in the proposed solvent scheme of arrangement, in which the policyholders’ rights are cut off and liquidated, the very risk transfer the policyholder sought to achieve may be turned back to the policyholder involuntarily. As Mr. Justice Lewison explains:

“[It is] unfair to require the manufacturers who have bought insurance policies designed to cast the risk of exposure to asbestos claims on insurers to have that risk compulsorily retransferred to them. The Company is in the risk business; and they are not. This is not a case of an insolvent company to which quite different considerations apply. . . .[T]he Company is able to meet its liabilities under such policies as and when they fall due. The purpose of the scheme is to allow surplus funds to be returned to shareholders in preference to satisfying the legitimate claims of creditors. No matter how useable and reasonable [a claims] estimate may be, the very fact that it is an estimate is likely to make it an inaccurate forecast of the actual liabilities of policyholders. If individual policyholders wish to compound the Company’s contingent liabilities to them, and to accept payment in full of an estimate of their claims, there is nothing to stop them doing so. But to compel dissentients to do so would . . . require them to do that which it is unreasonable to require them to do.”

(Paragraph 143) Although the discussion of the fundamental unfairness of solvent schemes technically may be an alternative holding of the court, the breadth and power of the court’s analysis surely casts a pall on their continued popularity. On a going-forward basis, policyholders receiving notice of a solvent scheme of arrangement should arrange to vote in the creditors’ meeting and object on grounds of fundamental unfairness (and consider whether it is appropriate to object to the constitution of the creditor classes). For those solvent schemes that have been approved by a majority, the court retains continuing jurisdiction, and previous objectors presumably may be able to renew their objections. (For a recommended treatise about the English insurance insolvency process, see here.)

A solvent scheme is a mechanism that is too clever by half. Mr. Justice Lewison's decision has become final, and no appeal was taken. Time will tell whether we’ll continue to see this particular form of scheming by solvent companies to cauterize their liabilities under the very broad coverage they sold to US policyholders.

A version of this article was published in 22 Tolley's Insolvency Law & Practice 23(London 2006).

Posted by Marc Mayerson at 5:29 PM | Comments (3) | TrackBack

July 21, 2005

No Whining: 2004 Was a Good Vintage for US Property-Casualty Insurers

The Insurance Services Office (ISO) recently released combined financial figures for the year 2004 for the US property-casualty industry, and it was a very good year for the industry.

One measure of performance is the combined ratio, which calculates the percentage of loss payouts and expenses as compared to premium income. A ratio of 100 means that the insurers paid out in losses the same amount of money they took in as premiums; this does not mean that the insurer that year was not profitable – the insurer takes the premium and invests it, so an insurer still will be profitable even if, on a premium-in, claim-out basis, it has made no money. An insurer with a loss ratio of 102, where it has paid out $1.02 in claims for every $1.00 in premium collected, will still be profitable if its investment returns are more than 1.02 times premiums collected.

A combined ratio of less than 100 indicates that policyholders collectively paid more in premiums than the insurer paid out in claims. As Warren Buffett has explained, from the insurance company perspective this means that other people are paying it to invest money for the insurance company’s benefit. If the combined ratio is less than 100, the insurance company’s “cost of float” is less than zero, that is, the insurance company is getting paid to hold other people’s money or, as Mr. Buffett has put is, “float is better than free.”

In 2004, the US property-casualty industry had a combined combined ratio of 98.1%. The insurers made $39.6 billion in investment income, on top of their underwriting profit of $5 billion, and the industry’s overall net income (taking into account investment, underwriting, and other cash and paper profit) was $53.4 billion.
In addition to being investment machines, insurance companies pay losses, which in 2004 totaled $299.5 billion, including loss-adjustment expenses. Last year there were several significant catastrophes affecting the industry, notably the series of hurricanes hitting Florida and other parts of the US. Overall, there were estimated to be $15.2 billion in catastrophe losses. Roughly $4.9 billion was devoted to environmental and asbestos (“E&A”) losses last year, which was down about $1.5 billion from the year before (2003). According to ISO, if one holds aside the exceptional items of catastrophes, E&A, and some reserve adjustments, the combined ratio for insurers was 92.3 percent.

The profitability of the industry last year led to an increase in net worth, or what is called in insurance parlance “policyholder surplus.” The surplus last year was at a record high, both absolutely and adjusted for inflation, of $393.5 billion, even after paying $13.3 billion to their owners as dividends. The insurers have recovered from their capital losses between 2000 and 2002, racking up $50.8 billion in capital gains in 2003 and 2004 overtaking their capitals losses $35.7 billion at the dawn of the millennium. The insurers’ rate of return on capital was at its highest level in nearly a decade, producing a 9.4 percent return on average net worth. The average yield on insurers’ cash and invested assets has averaged 4.6 percent over the past five years.

Insurers, however, like to compare their financial results to other industries based on return on new worth, complaining that industries that actually make things earn more than they do. ISO estimates that median returns for the Fortune 500 in 2004 was 14.9 percent, which is 5.5 percent higher than the 9.4 percent return on net worth for the insurance industry as a whole and 4.8 percent higher than the large American insurers’ rate of return of 10.1 percent.

It’s never been clear to me that that is a salient comparison, in that, unlike Lake Wobegon where all the children are above average, not every company has to have high rates of return to make the enterprise worthwhile; just because leading industrial companies may make more money does not make the insurers woe-begotten.

Posted by Marc Mayerson at 3:07 PM | Comments (1) | TrackBack

No Whining: 2004 Was a Good Vintage for US Property-Casualty Insurers

The Insurance Services Office (ISO) recently released combined financial figures for the year 2004 for the US property-casualty industry, and it was a very good year for the industry.

One measure of performance is the combined ratio, which calculates the percentage of loss payouts and expenses as compared to premium income. A ratio of 100 means that the insurers paid out in losses the same amount of money they took in as premiums; this does not mean that the insurer that year was not profitable – the insurer takes the premium and invests it, so an insurer still will be profitable even if, on a premium-in, claim-out basis, it has made no money. An insurer with a loss ratio of 102, where it has paid out $1.02 in claims for every $1.00 in premium collected, will still be profitable if its investment returns are more than 1.02 times premiums collected.

A combined ratio of less than 100 indicates that policyholders collectively paid more in premiums than the insurer paid out in claims. As Warren Buffett has explained, from the insurance company perspective this means that other people are paying it to invest money for the insurance company’s benefit. If the combined ratio is less than 100, the insurance company’s “cost of float” is less than zero, that is, the insurance company is getting paid to hold other people’s money or, as Mr. Buffett has put is, “float is better than free.”

In 2004, the US property-casualty industry had a combined combined ratio of 98.1%. The insurers made $39.6 billion in investment income, on top of their underwriting profit of $5 billion, and the industry’s overall net income (taking into account investment, underwriting, and other cash and paper profit) was $53.4 billion.
In addition to being investment machines, insurance companies pay losses, which in 2004 totaled $299.5 billion, including loss-adjustment expenses. Last year there were several significant catastrophes affecting the industry, notably the series of hurricanes hitting Florida and other parts of the US. Overall, there were estimated to be $15.2 billion in catastrophe losses. Roughly $4.9 billion was devoted to environmental and asbestos (“E&A”) losses last year, which was down about $1.5 billion from the year before (2003). According to ISO, if one holds aside the exceptional items of catastrophes, E&A, and some reserve adjustments, the combined ratio for insurers was 92.3 percent.

