Reflecting on the Past
A decade later, three significant insurer insolvencies offer a new perspective on receivership strategy.
Insolvent insurers may come and never quite go away quickly enough, but Reliance Insurance Co. will always occupy a special place in Joe DiMemmo's memory.
As Pennsylvania's deputy insurance commissioner for the Office of Liquidations, Rehabilitation and Special Funds, DiMemmo has spent the last decade leading a collective effort to resolve not just one, but three of the insurance industry's largest insolvencies.
DiMemmo said he keeps telling the Reliance team that they have two more years of cleanup work, but realizes it will take at least twice that time, if not more.
"We're looking at a five-year span to be pretty much done," DiMemmo said.
That same time span goes for Legion Insurance Co., an insurer that came under his office's supervision March 28, 2002--just five months after a judge ordered Reliance's liquidation.
Sandwiched in between those two events was the court-ordered liquidation of Phico Insurance Co., a state-based medical professional liability provider. These three Pennsylvania companies remain among the industry's top five property/casualty insolvencies, according to the National Conference of Insurance Guaranty Funds.
It's not something that DiMemmo brags about, but there is a confidence in the level of success that he anticipates once the three insolvencies conclude.
"I would think that Reliance, Legion and Phico, when they are completed, will be good examples of how to conduct a liquidation," DiMemmo said.
At the end of 2010, Reliance had estimated liabilities of $9 billion, according to the most recent court filing. Assets stood at $5 billion, with roughly $3 billion coming from reinsurance proceeds--a key recovery area in receiverships that can grow contentious and quickly chew up time and resources.
For another measure of success in Reliance's receivership, DiMemmo notes that $2 billion has been paid out to guaranty association funds for reimbursement of covered claims.
There also have been 160,073 proofs-of-claim filed against the Reliance estate.
"If we had 5,000 before that, that was a big number," DiMemmo said, referring to the magnitude of Reliance's insolvency. He said state regulators spent the first year trying to get their arms around what was essentially a multiline New York City-based operation with 500 employees.
It's not just sheer size that separates Reliance from other insolvencies. DiMemmo said several aspects have become "firsts." In prior insolvencies, about 95% of the value in filed claims was covered under state guaranty association limits. In Reliance's case, that level tapered off to 75%, meaning that the balance of those claims must be recovered from estate proceeds.
"That's the first time that we've actually seen that kind of allocation between covered and uncovered," he said.
Some claimants didn't qualify for guaranty association coverage because they had a net worth in excess of $50 million, something else DiMemmo said he's never come across.
The state also has posted detailed quarterly financial legal filings on Reliance, as well as other insolvencies, to a department-run public website. "It is information that is available to claimants to gauge where they stand and the likelihood of what they are going to get at the end of the day," DiMemmo said.
That effort indirectly serves yet another new wrinkle that DiMemmo saw while unfolding Reliance's book of business: claimants selling their stakes in the estate to third parties.
"There are people out there saying, 'I'll give you 20 cents on the dollar now,' hoping that they'll get 50 cents on that claim at the end of the day," DiMemmo said.
Fewer Impairments in 2010
The number of financially impaired insurers tapered off in 2010. Eleven property/casualty companies were deemed financially impaired in 2010, according to an A.M. Best Co. Special Report issued May 2, 2011. That was down from 19 in 2009. Of that 2010 group, seven were commercial insurers. The report also noted three impairments in 2011: two Florida automobile insurers and a California workers' compensation writer.
The A.M. Best Special Report cited the primary causes of last year's impairments as deficient loss reserves and inadequate pricing, a combination that accounted for 40% of the impairments that have occurred between 1969 and 2010.
On the life/health side, six companies were impaired in 2010, with the study again citing deficient loss reserves and inadequate pricing.
Daniel J. Ryan, vice president of property/casualty for A.M. Best, said the adoption of better practices in risk management and technology use over the past decade has had a positive impact on the property/casualty landscape. Improved data and information gathering has facilitated better pricing and reserve setting, while advancements in predictive modeling, price tiering, catastrophe modeling and agency management reviews have made property/casualty insurers "better equipped and more aware of their business than ever before."
Ryan said that, unfortunately, there may be a handful of insurers that is unwilling to follow industry's best practices. For casualty insurers, he said reserves will more than likely always be at the forefront of impairments due to the fact that setting reserves is not an exact science.
"More importantly, reserves for many casualty insurers typically represent a multiple of an insurer's surplus and any material deviation in reserves culminates in a direct impact to surplus," Ryan said. "Inadequate pricing and under-reserving for casualty insurers generally go in lockstep as pricing errors end up being the root cause of adverse reserve development."
Inadequate pricing issues can be a significant detrimental factor in long-tail lines of business, leaving those writers more at risk than the short-tail lines.
"A pricing model that's based on past historical experience but directly influenced by future experience can leave insurers years into a policy before learning of a new trend and being able to adjust its pricing," Ryan said.
Former Missouri regulator Douglas A. Hartz said a prevailing issue in the receivership segment is that there are fewer liquidations.
