Insurance Insolvencies: The Reinsurer's View

Introduction

The relationship between a reinsurer and a cedant is meant to be a mutually beneficial partnership. It is characterized by a high degree of trust and good faith dealings. But when the reinsured company gets into financial difficulty and ultimately fails, that relationship can change overnight. The bond is loosened; the benefits are no longer mutual; and, the level of trust between the parties often declines.

For most of those involved with the insolvent reinsured — its policyholders, employees, investors, brokers, officers and directors — the failure of the company is an unmitigated calamity quite apart from any changing relationship with the company’s reinsurers. Coverages, jobs, investments and careers are lost. To those directly involved with the sinking enterprise, whether the company has a strong relationship with or can recover from its reinsurers is of secondary importance, and best left to the appropriate regulator to address.

For the reinsurer of the insolvent, on the other hand, the significant change in the relationship can be a mixed blessing. No reinsurer deliberately begins a relationship with a cedant that is clearly headed towards liquidation. But the failure of the ceding company can surprisingly bring some financial benefits as well as the expected headaches.

In the following section, we discuss the storm clouds that gather over the reinsurer when its cedant fails. Later, some unexpected silver linings are pointed out.

The Storm Clouds Gather

Once the ceding company is declared insolvent and a receiver for the estate is named, the company is transformed. It has changed from an ongoing insurance enterprise to a ghost of its former self, under state supervision with the receiver standing in the shoes of the insolvent.

To the reinsurer, the cedant isn’t the same cedant anymore.

1. Before insolvency, it investigated and mitigated policyholder claims; now that it has become insolvent, it is some times perceived as searching for claims.

(See, for example, in Missouri § 375.1208 R.S.Mo 3: “At any time the liquidator may request the claimant to present information or evidence supplementary to that required under subsection 1 of this section and may take testimony under oath, require production of affidavits or depositions, or otherwise obtain additional information or evidence.” Reinsurers sometimes grumble that liquidators are too exuberant in encouraging claimants to pursue their claims in the receivership.)


2. Before the cedant asked for money only when it actually paid a claim; now it asks for reimbursement even though it has not actually paid anything.

(Most reinsurance contracts are indemnification agreements requiring the reinsurer to reimburse the cedant only for the amount of losses actually paid. Since the estate does not pay policyholders immediately for allowances, reinsurers may believe that they are not required to make a reimbursement until actual payment is made. However, the insolvency clause, contained in nearly all US reinsurance contracts, requires the reinsurer to pay the liquidator without diminution because of the insolvency. See NY Insurance Law Section 1308(a)(2). )

3. Once the cedant tried to commercially resolve disputes with its reinsurers
informally; now litigation and arbitration are commonplace.

(Quackenbush v. Allstate Ins. Co., 517 U.S. 706 (1996); Corcoran v. Andra, 77 N.Y.2d 225; 567 N.E.2d 969 (1990). )

4. Previously, the cedant protected the reinsurer from excessive financial shocks ; nowadays it tries to engineer a commutation of the entire reinsurance contract.

(If they lose money in a contract year, reinsurers traditionally expect to be made whole by the cedant in the following years. Cedants also protect their treaty reinsurers by buying specific (i.e. facultative) reinsurance protection for a particularly volatile risk that would otherwise fall under the treaty contract. )

4. Formerly, the cedant would not draw down on a letter of credit; now it may threaten to do so.

(See, Robert Hall, Drawing Down Letters of Credit in an Insurer Receivership Context. 11 Mealey’s Lit. Rep.: Ins. Insolvency 21 (April 6, 2000). )

5. Previously, the companies could set off losses against premium; that has changed — the insolvent may now want to hold on any premium for as long as possible but have the reinsurer pay all losses as well.

