Reliance: Liquidation Update

• Barbara Bowers
• September 2004
• 

Nearly three years after Reliance Insurance Co. went into liquidation, several major court cases involving the failed insurer have yet to be resolved.

Progress has been made, however, on separate litigation brought by Reliance employees against company executives. That outcome is a $5 million settlement, which will be the subject of a special hearing in Philadelphia on Sept. 30.

"We're moving through the process, but with a company the size of Reliance, it's going to take time," said Rosanne Placey, spokeswoman for the Pennsylvania Insurance Department. Pennsylvania Insurance Commissioner M. Diane Koken, Reliance's liquidator, is pursuing several civil actions she filed in 2002 against former directors and officers of the company, former auditors and appointed actuary, and companies and individuals from whom she is seeking recovery of alleged preferential payments made in the year before Reliance went into rehabilitation. The Commonwealth Court of Pennsylvania in Philadelphia has ordered the cases consolidated for pretrial purposes and all parties have agreed to a schedule order that projects a trial date of September 2005, although this date could well change, a department attorney said.

The largest property/casualty company ever to go under in the United States, Reliance was placed into liquidation in October 2001 after regulators found the company was insolvent by $1.1 billion. Officials of Reliance Group Holdings Inc. had declared bankruptcy on June 12, 2001.

In the directors and officers case, Reliance executives, including former Chairman Saul P. Steinberg, are accused of draining the company of money to support "lavish" lifestyles. Currently, this case is in mediation, Placey said.

This lawsuit, filed June 24, 2002, in the Commonwealth Court of Pennsylvania in Philadelphia, accuses Steinberg and 17 other directors and officers of breach of fiduciary duty and professional negligence for causing Reliance to fail. "The collapse of Reliance lies squarely at the feet of the defendant former directors and officers," the lawsuit said. Placey said that Koken couldn't comment directly on this or other pending litigation.

In court papers, regulators accuse the directors and officers of draining cash from the insurance company and giving it to the parent holding companies, Reliance Group Holdings Inc. and Reliance Financial Services Corp., which issued dividends to the shareholders, including Steinberg. The judgment of the directors and officers was "so distorted" that they "recklessly and negligently failed to adequately oversee, monitor and safeguard the financial condition of the company. Instead, they favored the interest of [the parent companies] and their shareholders, whose appetite for cash was insatiable," the lawsuit said.

The defendants permitted $500 million in cash to be diverted from the insurer to the parent companies in the form of dividends, bogus tax payments and loans, Koken said in the lawsuit. The directors and officers "knew or should have known that the lavish lifestyles of controlling shareholders, including defendant Saul Steinberg, the enormous debt of the parent holding companies and the huge personal debt of Saul Steinberg, had become the driving force behind the draining of Reliance's cash, rather than the best interests of the company and its policyholders," according to court documents.

Steinberg owed more than $41 million in personal loans, many of which were secured by his personal holdings of more than 36 million shares of Reliance Group Holding stock. When the stock declined from a high of $20 in 1998 to $5 in the summer of 1999, Steinberg's net worth fell, and he was informed by at least one bank that he'd have to post additional collateral or be in default.

The insurance company continued to pay dividends to the parent companies, which in turn paid dividends to Steinberg and others, even as its financial condition weakened due to unprofitable underwriting. "Defendants' relentless bleeding of cash and surplus from Reliance during the precise period when defendants knew or should have known that reserves were understated ... broke the back of the company and caused it to crumble and fail," the lawsuit said.

For instance, the same day the company retained a third party to investigate a possible $400 million cash infusion for Reliance Group Holdings, the directors approved a $50 million dividend to be paid to the parent companies, court papers said.

Executive Compensation

The lawsuit also accuses the defendants of rewarding executives with excessive salaries and bonuses, even as the company slipped into insolvency, and misusing corporate property. For instance, the company had a private jet with five bedrooms, but 55% of its use was for personal trips for Saul Steinberg and co-defendant Robert Steinberg, a director of the company, chairman of the board and chief executive officer of Reliance Insurance Co. Saul and Robert Steinberg are brothers.

In 2000 and 2001, when the company had become insolvent, Reliance paid $7 million to Robert Steinberg in lump salary and termination-settlement payments.

Koken also has filed a malpractice lawsuit against Reliance's former auditor and outside actuary, Deloitte & Touche LLP, and one of the firm's principals. Meanwhile, this case has been stayed pending mediation of the D&O case, Placey said.

Before Reliance was placed in rehabilitation in May 2001, Robert Steinberg was paid more than $3.6 million in severance, bonuses and "consulting" fees. The liquidator has begun a preference action against him, seeking the return of those monies. Through 13 other preference actions, Koken hopes to recoup $36 million in preferential payments.

ERISA Suit

On another front, a $5 million settlement reached in a class action brought by Reliance employees against company executives will be the subject of a fairness hearing on Sept. 30 in the United States District Court for the Eastern District of Pennsylvania in Philadelphia. The court will consider employees' objections to the settlement and decide if it should be approved. The settlement, announced May 14, 2004, resolves a lawsuit over whether the managers of the employees' retirement and welfare plans breached their fiduciary duties by violating ERISA, the federal Employee Retirement Income Security Act. This law, enacted in 1974, imposes certain fiduciary duties upon plan managers and gives employees the right to sue for benefits if they think the managers have failed to carry out those duties.

The defendants have continued to deny any liability with respect to the plaintiffs' claims, the court said.

The litigation covers about 5,000 people who participated in the Reliance Savings Incentive Plan from Jan. 1, 1999, to Dec. 24, 2003. Estimates are that the net settlement amount--once attorneys' fees, costs and expenses are deducted from the $5 million--could be about $3 million.

When Reliance was placed in receivership, more than 15,000 lawsuits were pending nationwide against the company and its insureds, the department estimated. "Although new litigation has largely subsided, a few new lawsuits are received each month, requiring the liquidator to seek stays of these matters," regulators wrote in a February 2004 report on Reliance's status.

In the same report, they told Commonwealth Court Judge James Gardner Colins that Reliance's assets trail the company's outstanding liabilities by nearly $3 billion. Reliance has total assets of $5.9 billion but has $8.7 billion of liabilities, of which $6.6 billion are related to direct business losses and loss-adjustment expenses and $1.2 billion are related to losses on assumed reinsurance business. The department said the gap could widen if Reliance fails to gain a significant portion of its $3.9 billion in reinsurance recoverables.

Reliance Group Holdings Inc. was founded in 1817 in Philadelphia. Reliance National, the group's largest property/casualty unit, provided specialized coverages and risk-management services for Fortune 1,000 companies domestically and internationally. As of Dec. 31, 1997, the group's revenues were $3.44 billion, net income was $229.4 million, and shareholders' equity was $962.5 million, a 42% increase from a year earlier.

Reliance Group's financial position began to deteriorate after it posted a fourth-quarter 1999 net loss of $123 million and took a $117 million after-tax charge to settle a dispute over workers' compensation business it took as a fronting company for the workers' comp reinsurance pool run by Unicover Managers Inc., later known as Cragwood Managers LLC.

By Barbara Bowers, senior associate editor, Best's Review: Barbara.Bowers@ambest.com