The profitability of the industry last year led to an increase in net worth, or what is called in insurance parlance “policyholder surplus.” The surplus last year was at a record high, both absolutely and adjusted for inflation, of $393.5 billion, even after paying $13.3 billion to their owners as dividends. The insurers have recovered from their capital losses between 2000 and 2002, racking up $50.8 billion in capital gains in 2003 and 2004 overtaking their capitals losses $35.7 billion at the dawn of the millennium. The insurers’ rate of return on capital was at its highest level in nearly a decade, producing a 9.4 percent return on average net worth. The average yield on insurers’ cash and invested assets has averaged 4.6 percent over the past five years.

Insurers, however, like to compare their financial results to other industries based on return on new worth, complaining that industries that actually make things earn more than they do. ISO estimates that median returns for the Fortune 500 in 2004 was 14.9 percent, which is 5.5 percent higher than the 9.4 percent return on net worth for the insurance industry as a whole and 4.8 percent higher than the large American insurers’ rate of return of 10.1 percent.

It’s never been clear to me that that is a salient comparison, in that, unlike Lake Wobegon where all the children are above average, not every company has to have high rates of return to make the enterprise worthwhile; just because leading industrial companies may make more money does not make the insurers woe-begotten.

Posted by Marc Mayerson at 3:07 PM | Comments (1) | TrackBack

June 29, 2005

Equitas Financial Reports – 2005 Version

As part of the Reconstruction and Renewal of Lloyd’s in 1996, several Equitas entities were created to serve as the final reinsurer-to-close and to manage the run-off of underwriter liabilities for non-life 1992 and earlier business.

On June 7, 2005, Equitas issued a press release on its annual results and more recently made available its Report & Accounts for the year ended 31 March 2005.

Equitas reported that its accumulated surplus increased immaterially and now totals £476 million; its solvency margin increased over last year by nearly 25 percent to 12.2 percent.

Equitas further hiked its asbestos reserves by £167 million, a figure notable in part given the obvious tactical advantage to Equitas in not raising its reserves at all, in view of the possibility that its reserves will be used as a benchmark for determining its contribution to the US asbestos trust fund, were it ever enacted.

Equitas continues to proclaim that it will be able to make payment of claims in full and emphasized that its board never has considered invoking “proportionate cover,” a power purportedly vested in Equitas to undergo a private bankruptcy in which it pays only a percentage of what it believes it owes on claims. See Report, Chairman’s Statement.
Equitas, however, continues to tout credit risk as a principal reason for policyholders to liquidate and settle their rights to coverage. See Report, Directors’ Report (“The principal risk remains that the Group may not be able to settle its liabilities in full.”).

The press release tries to stimulate further policyholder settlements, saying: “When many companies, including some of the world’s best known businesses, are agreeing settlements with Equitas, the directors of other policyholders will properly question why they should not do the same.” (Commentary at 6). What may have prompted Equitas to make this particular comment was the contrary view of Equitas settlements reported recently in London’s Financial Times, see Steven Fiedler, Will Equitas Come Back to Haunt the Big Companies? Financial Times (Nov. 8, 2004), at 15 (I confess that the FT article quotes me).

But Equitas’s justification of its own settlements confirms these may be one-sided deals. The Press Release explains that “[t]he value of claims from certain policyholders is susceptible to material change depending on the outcome of litigation or variation in claim trends. The liability for such policyholders are . . . the most dangerous. . . . Of the 28 major direct asbestos exposures we have settled since April 2001, 20 were among the most unpredictable that we faced. . . . Their resolution offers Equitas (and the policyholder) protection against wide swings in the value of these cases.” (Commentary at 6). No doubt a policyholder faces risk that there can be materially adverse developments in insurance-coverage law, but it is unlikely that Equitas is settling claims based on unusually policyholder-favorable interpretations of coverage; the wide swings in values to which Equitas refers are unlikely to result from insurance-law developments. Rather, holding aside such developments as a swing factor in the valuation of a settlement, the drivers of settlement values are predictions of the dollar cost of the asbestos claims and the claim flow.

For example, if the expectation is that the claim stream will total $150 in total over the next ten years, settling today for, say, $100 is the economic equivalent (assuming the discount rate used is right and full coverage). However, if the settlement is for $100 and the claim stream ends up costing $200 over the ten-year period, the policyholder has undersold its coverage, and Equitas has done a good deal. Equitas’s comments about the swings in values reveals that it is only the policyholder that is at risk, especially assuming that asbestos claim values unforeseeably escalate (which has happened in the past – several times). In other words, the “wide swing” that Equitas is protecting itself against is more likely than not to be a swing upwards in the value of claims – in which event the policyholder will have liquidated its coverage today without getting full value.

Only if the settlement is cast against the expectation that the value of the claim stream will (unaccountably) go down is there any swing favoring the policyholder in these deals (and potentially a windfall to the policyholder in receiving more payment for its coverage than the economic value of the amounts to which it otherwise would be entitled in the ordinary course). The likelihood of such a downdraft in asbestos claim values seems remote in the extreme. (The possible impact of federal asbestos-liability reform is taken into account in settlements separately, see below.)

Furthermore, given that the Lloyd’s policies that Equitas manages usually are excess policies, Equitas is not typically controlling the defense and settlement of the underlying asbestos liabilities. Accordingly, it is telling when Equitas says that “claims management strategies adopted by the group will reduce claims payments below the level that they would otherwise have been” (Report at Note 2). Equitas is not managing the claims to reduce the payouts to asbestos plaintiffs or to defense lawyers; Equitas is managing the claims to reduce payments to policyholders.

When one sprinkles into the mix a discount being provided by the policyholder for Equitas’s credit risk – which Equitas touts on the one hand and pooh-poohs on the other – then it is clear that Equitas continues its successful practice of inducing policyholders to settle for less than economic value.

In fact, Equitas annually monetizes the amounts it estimates it has saved by doing deals with policyholders at amounts below the reserve for the particular policyholder’s claim stream (note that Equitas discounts its reserves, so the reserve number and a present-value buyout should be equivalent). For the 2004-2005 fiscal year, Equitas says that “claims and commutation activities” produced £95 million of profit, that is, that through its claims settlements Equitas was able to take £95 million into income by settling for less than the reserved value of the claims. See Release, Commentary at 9. (Although the £95 million takes into account reinsurance settlements, given that in excess of 85 percent of Equitas’s outwards reinsurance already had been liquidated before the fiscal year began and assuming that Equitas had not seriously underestimated the value of its reinsurance recoverable, one can reasonably infer that the overwhelming bulk of the settlement “profit” came at the expense of policyholders that settle for amounts below the reserved level.) In fact, more than 70 percent of Equitas’ surplus is accountable to the impact of these Equitas-favorable settlements over the past three years alone (2005, £95 million; 2004, £97 million; 2003, £142 million).

The £95 million in settlement profit in 2004-05 – more than 25 percent of Equitas’s current reported surplus – in fact may represent an even larger amount considering that Equitas does not retroactively adjust its books when it later increases its asbestos reserves. In other words, if Equitas next year increases its reserves by, e.g., £150 million for asbestos liabilities (and in 2004 it increased asbestos reserves by £296 million), the settlement profit for year 2004-05 in truth will be greater than the £95 million (because the reserve for that policyholder should have been higher); but according to Equitas’s accounting practices, “any consequential adjustments to amounts previously reported will be reflected in the results of the year in which they are identified.” (Report at Note 2).