(In Quackenbush v. Mission Insurance Co, 46 Cal. App. 4th 458, 54 Cal. Rptr. 2d 112 (1996), the California Court of Appeal upheld objections of reinsurers and the Reinsurance Association of America (RAA) to a plan by which the California Insurance Commissioner proposed to wind up the Mission estate through the estimation of outstanding claims and incurred but not reported (IBNR) losses. However, in Quackenbush v Mission Ins. Co. (1998, 2nd Dist) 62 Cal App 4th 797, 73 Cal Rptr 2d 95 the court approved an amended plan which expressly prohibited the Commissioner from requiring payment of incurred but not reported loss amounts from reinsurers until their liability for and the amounts of such losses were determined. See Angoff v. Holland-America Insurance. Court of Appeals Missouri, Western District 937 S.W.2d 213; (1996) where the court found no objections to collection of IBNR estimates from the reinsurers. )

To sum up, before insolvency the cedant was a business partner of the reinsurer; now it is a cash flow drain and a burdensome administrative strain. There are other drawbacks for the reinsurer. Valuable resources, such as time, staff, office space and money for travel costs, are devoted to winding down obligations under the terminated reinsurance contracts. These resources would otherwise be better used for working with continuing profitable active cedants.

Trust and agreement between the parties is often at low ebb, so more expenses are incurred to monitor claim handling and litigate or arbitrate disputes. Reserves stay on the reinsurer’s books longer because of inherent delays and uncertainty and because the liquidator needs more time to get organized.

There is also a danger of damaging the reinsurer’s reputation as a dependable, promptly paying partner because of the increasingly public and antagonistic disputes with the insolvent reinsured. This may be the greatest loss of all. A reinsurer lives or dies by its reputation as a longterm dependable partner of the cedant. An important element of its good name is the ability and willingness to pay claims promptly. A negative reputation involving a claim dispute with an insolvent carrier can damage its image.

In short, the environment is less predictable and more hostile for the reinsurer.

Involvement with a failed ceding company leads the reinsurer from the familiar world of private enterprise to the alien environment of government regulation, politics, and close public scrutiny, where all the rules seem to be turned on their head. With normal cedant/reinsurer relationships, the goal of both parties is to have a longstanding mutually profitable relationship. With insolvency, the goals diverge. The receiver is seeking generally to:

(1) fix the estate’s liabilities;
(2) marshal its assets; and,
(3) wind down the estate as promptly but as fairly as possible.

The reinsurer, on the other hand, is trying to become disentangled from the estate with the least damage in losses and expense costs.

The Reinsurer’s Silver Lining-Paying Less And Paying It Later

For the reinsurer, there can be a brighter side: lower settlements and delayed payments. These often are the advantages of a cedant’s failure. For many insolvencies, especially those with long tail exposures, it is certain the reinsurer would have paid more money more quickly if the company had survived. The ceding company’s failure generally throws a monkey wrench into the process, creating confusion and discouraging claimants from filing their claims in the first place or at least dampening their enthusiasm to pursue their claim.

Lower Payments.

Policyholder settlements with receivers are often lower than they would have been on an identical claim with a solvent company. Reinsurers, of course, benefit from this phenomenon.

Here are some of the reasons:

• Liquidations impose claim bar dates — in most states, 18 months or less after liquidation unless specially extended. Policyholders with long tail claims can find their claims have been barred before they were even asserted. When extensions are available, discouraged claimants don’t always apply for them.

• Even if they get past the bar date problem, insureds are not familiar with the protracted insolvency process and are, therefore, not as diligent or effective during the negotiations in maximizing their recovery and protecting their interests. Also, they may not invest sufficient time and effort to maximize their recoveries because they are doubtful they will ever recover much from the insolvency;

• Many large insureds abandon or ignore their claims against the estate completely, believing they would be throwing good money after bad in pursuing a small recovery in the insolvency court;

• Guarantee funds and receivers can play hardball in the negotiations with the policyholder, knowing threats of a bad faith claim are remote;

• In environmental and toxic tort claims, which can trigger many policies, policyholders ordinarily seek first to maximize recoveries from all solvent carriers and later seek discounted reimbursements from insolvents; and,

• In environmental and toxic tort claims, liquidators are not involved in costly coverage and defense litigation. Once it has been declared insolvent, all actions against the liquidated company are ordinarily stayed. (See Note 1 below) The cost of this litigation can be quite considerable.