Hartz, a consultant and deputy receiver with the Insurance Regulatory Consulting Group, said state regulators have become more adept at taking early action over the last half-dozen years or so, which has decreased the negative consequences for consumers and the industry.
"The much-improved early detection was useless without this shift to earlier action. Now, when they do find a problem, they start taking less-drastic steps than liquidation," Hartz said. "We see a lot more companies going from supervision or rehab into a more sustainable runoff as a result of this."
Hartz, former senior counsel for financial and insolvency regulation at the National Association of Insurance Commissioners, said regulators have focused on the insolvency aspect for too long. He said it can be hard to prove, and a costly case to litigate if company management wages a legal fight.
Placing more scrutiny on impairment, where a company's financial stability is called into question earlier, can provide a more viable alternative, Hartz added.
"Issuing a formal order to correct the problems in a company, and then having that company fail to adhere, can provide black-and-white grounds for receivership rather than trying to prove insolvency," he said.
Difficult to Come Back
Hartz said that once a company's financial standing is downgraded, it can have a debilitating effect on an insurer's full recovery to writing business. He said it's not so much an issue of fixing financial issues, but the stigma that a downgrade represents in terms of trying to re-enter the market. Usually an insurer cannot get an upgrade without new ownership, he said.
"[That rating] is a huge factor in being able to write business," Hartz said. "Whereas 20 years ago it really wasn't, it is more so now."
As regulators grow less-inclined to step toward the full liquidation route, guaranty funds or associations may find themselves less active. Hartz said the scenario presents a dilemma for the managers of state guaranty associations, which cover authorized policyholder claims. While a guaranty association's size must reflect the level of liquidation activity, there's always a worst-case scenario to contemplate.
"You just don't know when the next Reliance may happen and you need to be able to gear up very quickly," Hartz said. "But you can't stay at the Reliance-ready size. That's just not cost-effective."
Maintaining a level of readiness is one of the core components that NCIGF reinforces to its membership. The coalition of guaranty fund associations also serves as a central clearinghouse in an insolvency scenario that involves a multistate book of business.
Those reimbursable claims tend to be capped at $300,000, but can fluctuate by state.
Connecticut's fund pays up to $400,000, while Alaska, California, Rhode Island and Vermont have a $500,000 cap, according to the A.M. Best report. The report also notes that most state funds provide full coverage on workers' compensation claims, with several states maintaining separate funds.
Roger Schmelzer, NCIGF president and chief executive, said there is a more concerted effort among state regulators to connect with one another's receivership issues. Schmelzer said the NAIC has created a financial analysis working group that provides a forum to "discuss these receiverships as opposed to having just one state become the receiver and handle it."
"This is now a process that lets regulators in all of the affected states know more about a receivership that is being administered by a single state," he said.
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A Different Approach in the UK
While U.S. regulators steer insolvencies through a defined legal course, a schemes-of-arrangement approach in the United Kingdom cedes decision-making authority to creditors.
An underlying goal of the schemes process is to engage companies and creditors in ways that affect an expedient outcome for insolvencies. While the scheme itself must be sanctioned by the court, its key decisions are subject to approval by a majority of creditors.
Harold Horwich, partner in Bingham McCutchen LLP's restructuring department and head of the firm's insurance practice, likened the approach to Chapter 11 bankruptcy proceedings in the United States.
"You have both voting and court approval with the expectation that the court is the place where someone could challenge the validity of the votes, but also the structure of the plan," Horwich said.
Horwich said it's difficult to make a generalization about which system is faster. But he did say there is a general perception that U.K. schemes move more quickly, efficiently and effectively.
"In part because you have insolvency practitioners who are moving the case," he said. "They don't have the regulatory history with the company like a U.S. regulator has, so they come to it with a somewhat freer hand."
Richard Grant, managing director at Alan Gray Inc., concurred that the schemes approach can be quicker, especially when viewed in light of some larger U.S. insolvencies that continue to languish in receivership.
"One of the big differences is that each insolvency is the responsibility of the individual state in which it's domiciled," Grant said.
"Everybody does it a little bit differently. There's not the consistency that there is over there," Grant added.
Rhode Island has adopted a solvency scheme approach that is used in the United Kingdom. The state law provides a mechanism for its domiciled commercial insurers to extinguish liability for past and future claims short of an actual insolvency. Such an approach can enable companies to redistribute capital more quickly.
Horwich said that the U.K.'s solvent scheme approach begs a larger question over who should bear the brunt of what may happen to a policyholder in the future.
"Is it the policyholder, or the holders of the equity?" Horwich asked.
"In the U.K., they've said that it's the policyholder's risk."
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10 Years After: Regulators are still liquidating three insolvent Pennsylvania insurers.
Ten years ago, the Pennsylvania Department of Insurance was quickly saddled with three foundering insurers in the span of just 10 months. The first, Reliance Insurance Co., occurred a little more than three months before the 9/11 terrorist attacks upended reinsurance markets. Reliance, Phico Insurance Co. and Legion Insurance Co., remain three of the top-five-largest insolvencies, according to the National Conference of Insurance Guaranty Funds.