Finally, Equitas rectified an omission in last year’s report by discussing the impact of the “out” clauses it has included in recent major settlements of asbestos liabilities, in which the settlement with the policyholder is altered or vitiated in the event that, e.g., federal asbestos-liability reform legislation is enacted vel non. Equitas reports that a total of £370 million may be returned to it based on various contingencies, principally regarding federal asbestos legislation, but that contingent asset presumably will need be offset against the reinstatement of some policyholder claims.

(Note: As of 31 March 2005, £1 GBP = ~ $1.88 US.)

Posted by Marc Mayerson at 4:40 PM | Comments (0) | TrackBack

Equitas Financial Reports – 2005 Version

As part of the Reconstruction and Renewal of Lloyd’s in 1996, several Equitas entities were created to serve as the final reinsurer-to-close and to manage the run-off of underwriter liabilities for non-life 1992 and earlier business.

On June 7, 2005, Equitas issued a press release on its annual results and more recently made available its Report & Accounts for the year ended 31 March 2005.

Equitas reported that its accumulated surplus increased immaterially and now totals £476 million; its solvency margin increased over last year by nearly 25 percent to 12.2 percent.

Equitas further hiked its asbestos reserves by £167 million, a figure notable in part given the obvious tactical advantage to Equitas in not raising its reserves at all, in view of the possibility that its reserves will be used as a benchmark for determining its contribution to the US asbestos trust fund, were it ever enacted.

Equitas continues to proclaim that it will be able to make payment of claims in full and emphasized that its board never has considered invoking “proportionate cover,” a power purportedly vested in Equitas to undergo a private bankruptcy in which it pays only a percentage of what it believes it owes on claims. See Report, Chairman’s Statement.
Equitas, however, continues to tout credit risk as a principal reason for policyholders to liquidate and settle their rights to coverage. See Report, Directors’ Report (“The principal risk remains that the Group may not be able to settle its liabilities in full.”).

The press release tries to stimulate further policyholder settlements, saying: “When many companies, including some of the world’s best known businesses, are agreeing settlements with Equitas, the directors of other policyholders will properly question why they should not do the same.” (Commentary at 6). What may have prompted Equitas to make this particular comment was the contrary view of Equitas settlements reported recently in London’s Financial Times, see Steven Fiedler, Will Equitas Come Back to Haunt the Big Companies? Financial Times (Nov. 8, 2004), at 15 (I confess that the FT article quotes me).

But Equitas’s justification of its own settlements confirms these may be one-sided deals. The Press Release explains that “[t]he value of claims from certain policyholders is susceptible to material change depending on the outcome of litigation or variation in claim trends. The liability for such policyholders are . . . the most dangerous. . . . Of the 28 major direct asbestos exposures we have settled since April 2001, 20 were among the most unpredictable that we faced. . . . Their resolution offers Equitas (and the policyholder) protection against wide swings in the value of these cases.” (Commentary at 6). No doubt a policyholder faces risk that there can be materially adverse developments in insurance-coverage law, but it is unlikely that Equitas is settling claims based on unusually policyholder-favorable interpretations of coverage; the wide swings in values to which Equitas refers are unlikely to result from insurance-law developments. Rather, holding aside such developments as a swing factor in the valuation of a settlement, the drivers of settlement values are predictions of the dollar cost of the asbestos claims and the claim flow.

For example, if the expectation is that the claim stream will total $150 in total over the next ten years, settling today for, say, $100 is the economic equivalent (assuming the discount rate used is right and full coverage). However, if the settlement is for $100 and the claim stream ends up costing $200 over the ten-year period, the policyholder has undersold its coverage, and Equitas has done a good deal. Equitas’s comments about the swings in values reveals that it is only the policyholder that is at risk, especially assuming that asbestos claim values unforeseeably escalate (which has happened in the past – several times). In other words, the “wide swing” that Equitas is protecting itself against is more likely than not to be a swing upwards in the value of claims – in which event the policyholder will have liquidated its coverage today without getting full value.

Only if the settlement is cast against the expectation that the value of the claim stream will (unaccountably) go down is there any swing favoring the policyholder in these deals (and potentially a windfall to the policyholder in receiving more payment for its coverage than the economic value of the amounts to which it otherwise would be entitled in the ordinary course). The likelihood of such a downdraft in asbestos claim values seems remote in the extreme. (The possible impact of federal asbestos-liability reform is taken into account in settlements separately, see below.)

Furthermore, given that the Lloyd’s policies that Equitas manages usually are excess policies, Equitas is not typically controlling the defense and settlement of the underlying asbestos liabilities. Accordingly, it is telling when Equitas says that “claims management strategies adopted by the group will reduce claims payments below the level that they would otherwise have been” (Report at Note 2). Equitas is not managing the claims to reduce the payouts to asbestos plaintiffs or to defense lawyers; Equitas is managing the claims to reduce payments to policyholders.

When one sprinkles into the mix a discount being provided by the policyholder for Equitas’s credit risk – which Equitas touts on the one hand and pooh-poohs on the other – then it is clear that Equitas continues its successful practice of inducing policyholders to settle for less than economic value.

In fact, Equitas annually monetizes the amounts it estimates it has saved by doing deals with policyholders at amounts below the reserve for the particular policyholder’s claim stream (note that Equitas discounts its reserves, so the reserve number and a present-value buyout should be equivalent). For the 2004-2005 fiscal year, Equitas says that “claims and commutation activities” produced £95 million of profit, that is, that through its claims settlements Equitas was able to take £95 million into income by settling for less than the reserved value of the claims. See Release, Commentary at 9. (Although the £95 million takes into account reinsurance settlements, given that in excess of 85 percent of Equitas’s outwards reinsurance already had been liquidated before the fiscal year began and assuming that Equitas had not seriously underestimated the value of its reinsurance recoverable, one can reasonably infer that the overwhelming bulk of the settlement “profit” came at the expense of policyholders that settle for amounts below the reserved level.) In fact, more than 70 percent of Equitas’ surplus is accountable to the impact of these Equitas-favorable settlements over the past three years alone (2005, £95 million; 2004, £97 million; 2003, £142 million).

The £95 million in settlement profit in 2004-05 – more than 25 percent of Equitas’s current reported surplus – in fact may represent an even larger amount considering that Equitas does not retroactively adjust its books when it later increases its asbestos reserves. In other words, if Equitas next year increases its reserves by, e.g., £150 million for asbestos liabilities (and in 2004 it increased asbestos reserves by £296 million), the settlement profit for year 2004-05 in truth will be greater than the £95 million (because the reserve for that policyholder should have been higher); but according to Equitas’s accounting practices, “any consequential adjustments to amounts previously reported will be reflected in the results of the year in which they are identified.” (Report at Note 2).

Finally, Equitas rectified an omission in last year’s report by discussing the impact of the “out” clauses it has included in recent major settlements of asbestos liabilities, in which the settlement with the policyholder is altered or vitiated in the event that, e.g., federal asbestos-liability reform legislation is enacted vel non. Equitas reports that a total of £370 million may be returned to it based on various contingencies, principally regarding federal asbestos legislation, but that contingent asset presumably will need be offset against the reinstatement of some policyholder claims.

(Note: As of 31 March 2005, £1 GBP = ~ $1.88 US.)