This is not a one-way street though. There can be instances where the nsolvency itself may increase the amount of the reinsurer’s claims payments. For example, solvent insurers can at times resolve long-tail claims for less than the ultimate loss exposure by settling with the insured on a present value basis. The reinsurer may benefit from this lower settlement. (See note 2 below) policyholders are generally not willing to give any credit for the present value of money in negotiations with the insolvent since it will not pay the insured any part of a settled allowance until a court approved distribution from the estate is made (which can be many years in the future.) The reinsurer in this case may pay more on an identical loss because of the insolvency.

The reinsurer of an insolvent may also pay a higher amount more quickly, if the receiver estimates the ultimate value of the claims against the estate and demands immediate payment on these estimates from the reinsurer. Some states have provisions in their statutes that allow the receiver to do this. (See Note 3 below.)

The proposed Uniform Receivership Law (URL) also has a claim estimation provision with some limitations allowing what amounts to an arbitrated forced commutation. Reinsurers contend that these estimates can be unreliable and often are too high. (See note 4 below) They also argue that accelerating insurance recoveries breaches the fundamental terms of the agreement with the ceding company. On the other hand, claim estimation based on projections of past experience may understate the cost of late-developing claims. By “cutting off the tail” of long term liability policies, estimation may save reinsurers significant sums. (See Note 5 below.)

Delayed Payments.

Liquidation slows the entire claim evaluation and disposition process, frequently to a crawl, sometimes to what appears to be a standstill. There are instances of insurers taken over by receivers in the 1970’s, which are not yet, in the new millennium, finalized. (See note 6 below)

Reinsurers may benefit when the day of reckoning is postponed (or never reached.) The interest that a reinsurer can earn on years of postponed reimbursements can be significant. Several factors, unique to the insolvency of the company, impede the flow of money from the reinsurer to the cedant to the policyholder to the claimant. Here are some of the common ones:

• Many years can be spent just locating and organizing the records of the failed insurer. Insolvents’ accounts are often found by the receiver to be disordered, incomplete, kept in diverse places, or difficult to decipher. Disorganized records are often the reason why the company got into trouble in the first place, or else a consequence of the chaos that preceded its failure. With many of the original employees quickly leaving the insolvent, the receiver has a difficult time finding and reconstructing basic information, including insurance policies and reinsurance contracts.

• Unless appropriate financial and employment incentives are put in place, the receiver’s staff can slow the process, consciously or not. Faced with the prospect of losing their jobs once the estate is finalized, they may not be in a hurry to speed things along. They deserve to be given a financial or other good reason why a swift winding down of the estate is in their best professional and personal interest. Many estates have done this, but others have not.

• Policyholders often drag their heels in submitting timely and complete information to the receiver. Ordinarily, they are not acquainted with the receivership claim process, which includes completing a proof of claim and cooperating with the liquidator. They lose time just understanding what they must do to recover. Often may they become active only when they learn that the estate is going to pay an interim dividend or that the bar date is imminent.

• Reinsurers cause delays by scrutinizing settlements and coverage decisions more closely. Since the insolvent is no longer a business partner, the reinsurer is less likely to be overly accommodating, or to view a questionable claim with magnanimity.

• In the case of latent injury claims, which often trigger numerous policies, insureds usually first seek recovery from solvent carriers. Afterward, sometimes many years later, they may actively pursue their claim against the receivership, if they are not time barred. As the reinsurer of a very unprofitable insurance company it is, in some ways, a stroke of luck and good fortune that the cedant is declared insolvent. For the reinsurer, the ceding company’s insolvency tends to diminish the damaging effects of unprofitable underwriting.

Conclusion

The reinsurer’s difficulties with an insolvent cedant are well documented and easily understood. The benefits, meager as they sometimes are, can be overlooked or discounted. The reinsurer needs to accept the new, sometimes harsh, realities stemming from the insolvency of a cedant and develop a pragmatic and cost-effective exit plan.

Understanding why things are suddenly turned on their head is the first step towards these goals. The second step is to meet all obligations under the reinsurance contracts in this challenging new environment so that the situation does not go from bad to worse. Developing a close and supportive working relationship with the receiver’s claims operation will ensure that defendable claims are skillfully handled. Communicating and cooperating in general with the receiver makes good business sense.