Joe DiMemmo, Pennsylvania's deputy insurance commissioner for the Office of Liquidations, Rehabilitation and Special Funds, can finally see light at the end of the tunnel for closing these three cases. Here's a rundown of how those insolvencies unfolded, and where they stand.
Reliance Insurance Co.
Rehabilitation: May 29, 2001
Liquidation: Oct. 3, 2001
Reliance reported a $1.7 billion surplus in 1998, the highest in its 181-year history. The issuance of its 1999 financial statement tipped Pennsylvania regulators to a below-standard capital level. A financial exam ordered a day later, on March 2, 2000, resulted in the following: an outside actuary reviewing reserve levels; agreements to increase financial reporting requirements; and a supervised runoff.
At the time of rehabilitation, then-Insurance Commissioner Diane Koken noted two key events. First, Reliance had experienced larger and more-frequent claims in its high-risk business, which required increased loss reserves. Second, she said that when A.M. Best Co. downgraded Reliance's Financial Strength Rating from A- (Excellent) to B++ (Good) in June 2000, "it resulted in the loss of the company's brokered commercial business."
DiMemmo said every time an actuary looked at the company's liabilities, that amount increased by several hundred million dollars.
"What we were experiencing was a cash flow problem, and when 9/11 hit, all the reinsurers stopped paying completely," he said. "By October we realized there's no way we could do this."
A lawsuit filed on June 24, 2002, accused former Reliance Chairman Saul Steinberg and other executives of draining company revenue to support lavish lifestyles. Cash was siphoned off and given to Reliance Group Holdings Inc. and Reliance Financial Services Corp., which issued dividends to shareholders, according to the lawsuit.
The former directors eventually settled civil claims for $85 million, with $51 million set aside for Reliance policyholders. In 2008, Deloitte & Touche LLP settled claims regarding breach of fiduciary duty and professional negligence for $40 million.
As of December 2010, Reliance had $9 billion in remaining liabilities and $5 billion in assets.
Phico Insurance Co.
Rehabilitation: Aug. 16, 2001
Liquidation: Feb. 1, 2002
The Mechanicsburg, Pa.-based company was the state's second-largest writer when Commonwealth Court of Pennsylvania approved liquidation. The company's primary business was medical professional liability for health systems, hospitals and physicians. State regulators said a quarterly statement filed in August 2001 showed a surplus of $6.8 million, an alarming decrease from the year-end 2000 surplus of more than $127 million.
DiMemmo said a turning point came two years ago when the court agreed to set a deadline on new claims. Reinsurers were then approached about commuting existing treaties.
"We negotiated and settled all the reinsurance, which was pretty close to $1 billion," DiMemmo said. "Once we settled the reinsurance, we went back to the guaranty associations and commuted with them."
DiMemmo also said the court obliged with a claims estimation date regarding outstanding contingent claims, which mainly involved medical liability issues. It required anyone who believed they would have a claim to provide an estimated value.
"Now we're down to 10 claims," he said "We're trying to negotiate in regard to their value, but to the extent we can't, we're going to turn those over to the court to adjudicate and the court will put a dollar amount on that. My hope is that we should be done by the end of 2011. So within nine years we were able the clean that up."
As of March 31, 2011, Phico's estate had $1 billion in estimated liabilities; assets totaled $614.6 million, according to court records. That same court filing indicated that early access advances to guaranty associations totaled $457.7 million.
Legion Insurance Co.
Rehabilitation: March 28, 2002
Liquidation: July 28, 2003
Mutual Risk Management Ltd. was the ultimate controlling shareholder for Legion Insurance Co. and Villanova Insurance Co., two fronting carriers in the commercial property/casualty segment. Revenue for the two insurers, known as the Legion Group, was generated through fees as opposed to underwriting profit. The approach resulted in the entities retaining little risk.
DiMemmo said that at the end of 2001, just prior to rehabilitation, the Legion Group had a $300 million surplus. He said that led regulators to believe they could rehabilitate the company. But once they took over, they realized how difficult things were.
"Ninety percent of the premiums they took in were ceded back out to reinsurers," he said. "When they got a claim they had to pay 100 cents on the dollar and seek reimbursement from the reinsurer for 90 cents."
DiMemmo described the company as "virtual" in that its infrastructure consisted of managing general agents and third-party administrators. When the company experienced cash flow issues in 1999, it opted to bill reinsurers more quickly. That move, however, led to reinsurance disputes and subsequently resulted in A.M. Best Co. downgrading Legion's and Villanova's Financial Strength Ratings from A to A- in December 2000.
"Once Legion lost its A.M. Best A rating, reinsurers stopped paying," DiMemmo said. "They do that because they realize something is happening. What they don't want to do is pay the company too much and get caught up in a receivership and have to get the money back."
As of March 31, 2011, the Legion Group's estate had $3.05 billion in assets, with reinsurance and future reinsurance recoverables totaling $1.5 billion, according to court records. Total estimated liabilities were listed at $3.9 billion.
By Al Slavin, senior associate editor, BestWeek