Posted by Marc Mayerson at 4:40 PM | Comments (0) | TrackBack

June 9, 2005

D&O Implications of the AIG Mess

New York’s Attorney General and Insurance Commissioner have filed a civil complaint against AIG, Maurice Greenberg, and Howard Smith. (A copy of the complaint is available at http://www.oag.state.ny.us/press/2005/may/Summons%20and%20Complaint.pdf .) Further insight into the nature of the transactions comes from the SEC’s complaint against a former executive of General Re, who allegedly aided and abetted some of the allegedly fraudulent conduct engaged in by AIG to improve its balance sheet, which made a $144 million decrease in reserves in fourth quarter 2000 look like a $106 million reserve strengthening, and a $187 million decrease the following quarter appear as a $63 million increase in reserves, measures that improved AIG’s appearance to Wall Street and positively affecting its share price. (The SEC’s June 6 complaint is available at http://www.sec.gov/litigation/complaints/comp19248.pdf ) While an increase in reserves decreases an insurance company’s surplus, a positive one-dollar movement in AIG stock price supposedly increases Greenberg’s personal worth by $65 million, according to the NY complaint. Other actions have been filed against Mr. Greenberg relating to AIG, including one filed the same day by Ohio seeking to block his now well-known effort to give several million AIG shares of stock to his wife as the turbulence was increasing. See http://www.kpmginsiders.com/display_reuters.asp?cs_id=133552

Corporate policyholders, directors and officers should monitor these matters because AIG is seeking coverage under the directors’ and officers’ insurance policies that it purchased to protect its directors against claims of liability. According to Business Insurance, “AIG purchased about $125 million of limits, with Great American Insurance Co. of Cincinnati, Ohio, writing the first $25 million layer . . . . Great American often offers primary D&O limits to financial institutions, but the insurer typically does not write primary coverage for other large risks, according to market executives. Warren, N.J.-based Chubb Corp. participates on a low excess layer of AIG's program, according to sources.” See AIG Set to Test Own Cover, BUSINESS INSURANCE (May 16, 2005), at 1, available at http://www.businessinsurance.com/cgi-bin/article.pl? articleId=16843&a=a&bt=aig

Here’s the point: For AIG – or Messrs. Greenberg and Smith – to seek insurance coverage, they likely have to take the position that certain exclusions dealing with fraudulent misconduct (that we can assume appear) do not apply and that certain monetary relief being pursued against them represent covered ‘losses.’ But when AIG does this, it will be admitting that such a construction of the policy language supporting coverage is reasonable, setting the stage for the argument that relative to its own insureds similar constructions are reasonable, yielding the result that as AIG reaches for coverage it exposes itself on the policies it issued. (And
AIG’s own insurers should adopt the inverse tack of looking to AIG’s positions in service of denials of coverage to buttress their arguments that AIG now is making opportunistic arguments seeking recovery here. E.g., Serio v. National Union, 2005 NY Slip Op 03977 (May 17, 2005), available at http://www.courts.state.ny.us/reporter/3dseries/2005/2005_03977.htm. Oh what a tangled web.)

AIG may recognize this box and elect not to pursue the coverage it purchased so as to protect the coverage it sold. But it cannot control Messrs. Greenberg and Smith who no doubt as major shareholders of AIG have an interest in AIG’s not paying claims, but probably have an interest in not paying out of their own pockets for their attorneys (or any settlement or judgment) either. Given the nature of the conduct alleged, it may well be that AIG cannot indemnify these gentlemen pursuant to standard corporate indemnifications, which means that Greenberg and Smith will seek this coverage on their own. (Whether AIG can avoid indemnifying these alleged scoundrels is a tricky question. See Bergnozi v. Rite Aid Corp., http://courts.state.de.us/opinions/ (qnuzep45rti2tom1sweqc5r1)/download.aspx?ID=37080 (Del. Ch. Oct. 20, 2003); Globus v. Law Res. Serv. Inc., 418 F.2d 1276, 1288-89 (2d Cir. 1969). While the individual’s own pursuit of D&O coverage may not be quite the admission against interest that AIG’s seeking this coverage is, it still is probative, given who they were in the company and their knowledge of insurance.

Maybe AIG will commit hari kari on the coverage it purchased in the hope of obtaining the result that both the D&O coverage it purchased does not apply and that Messrs. Greenberg and Smith are not entitled to indemnification under the corporate indemnity. Compare http://www.sec.gov/news/press/2004-67.htm (indicating SEC’s ire at Lucent’s indemnifying its directors/officers). That seemingly would be the company’s best play.

At all events, in coverage disputes henceforth with AIG, Great American, and Chubb, policyholders should be pursuing discovery into the exchanges on coverage.

A final twist bears mention: Throughout Attorney General Spitzer’s complaint, he relies on the individual defendant’s invocation of his right to refuse to self-incriminate under the Fifth Amendment. Of course, in a criminal case, a prosecutor may not invite a jury to assume that the answer to a question that is not responded to on Fifth Amendment grounds supports an inference that the defendant is guilty; in a civil case, that limitation generally does not apply. (See generally Robert Johnston, Inferring Dishonesty: The Fifth Amendment and Fidelity Coverage, available at http://www.spriggs.com/news/pdfs/ACFB9AE.PDF .) But the New York action is a civil complaint, which presumably makes use of Greenberg’s invoking the Fifth fair game to support the inference that the answer would support the violation being alleged. (Query whether the State may sidestep the Fifth Amendment this way, which surely will be litigated in the case.)

But given the crucial use of the refusals-to-answer as an element of proof in the State’s case, one can assume that the D&O insurers will contend that the failure to answer somehow lays the foundation for a breach of the duty to cooperate. See Allstate Ins. Co. v. United Ins. Co., 2005 NY Slip Op. 02419 (March 28, 2005) http://www.courts.state.ny.us/reporter/3dseries/2005/2005_02419.htm. There ordinarily is not an “examination under oath” provision in D&O policies, and one can surely mount the argument that the D&O insurers’ (hypothesized) demand that Messrs. Greenberg and Smith waive their Fifth Amendment protections or sacrifice D&O coverage smacks of bad faith (see Gruenberg v Aetna Insurance Co., 9 Cal 3d 566 (1973); cf. Sakup v. State, 227 N.E.2d 822 (1967) (New York first-party bad faith). This is especially true in the context of an insurance policy with (we suppose) exclusions for fraud and one that lacks an examination-under-oath provision; in other words, it would be incongruous to permit the D&O insurers to deny coverage for refusing to answer questions/breach of cooperation when a crucial purpose of the policy is to protect against claims alleging fraud. Compare Federal Ins. Co. v. Kozlowski, 2005 NY Slip Op 02287 (March 22, 2005) http://www.courts.state.ny.us/reporter/3dseries/2005/2005_02287.htm (requiring insurer to defend and precluding litigation of its rescission claim while liability action against directors and officers were pending).

The ebbs and flow of the related liability and coverage matters here bears monitoring by policyholders and, for the parties involved, careful consideration of the big picture. (For other comments and tracking of the AIG mess, see the White Collar Crime Prof Blog.) These same tensions will arise regarding the application of ERISA fudiciary-liability insurance coverage, since (at least one) ERISA-based class action has been filed against Mr. Greenberg and others.