ENDNOTES


1. For example see 215 ILCS 5/189 ”. . . The court may also restrain all persons, companies, and entities from bringing or further prosecuting all actions and proceedings at law or in equity or otherwise, whether in this State or elsewhere, against the company or its assets or property or the Director except insofar as those actions or proceedings arise in or are brought in the conservation, rehabilitation, or liquidation proceeding.”

2. The reinsurer may not benefit. The cedant could argue that its present value settlement should be shared with the reinsurer in the same ratio that the ultimate loss would have been shared in the absence of the settlement.

3. See for example in Illinois 215 ILCS 5/209(7); and in New Jersey see 8 Mealeys Lit. Rep.: Ins. Insolvency 13, at 4 (Dec. 2, 1996).

4. See Hall. Estimation of Claims and Acceleration of Reinsurance Recoverables: The Uniform Receivership Law. 10 Mealey’s Insolv. Rep. No. 17 at 16 (1999).

5. For a discussion of the prominent issues in claim estimations see Veed, Cutting the Gordian Knot: Long Tail Claims in Insurance Insolvencies. 34 Tort and Insurance Law Journal, No. 1, p. 167 (Fall 1998).

6. For example, Signal and Imperial in California were placed in liquidation in 1978. American Reserve in Illinois went into liquidation in 1979. These estates are still open.

Reinsurance Claim Handling in a Nutshell (Letter to a Reinsurance Friend)

Dear John,

So you took the plunge. You quit that stuffy old law firm and accepted a senior claims job at Total Reinsurance Company. Congratulations. I wanted to be among the first to wish you luck. When we spoke yesterday, you asked me to give you some suggestions on what to do in your new claim job at a big reinsurance company. I am flattered you asked and happy to oblige but I can only give you my two cents — you’ll have to judge things for yourself when you get there. After you have gotten your feet wet at the company, read this again and let me know how close to the mark I was.

First things first. Being a claim representative of a big reinsurer is fun. You will be exposed to a diversity of claims: everything from auto cases to medical malpractice to D&O claims to major property losses to environmental (asbestos, hazardous waste, etc.)Most of these claims will be large and complicated and will require your detailed analysis.

You will travel to many parts of the country and see how a wide variety of insurers and self-insureds handle their claims. Cedants will view you differently depending on the size of the company you visit. To the small companies, you will be an all-knowing visionary whose every word is inspired. To the large companies, you will be an annoying pest.

Keep in mind, also, that things are changing in the insurance and reinsurance world. The whole industry is consolidating into fewer and ever larger companies (think Berkshire Hathaway purchasing General Re and Munich Re acquiring American Re.) And now the line is blurring between insurance and reinsurance products. There are lots of reasons for this including cedants’ flight to quality and reinsurers’ need to achieve economies of scale. If they hired you at Total Re, I would say they really, really needed you. There are no extra bodies hanging around the offices of insurers or reinsurers anymore.

Second, at Total Re you will not be a claims person at all. Not really. They may call you that, but don’t believe it. You will not interview witnesses, photograph accident scenes, take statements, depose experts, or supervise counsel. The claim staff at the ceding company does all of those traditional claim tasks. Instead, at Total Re consider yourself part of underwriting, treaty production, actuarial, and accounting all at the same time with a sub-specialty in the claims field. Your true role at Total Re is to work within each of these departments and to bring to light the claims issues that affect these groups.

Let’s take them one by one.

1. Underwriting. Total Re’s goal is to make money reinsuring its cedants. It wants to pick the right companies and charge the right price. That is an underwriting function. To do this, the Total Re underwriting department will examine the business to be reinsured and structure a program. How the program is structured depends largely on the degree of risk that the underwriter sees in the transaction.

To weigh the risk, the underwriter will need to know, among other things, how well the cedant’s claim department shapes up in comparison with others. Does it have enough people? Are they competent? Do they do a good job in investigating, reserving and settling their cases? How quickly will they report claims to their reinsurer?

The Total Re underwriters are interested in these things because they affect the adequacy of the rate charged the ceding company. This is where you come in. The poorer the quality of the cedant’s claim handling, the higher the rate must be to make up for the riskiness this deficiency creates. The better the quality, the less risk and the lower the price can be. Of course, if the claim handling is extremely bad, no price will ever be adequate to cover the losses.

As a claim person, you can also shed light on the kinds of exposures the underwriters should expect on a specific book of business. Tell the Total Re underwriters about the types of claims that will arise, the trends in values, as well as important coverage issues. Anecdotes are instructive. Provide lots of examples. This will give them concrete knowledge and allow them to more profitably structure the reinsurance program.

If there are problems in the cedant’s claim department, you will need to make suggestions for improvement so that the cedant and Total Re can improve their bottom line.

At Total Re, you will really be a part of the Underwriting Department.

2. Production. To the ceding company, you are the day-to-day face of Total Re because of your periodic claim visits. This makes you an important part of the marketing department.

If you act professionally, competently and reliably, the cedant will tend to think of Total Re in the same way. Don’t you make a judgment about your auto carrier based on how they handle your claim? It is the same way with reinsurers, believe it or not.

Pay the claim promptly if it is warranted. Total Re’s business will grow only if it swiftly reimburses the cedant on valid claims. Most reinsurers generally require that the claim be paid within 5-7 business days after receipt of the claim. The cedant’s senior staff can get very nervous if their reinsurer is slow to pay on legitimate claims or comes up with spurious reasons why it will not pay.

From time to time you will have a question on whether you should pay a claim. Express your reservations long before the request for payment comes in, if possible. A difference of opinion on a single claim should not interfere with overall good relations between your companies.

Provide added value. This is a part of marketing. For example, you probably have seen more large complex cases than the cedants’ claim staff. Sharing your experience may prove useful to the cedant in handling a claim. But don’t be a know it all. The cedant’s claim staff usually knows a lot about their own business. Remember, also, that under the Follow the Fortunes clause in most reinsurance contracts, the cedant’s claims handlers generally have the last word in how the case is handled. All you can do and should do is make suggestions. The cedant’s claim staff can take it or leave it.

Total Re may have specialized departments to help its cedants with unique claims situations. These services will distinguish Total Re from the other reinsurers. Some examples of specialized claim services are a rehabilitation department, staff with considerable experience in large catastrophe property claims or a structured settlement department.

At Total Re, you will really be a part of the Marketing Department.

3. Actuarial. A lot of what you in do in claims is also what the actuarial group does: estimate the value of losses affecting your reinsurance contracts. The only difference is that you make estimates on claims one by one while the actuaries make estimates on claims — both reported and unreported — as a group.

As an honorary member of the actuarial department, you are interested in whether the cedant’s individual case reserves are timely and adequate. Your advice to the actuaries on these issues will affect how they interpret the loss statistics. If you report that a cedant’s claim staff is prompt and sensible in establishing and reporting their case reserves, the actuaries will feel more comfortable selecting the lower end of an estimate range. If the cedant is slow and unrealistic then the actuaries will opt for a higher estimate.

The actuarial department is also interested in whether there is a change in the company’s reserving approach. Changes in reserve methods could include speeding up or slowing down the posting of full, mature reserves. Unless they know about these changes, the actuaries will interpret a sudden increase or decrease in the reserves as new and significant trend when it may be nothing of the kind. Only you can discover and report to the actuaries what the claim department is doing in setting its reserves.

At Total Re, you will really be a part of the Actuarial Department.

4. Accounting. You will be called upon to review and communicate payment and collection problems between Total Re and its cedants. That is an accounting function. You may think that such tasks are not within your job description, but you will become a valuable resource for both parties in avoiding misunderstandings and acrimonious disputes.

On the one hand, the cedant will view you as a spokesperson for Total Re when querying the status of payment on outstanding claims. At the same time, Total Re may turn to you when they want a quick assessment of reinsurance accounting issues where a particular program’s underwriting is tied to claims paid or reserves posted.

At Total Re, you will really be a part of the Accounting Department.