Posted by Marc Mayerson at 4:42 PM | Comments (6) | TrackBack

D&O Implications of the AIG Mess

New York’s Attorney General and Insurance Commissioner have filed a civil complaint against AIG, Maurice Greenberg, and Howard Smith. (A copy of the complaint is available at http://www.oag.state.ny.us/press/2005/may/Summons%20and%20Complaint.pdf .) Further insight into the nature of the transactions comes from the SEC’s complaint against a former executive of General Re, who allegedly aided and abetted some of the allegedly fraudulent conduct engaged in by AIG to improve its balance sheet, which made a $144 million decrease in reserves in fourth quarter 2000 look like a $106 million reserve strengthening, and a $187 million decrease the following quarter appear as a $63 million increase in reserves, measures that improved AIG’s appearance to Wall Street and positively affecting its share price. (The SEC’s June 6 complaint is available at http://www.sec.gov/litigation/complaints/comp19248.pdf ) While an increase in reserves decreases an insurance company’s surplus, a positive one-dollar movement in AIG stock price supposedly increases Greenberg’s personal worth by $65 million, according to the NY complaint. Other actions have been filed against Mr. Greenberg relating to AIG, including one filed the same day by Ohio seeking to block his now well-known effort to give several million AIG shares of stock to his wife as the turbulence was increasing. See http://www.kpmginsiders.com/display_reuters.asp?cs_id=133552

Corporate policyholders, directors and officers should monitor these matters because AIG is seeking coverage under the directors’ and officers’ insurance policies that it purchased to protect its directors against claims of liability. According to Business Insurance, “AIG purchased about $125 million of limits, with Great American Insurance Co. of Cincinnati, Ohio, writing the first $25 million layer . . . . Great American often offers primary D&O limits to financial institutions, but the insurer typically does not write primary coverage for other large risks, according to market executives. Warren, N.J.-based Chubb Corp. participates on a low excess layer of AIG's program, according to sources.” See AIG Set to Test Own Cover, BUSINESS INSURANCE (May 16, 2005), at 1, available at http://www.businessinsurance.com/cgi-bin/article.pl? articleId=16843&a=a&bt=aig

Here’s the point: For AIG – or Messrs. Greenberg and Smith – to seek insurance coverage, they likely have to take the position that certain exclusions dealing with fraudulent misconduct (that we can assume appear) do not apply and that certain monetary relief being pursued against them represent covered ‘losses.’ But when AIG does this, it will be admitting that such a construction of the policy language supporting coverage is reasonable, setting the stage for the argument that relative to its own insureds similar constructions are reasonable, yielding the result that as AIG reaches for coverage it exposes itself on the policies it issued. (And
AIG’s own insurers should adopt the inverse tack of looking to AIG’s positions in service of denials of coverage to buttress their arguments that AIG now is making opportunistic arguments seeking recovery here. E.g., Serio v. National Union, 2005 NY Slip Op 03977 (May 17, 2005), available at http://www.courts.state.ny.us/reporter/3dseries/2005/2005_03977.htm. Oh what a tangled web.)

AIG may recognize this box and elect not to pursue the coverage it purchased so as to protect the coverage it sold. But it cannot control Messrs. Greenberg and Smith who no doubt as major shareholders of AIG have an interest in AIG’s not paying claims, but probably have an interest in not paying out of their own pockets for their attorneys (or any settlement or judgment) either. Given the nature of the conduct alleged, it may well be that AIG cannot indemnify these gentlemen pursuant to standard corporate indemnifications, which means that Greenberg and Smith will seek this coverage on their own. (Whether AIG can avoid indemnifying these alleged scoundrels is a tricky question. See Bergnozi v. Rite Aid Corp., http://courts.state.de.us/opinions/ (qnuzep45rti2tom1sweqc5r1)/download.aspx?ID=37080 (Del. Ch. Oct. 20, 2003); Globus v. Law Res. Serv. Inc., 418 F.2d 1276, 1288-89 (2d Cir. 1969). While the individual’s own pursuit of D&O coverage may not be quite the admission against interest that AIG’s seeking this coverage is, it still is probative, given who they were in the company and their knowledge of insurance.

Maybe AIG will commit hari kari on the coverage it purchased in the hope of obtaining the result that both the D&O coverage it purchased does not apply and that Messrs. Greenberg and Smith are not entitled to indemnification under the corporate indemnity. Compare http://www.sec.gov/news/press/2004-67.htm (indicating SEC’s ire at Lucent’s indemnifying its directors/officers). That seemingly would be the company’s best play.

At all events, in coverage disputes henceforth with AIG, Great American, and Chubb, policyholders should be pursuing discovery into the exchanges on coverage.

A final twist bears mention: Throughout Attorney General Spitzer’s complaint, he relies on the individual defendant’s invocation of his right to refuse to self-incriminate under the Fifth Amendment. Of course, in a criminal case, a prosecutor may not invite a jury to assume that the answer to a question that is not responded to on Fifth Amendment grounds supports an inference that the defendant is guilty; in a civil case, that limitation generally does not apply. (See generally Robert Johnston, Inferring Dishonesty: The Fifth Amendment and Fidelity Coverage, available at http://www.spriggs.com/news/pdfs/ACFB9AE.PDF .) But the New York action is a civil complaint, which presumably makes use of Greenberg’s invoking the Fifth fair game to support the inference that the answer would support the violation being alleged. (Query whether the State may sidestep the Fifth Amendment this way, which surely will be litigated in the case.)

But given the crucial use of the refusals-to-answer as an element of proof in the State’s case, one can assume that the D&O insurers will contend that the failure to answer somehow lays the foundation for a breach of the duty to cooperate. See Allstate Ins. Co. v. United Ins. Co., 2005 NY Slip Op. 02419 (March 28, 2005) http://www.courts.state.ny.us/reporter/3dseries/2005/2005_02419.htm. There ordinarily is not an “examination under oath” provision in D&O policies, and one can surely mount the argument that the D&O insurers’ (hypothesized) demand that Messrs. Greenberg and Smith waive their Fifth Amendment protections or sacrifice D&O coverage smacks of bad faith (see Gruenberg v Aetna Insurance Co., 9 Cal 3d 566 (1973); cf. Sakup v. State, 227 N.E.2d 822 (1967) (New York first-party bad faith). This is especially true in the context of an insurance policy with (we suppose) exclusions for fraud and one that lacks an examination-under-oath provision; in other words, it would be incongruous to permit the D&O insurers to deny coverage for refusing to answer questions/breach of cooperation when a crucial purpose of the policy is to protect against claims alleging fraud. Compare Federal Ins. Co. v. Kozlowski, 2005 NY Slip Op 02287 (March 22, 2005) http://www.courts.state.ny.us/reporter/3dseries/2005/2005_02287.htm (requiring insurer to defend and precluding litigation of its rescission claim while liability action against directors and officers were pending).

The ebbs and flow of the related liability and coverage matters here bears monitoring by policyholders and, for the parties involved, careful consideration of the big picture. (For other comments and tracking of the AIG mess, see the White Collar Crime Prof Blog.) These same tensions will arise regarding the application of ERISA fudiciary-liability insurance coverage, since (at least one) ERISA-based class action has been filed against Mr. Greenberg and others.

Posted by Marc Mayerson at 4:42 PM | Comments (6) | TrackBack

May 9, 2005

The Economics of the Property-Casualty Insurance Business (including Reinsurance)

Warren Buffett annually issues a letter to the shareholders of Berkshire Hathaway discussing business developments over the year. As is well known, a significant core of Berkshire Hathaway’s business is insurance: property-casualty from National Indemnity, auto from GEICO, and reinsurance, especially usual reinsurance placements.

In his annual letters, Buffett from time to time analyzes the business of insurance – and provides the truest and simplest explanation of the nature of the property-casualty business and its economics. His letter for year 2004 (released in March 2005) focuses on the business models of the three main areas of Berkshire Hathaway’s business. It is available at http://www.berkshirehathaway.com/letters/2004ltr.pdf and in particular see pages 6 through 11.

Before reading the year 2004 letter, however, read Buffett’s letter about 2001, available at http://www.berkshirehathaway.com/letters/2001pdf.pdf and in particular pages 6 through 11. This analysis should be required reading for anyone in the property-casualty business (lawyers included). The 2004 letter is good and interesting; the 2001 letter (which recapitulates points and themes Mr. Buffett has set forth before) is essential to understanding insurance markets and dispelling pervasive myths about the pricing and profitability of insurance companies.

Posted by Marc Mayerson at 3:56 PM | Comments (2) | TrackBack

The Economics of the Property-Casualty Insurance Business (including Reinsurance)

Warren Buffett annually issues a letter to the shareholders of Berkshire Hathaway discussing business developments over the year. As is well known, a significant core of Berkshire Hathaway’s business is insurance: property-casualty from National Indemnity, auto from GEICO, and reinsurance, especially usual reinsurance placements.

In his annual letters, Buffett from time to time analyzes the business of insurance – and provides the truest and simplest explanation of the nature of the property-casualty business and its economics. His letter for year 2004 (released in March 2005) focuses on the business models of the three main areas of Berkshire Hathaway’s business. It is available at http://www.berkshirehathaway.com/letters/2004ltr.pdf and in particular see pages 6 through 11.

Before reading the year 2004 letter, however, read Buffett’s letter about 2001, available at http://www.berkshirehathaway.com/letters/2001pdf.pdf and in particular pages 6 through 11. This analysis should be required reading for anyone in the property-casualty business (lawyers included). The 2004 letter is good and interesting; the 2001 letter (which recapitulates points and themes Mr. Buffett has set forth before) is essential to understanding insurance markets and dispelling pervasive myths about the pricing and profitability of insurance companies.

Posted by Marc Mayerson at 3:56 PM | Comments (2) | TrackBack

April 22, 2005

Expecting the Run-Around: Juries and Insurance-Coverage Cases

Over the past few years, we have participated in mock jury exercises in some of our coverage cases for policyholders. These exercises are extremely helpful in preparing for trial. They allow us to road test trial themes and to see what points gain transaction with our mock jury. Mock jury exercises sometimes will provide us with great handles for the real trial, such as a phrase or analogy that we had not thought of ourselves. We watch via closed-circuit television or through a one-way mirror while the jurors discuss the case and deliberate (they also fill out a raft of questionnaires that help us understand attitudes, demographics, and the like). But it is the deliberations that are most helpful to the trial lawyer. As an example, a mock juror in one exercise said, “A half truth is a whole lie,” which nicely characterized what we were trying to say about how the insurance company had misrepresented the policy language to the policyholder by omitting the key sentence that undercut its position entirely.

Typically, we compress the case into two 90-minute presentations, one for the insurer and one for the policyholder. (We – that is, lawyers for the policyholder – play both roles, but I haven’t found this to skew the exercise in the policyholder’s favor; we don’t tell the jurors that the lawyer playing the insurance-company’s lawyer really is a lawyer for the policyholder.) The presentations will use key documents and graphics. One of the consultants with whom I’ve worked calls what we do a “clopening”, that is, a combination of opening statement and closing argument. Essentially, we summarize and present the evidence and then argue our case. We’ll have a group of 30 to 40 people who are the audience; sometimes we make the presentation to all the jurors, and sometimes we present the case twice or three times to different juror panels (this allows us to tinker with our presentations based on the feedback from the prior mock jury).

Reflecting on the exercises I’ve participated in over the years has led me to the surprising realization that one consequence of (what I believe to be) the downward moral spiral of the insurance industry over the last couple of decades has been the lowering of expectations of jurors as to appropriate insurance company conduct. Jurors may have experienced the runaround themselves in the adjustment of their own claims, seen major price hikes in personal-lines coverage, and been flooded the stream of news of corruption in the industry (such as the broker-compensation imbroglio, the AIG mess, insurer bankruptcies, or in some states insurance commissioners being in the pocket – or trying to be – of insurance companies). I think the conventional wisdom is that juries are therefore primed to sock it to an insurance company and to cast the policyholder as a hero that in a surrogate capacity is vindicating the rights of the jurors.

No doubt that some jurors have this reaction. But I am increasingly feeling that the accumulation of years and years of insurer misconduct has browbeaten juries into submission. It is not that jurors feel that insurers are right or correct; rather, there is more of a sense that this is what you get when you buy insurance, whether you are a big guy or a little one. (One can think of this as a variant on a blame-the-victim theme.) In some ways, it may even be a relief to jurors to see companies encounter the same runarounds and hurdles that individuals deal with. None of this is to say that the insurance company is doing the right thing or is properly construing the policy or forthrightly dealing with its policyholder. Rather, misconduct now may be increasingly seen as par for the course. (The recent movie The Incredibles portrays well some of the inappropriate attitudes and approaches by insurers, where one needs an ex-superhero on your side in order to have your claim fully paid.)

The startling cynicism of some jurors – and perhaps an increasing percentage of them – has some important consequences:

1. At trial, it is crucial to establish the standards by which insurers are to be judged. The jurors must understand that both the aspirations of the insurance industry and its (best) customs and practices embrace fidelity to the interests of the insured and providing help and support in the policyholder’s time of need. The jury cannot be permitted to take the reality of current (mis) conduct and raise that to a normative standard by which to judge the insurer’s actions.

2. Long before we get to trial or litigation, the policyholder needs to be mindful that it has to set up its claim well. This means not putting things on the table simply in order to take them away and thus have something to negotiate with; that only serves to legitimize insurer nit-picking. The policyholder also must consistently provide full and detailed responses to the insurance company, demonstrating patience but also showing that the insurer is abandoning the insured and failing to discharge its obligations. (I’m not saying that policyholders should threaten bad faith at every turn but rather explain how they need the insurer’s support and are looking to the insurer for help.) Policyholders need to cross their T’s, dot their I’s, and turn square corners, or one provides the insurer with a cover for misconduct. (For some guidelines on doing this see, Mayerson, Pursuing and Perfecting Liability Insurance Coverage: A Primer for Policyholders on Complying with Notice Obligations, 32 Tort & Ins. L. J. 1003 (1997), available http://www.spriggs.com/news/pdfs/MSM-6.pdf.)

3. Insurance companies should not be heartened by all of this. In the short term, this may help insurers win trials (or the bad-faith claim) by moving the line for bad faith further out, such that bad faith is considered less to be a breach of acting in good faith and instead to require evil and malicious conduct (collapsing bad-faith liability into punitive damages). In the long run, however, a recognition by consumers and businesses that insurance really isn’t there for you when you need it most will doom the industry. What value would there be in buying insurance? On this point, see the extraordinarily thoughtful article (that also discusses past episodes of insurer shenanigans), Richard Stewart and Barbara Stewart, The Loss of the Certainty Effect, 4 Risk Management & Ins. Rev. 29 (2002), available at http://www.stewarteconomics.com/Certainty%20Effect.pdf.