5. Claims. If they insist on telling you that you are in the Claim Department, don’t fight it. You will in fact be doing some things that are commonly thought of as “claims” functions. For example, you will review coverage issues, set reserves, make claim-handling recommendations, and conduct audits. But remember how these activities fit into the bigger picture at Total Re. What you do directly impacts the company’s bottom line and don’t forget it. It may sound trite, but you need to communicate and work together with underwriting, production, actuarial and accounting.

Finally, you asked for some advice on what to do and what to look for on claim reviews (some call them audits, but that sounds like the IRS to me.) Of course, you are reviewing the claims in your capacity as an underwriter, marketer, actuary and reinsurance accountant — not really as a claim executive. During a visit with a cedant, there are 3 distinct activities underway:

(a) Re-analyzing allocations and coverage under reinsurance contracts.

There is sometimes wide latitude available to the cedant in judging whether a claim falls under a contract and how expenses are allocated. If this judgment is supportable and consistent with past coverage positions, then the reinsurer normally must go along with the decision. If it is not supportable, then an adjustment should be made in the amounts owed by the reinsurer. Reviewing the entire file gives a full picture of how these decisions were made.

(b) Establishing independent reserves on claims subject to the reinsurance contract.

Establishing reserves on reported and unreported claims during the claim reviews is often more accurate because the entire file is available as is the staff handling the case on a day to day basis. If you disagree with the ceded reserve, you will set an Additional Case Reserve (ACR) on the claim to make sure Total Re is adequately reserved. Also, the cedant’s claim staff can sometimes say in conversation what they would not write on paper so it is very important to discuss high exposure claims with the claim staff.

(c) Evaluating the quality of the ceding company’s overall claims operation.

All ceding companies are not created equal. To fully understand the quality of the cedant’s claim operation, there is no substitute for an onsite visit to the ceding company’s offices. Among other things you must review the timeliness and diligence of the cedant’s investigation; the promptness and adequacy of the reserves; the cedant’s attitude towards settlement (settle or go to trial); and, how quickly it reports claims to Total Re. If possible, conduct your review at a desk in the middle of the claim department. That way you have immediate access to the person handling the claim. More importantly, you can pick up vibes by seeing how the claim staff interacts and works. If the reinsured company does not want you to be among them, be suspicious. You might ask what they are trying to hide. Of course, it may be that they just don’t have any room for you and there is nothing at all to suspect.

You may deal largely with claim issues at Total Re, but you won’t really be a part of its Claim Department.

Well that’s it. Just remember you will be wearing many hats at Total Re including those of underwriting, marketing, actuarial and accounting and just a little bit of claims. Working in all of these departments simultaneously is a tall order (and you only get one paycheck)but I know you are up to the challenge.

Good luck. And don’t be a stranger.

Jack

Mark Twain's pessimism about war

Speaking about war in the book, The Mysterious Stranger, he said:

There has never been a just one, never an honorable one -- on the part of the instigator of the war. I can see a million years ahead, and this rule will never change in so many as half a dozen instances. The loud little handful -- as usual -- will shout for the war. The pulpit will -- warily and cautiously -- object -- at first; the great, big, dull bulk of the nation will rub its sleepy eyes and try to make out why there should be a war, and will say, earnestly and indignantly, "It is unjust and dishonorable, and there is no necessity for it." Then the handful will shout louder. A few fair men on the other side will argue and reason against the war with speech and pen, and at first will have a hearing and be applauded; but it will not last long; those others will outshout them, and presently the anti-war audiences will thin out and lose popularity. Before long you will see this curious thing: the speakers stoned from the platform, and free speech strangled by hordes of furious men who in their secret hearts are still at one with those stoned speakers -- as earlier -- but do not dare to say so. And now the whole nation -- pulpit and all -- will take up the war-cry, and shout itself hoarse, and mob any honest man who ventures to open his mouth; and presently such mouths will cease to open. Next the statesmen will invent cheap lies, putting the blame upon the nation that is attacked, and every man will be glad of those conscience-soothing falsities, and will diligently study them, and refuse to examine any refutations of them; and thus he will by and by convince himself that the war is just, and will thank God for the better sleep he enjoys after this process of grotesque self-deception.