Posted by Marc Mayerson at 3:54 PM | Comments (3) | TrackBack

Expecting the Run-Around: Juries and Insurance-Coverage Cases

Over the past few years, we have participated in mock jury exercises in some of our coverage cases for policyholders. These exercises are extremely helpful in preparing for trial. They allow us to road test trial themes and to see what points gain transaction with our mock jury. Mock jury exercises sometimes will provide us with great handles for the real trial, such as a phrase or analogy that we had not thought of ourselves. We watch via closed-circuit television or through a one-way mirror while the jurors discuss the case and deliberate (they also fill out a raft of questionnaires that help us understand attitudes, demographics, and the like). But it is the deliberations that are most helpful to the trial lawyer. As an example, a mock juror in one exercise said, “A half truth is a whole lie,” which nicely characterized what we were trying to say about how the insurance company had misrepresented the policy language to the policyholder by omitting the key sentence that undercut its position entirely.

Typically, we compress the case into two 90-minute presentations, one for the insurer and one for the policyholder. (We – that is, lawyers for the policyholder – play both roles, but I haven’t found this to skew the exercise in the policyholder’s favor; we don’t tell the jurors that the lawyer playing the insurance-company’s lawyer really is a lawyer for the policyholder.) The presentations will use key documents and graphics. One of the consultants with whom I’ve worked calls what we do a “clopening”, that is, a combination of opening statement and closing argument. Essentially, we summarize and present the evidence and then argue our case. We’ll have a group of 30 to 40 people who are the audience; sometimes we make the presentation to all the jurors, and sometimes we present the case twice or three times to different juror panels (this allows us to tinker with our presentations based on the feedback from the prior mock jury).

Reflecting on the exercises I’ve participated in over the years has led me to the surprising realization that one consequence of (what I believe to be) the downward moral spiral of the insurance industry over the last couple of decades has been the lowering of expectations of jurors as to appropriate insurance company conduct. Jurors may have experienced the runaround themselves in the adjustment of their own claims, seen major price hikes in personal-lines coverage, and been flooded the stream of news of corruption in the industry (such as the broker-compensation imbroglio, the AIG mess, insurer bankruptcies, or in some states insurance commissioners being in the pocket – or trying to be – of insurance companies). I think the conventional wisdom is that juries are therefore primed to sock it to an insurance company and to cast the policyholder as a hero that in a surrogate capacity is vindicating the rights of the jurors.

No doubt that some jurors have this reaction. But I am increasingly feeling that the accumulation of years and years of insurer misconduct has browbeaten juries into submission. It is not that jurors feel that insurers are right or correct; rather, there is more of a sense that this is what you get when you buy insurance, whether you are a big guy or a little one. (One can think of this as a variant on a blame-the-victim theme.) In some ways, it may even be a relief to jurors to see companies encounter the same runarounds and hurdles that individuals deal with. None of this is to say that the insurance company is doing the right thing or is properly construing the policy or forthrightly dealing with its policyholder. Rather, misconduct now may be increasingly seen as par for the course. (The recent movie The Incredibles portrays well some of the inappropriate attitudes and approaches by insurers, where one needs an ex-superhero on your side in order to have your claim fully paid.)

The startling cynicism of some jurors – and perhaps an increasing percentage of them – has some important consequences:

1. At trial, it is crucial to establish the standards by which insurers are to be judged. The jurors must understand that both the aspirations of the insurance industry and its (best) customs and practices embrace fidelity to the interests of the insured and providing help and support in the policyholder’s time of need. The jury cannot be permitted to take the reality of current (mis) conduct and raise that to a normative standard by which to judge the insurer’s actions.

2. Long before we get to trial or litigation, the policyholder needs to be mindful that it has to set up its claim well. This means not putting things on the table simply in order to take them away and thus have something to negotiate with; that only serves to legitimize insurer nit-picking. The policyholder also must consistently provide full and detailed responses to the insurance company, demonstrating patience but also showing that the insurer is abandoning the insured and failing to discharge its obligations. (I’m not saying that policyholders should threaten bad faith at every turn but rather explain how they need the insurer’s support and are looking to the insurer for help.) Policyholders need to cross their T’s, dot their I’s, and turn square corners, or one provides the insurer with a cover for misconduct. (For some guidelines on doing this see, Mayerson, Pursuing and Perfecting Liability Insurance Coverage: A Primer for Policyholders on Complying with Notice Obligations, 32 Tort & Ins. L. J. 1003 (1997), available http://www.spriggs.com/news/pdfs/MSM-6.pdf.)

3. Insurance companies should not be heartened by all of this. In the short term, this may help insurers win trials (or the bad-faith claim) by moving the line for bad faith further out, such that bad faith is considered less to be a breach of acting in good faith and instead to require evil and malicious conduct (collapsing bad-faith liability into punitive damages). In the long run, however, a recognition by consumers and businesses that insurance really isn’t there for you when you need it most will doom the industry. What value would there be in buying insurance? On this point, see the extraordinarily thoughtful article (that also discusses past episodes of insurer shenanigans), Richard Stewart and Barbara Stewart, The Loss of the Certainty Effect, 4 Risk Management & Ins. Rev. 29 (2002), available at http://www.stewarteconomics.com/Certainty%20Effect.pdf.

Posted by Marc Mayerson at 3:54 PM | Comments (2) | TrackBack

June 25, 2004

Equitas Financial Reports – 2004 Version

As is well known, Equitas Ltd. manages the run off of liabilities under non-life insurance policies issued by underwriters at Lloyd’s, London, prior to 1993, and these policies are exposed to paying for liabilities of US companies for certain asbestos, environmental, and other “health hazard” claims of injury or damage that occurred in the period of their coverage. Each year, Equitas publishes its financial results as of 31 March (for 2004, its Reports and Accounts were released in late June but were dated 3 June 2004) and provides additional commentary via an accompanying press release (dated 8 June 2004).

Equitas’s press release confirms that the accumulated surplus of Equitas has been reduced to ₤460 million, down ₤67 million the year before.

Equitas has liquidated approximately 85% of its total reinsurance receivable.

Equitas notes that its gross undiscounted asbestos reserves have increased to ₤4.0 billion (increased by ₤296 million).

According to its figures Equitas’s solvency margin improved to 9.8% from 8.7%.

Of particular note are the following:

• Equitas’s Chief Executive Officer, Scott Moser, candidly acknowledged that, when assureds agree to policy buyouts (whereby they liquidate and extinguish all rights to coverage under policies issued by Lloyd’s underwriters prior to 1993), one key factor driving the pricing for those assured is “eliminating credit risk” (Release p.2; Report p. 5) – that is the credit risk of Equitas’s being unable to pay claims. Nevertheless, in a typical example of Equitas double-talk, footnote 1 to Equitas’s financial statements proclaims, “The Directors believe that the assets should be sufficient to meet all liabilities in full” (Report p. 33) (emphasis added). While Equitas represents to policyholders that there is substantial credit risk, to their auditors Equitas represents the opposite.
• Equitas acknowledged that its claims settlements with policyholders were for an amount nearly ₤100 million less than the book value of the claims. (Release p.8) In other words, Equitas paid ₤97 million less to its assureds than the amounts Equitas reserved for their future stream of claim payments. As we have seen upwards adjustments annually to Equitas’s asbestos reserves for the past several years, if one were to assume that next year Equitas again “strengthens” its reserves, the underpayment to its assureds in fact will turn out to be greater than the ₤100 million in savings Equitas acknowledged this year. (Last year (2003), Equitas acknowledged freeing ₤142 million through settlements with its assureds for less than the reserved values, but its current release does not indicate the appropriate upward adjustment of the “savings” from the prior year’s settlements, given that, even considering those policy buyouts, Equitas was constrained to increase its asbestos reserves again.)
• Equitas’s analysis of the proposed US asbestos-reform legislation showed that its passage would have resulted in Equitas’s risking becoming insolvent. That Equitas views the legislation’s passage as risking its own solvency calls into the question its ability to meet the asbestos-coverage claims of its US assureds.
• Equitas’s major asbestos deals this past year vest in it the right to a refund, or reduction in its future payout obligation, of ₤400 million, in the event federal asbestos-liability reform legislation passes. Equitas does not explain whether it takes this contingent asset into account in its financial statement or in its analysis that passage of the legislation may result in its insolvency.
• Equitas has commuted (liquidated) more than 85 percent of its potential reinsurance recoverables. (Report p. 6) As a result, Equitas is unable to justify its oft-invoked statements to policyholders that unless they demonstrate syndicate information on their Lloyd’s coverage Equitas is unable to make any payment; though this position had some equitable force when Equitas needed such information to facilitate its own outward reinsurance recoveries, that those recoveries have been received already via commutations means that Equitas’s need for this information has correspondingly diminished. Given that Equitas was itself able to achieve commutations without knowing each particular assured’s allocation of liabilities to particular policies, Equitas cannot equitably contend that it should pay nothing with respect to a policy that is known to cover a certain dollar amount but as to which syndicate-participation information is lacking.
• Equitas balances the candid admission of its underpaying its own assureds with the exhortation to its policyholders to settle their claims with Equitas: “If you are being told that you cannot do a fair deal with Equitas, you need new advisers.” (Release p.3; Report p.11) Equitas plainly believes that “fair” deals are at less than its reserve levels for the claims released and are priced against the threat of Equitas’s insolvency.
• The impact of an Equitas insolvency, however, must be offset against the financial structures undergirding the original sale in the US of policies through Lloyd’s. There are US based trust funds, as well as the “old” and “new” Central Funds and possibly the full capital resources of Lloyd’s current membership, that are part of the “chain of security” backing Lloyd’s underwriters’ policies. For example, according to the 2004 Report, there is in excess of ₤2.5 billion in US and Canadian trust funds “for the settlement of claims relating to those jurisdictions.” (Report p.40). A policyholder’s right of recourse to these monies, however, is released in policy settlements with Equitas.

Posted by Marc Mayerson at 6:24 PM | Comments (0)

Equitas Financial Reports – 2004 Version

As is well known, Equitas Ltd. manages the run off of liabilities under non-life insurance policies issued by underwriters at Lloyd’s, London, prior to 1993, and these policies are exposed to paying for liabilities of US companies for certain asbestos, environmental, and other “health hazard” claims of injury or damage that occurred in the period of their coverage. Each year, Equitas publishes its financial results as of 31 March (for 2004, its Reports and Accounts were released in late June but were dated 3 June 2004) and provides additional commentary via an accompanying press release (dated 8 June 2004).

Equitas’s press release confirms that the accumulated surplus of Equitas has been reduced to ₤460 million, down ₤67 million the year before.

Equitas has liquidated approximately 85% of its total reinsurance receivable.

Equitas notes that its gross undiscounted asbestos reserves have increased to ₤4.0 billion (increased by ₤296 million).

According to its figures Equitas’s solvency margin improved to 9.8% from 8.7%.

Of particular note are the following:

• Equitas’s Chief Executive Officer, Scott Moser, candidly acknowledged that, when assureds agree to policy buyouts (whereby they liquidate and extinguish all rights to coverage under policies issued by Lloyd’s underwriters prior to 1993), one key factor driving the pricing for those assured is “eliminating credit risk” (Release p.2; Report p. 5) – that is the credit risk of Equitas’s being unable to pay claims. Nevertheless, in a typical example of Equitas double-talk, footnote 1 to Equitas’s financial statements proclaims, “The Directors believe that the assets should be sufficient to meet all liabilities in full” (Report p. 33) (emphasis added). While Equitas represents to policyholders that there is substantial credit risk, to their auditors Equitas represents the opposite.
• Equitas acknowledged that its claims settlements with policyholders were for an amount nearly ₤100 million less than the book value of the claims. (Release p.8) In other words, Equitas paid ₤97 million less to its assureds than the amounts Equitas reserved for their future stream of claim payments. As we have seen upwards adjustments annually to Equitas’s asbestos reserves for the past several years, if one were to assume that next year Equitas again “strengthens” its reserves, the underpayment to its assureds in fact will turn out to be greater than the ₤100 million in savings Equitas acknowledged this year. (Last year (2003), Equitas acknowledged freeing ₤142 million through settlements with its assureds for less than the reserved values, but its current release does not indicate the appropriate upward adjustment of the “savings” from the prior year’s settlements, given that, even considering those policy buyouts, Equitas was constrained to increase its asbestos reserves again.)
• Equitas’s analysis of the proposed US asbestos-reform legislation showed that its passage would have resulted in Equitas’s risking becoming insolvent. That Equitas views the legislation’s passage as risking its own solvency calls into the question its ability to meet the asbestos-coverage claims of its US assureds.
• Equitas’s major asbestos deals this past year vest in it the right to a refund, or reduction in its future payout obligation, of ₤400 million, in the event federal asbestos-liability reform legislation passes. Equitas does not explain whether it takes this contingent asset into account in its financial statement or in its analysis that passage of the legislation may result in its insolvency.
• Equitas has commuted (liquidated) more than 85 percent of its potential reinsurance recoverables. (Report p. 6) As a result, Equitas is unable to justify its oft-invoked statements to policyholders that unless they demonstrate syndicate information on their Lloyd’s coverage Equitas is unable to make any payment; though this position had some equitable force when Equitas needed such information to facilitate its own outward reinsurance recoveries, that those recoveries have been received already via commutations means that Equitas’s need for this information has correspondingly diminished. Given that Equitas was itself able to achieve commutations without knowing each particular assured’s allocation of liabilities to particular policies, Equitas cannot equitably contend that it should pay nothing with respect to a policy that is known to cover a certain dollar amount but as to which syndicate-participation information is lacking.
• Equitas balances the candid admission of its underpaying its own assureds with the exhortation to its policyholders to settle their claims with Equitas: “If you are being told that you cannot do a fair deal with Equitas, you need new advisers.” (Release p.3; Report p.11) Equitas plainly believes that “fair” deals are at less than its reserve levels for the claims released and are priced against the threat of Equitas’s insolvency.
• The impact of an Equitas insolvency, however, must be offset against the financial structures undergirding the original sale in the US of policies through Lloyd’s. There are US based trust funds, as well as the “old” and “new” Central Funds and possibly the full capital resources of Lloyd’s current membership, that are part of the “chain of security” backing Lloyd’s underwriters’ policies. For example, according to the 2004 Report, there is in excess of ₤2.5 billion in US and Canadian trust funds “for the settlement of claims relating to those jurisdictions.” (Report p.40). A policyholder’s right of recourse to these monies, however, is released in policy settlements with Equitas.

Posted by Marc Mayerson at 6:24 PM | Comments (0)