Benchmarking & Restructuring
Speech by Peggy Berton,
President of CNA Global Resource Managers
presented at a conference sponsored by
Global Business Research Ltd.
The concept behind the term "Good Bank
Bad Bank" harks
all the way back to depression days. In the 1930's, as bank after
bank began to fail in the wake of stock market crash of 1929,
the US government rode in on a white horse and acquired the failing
bank's devalued assets. This allowed the still viable part of
the bank to go forward with those of its assets which still retained
their value, and with fresh funds. It then was able to satisfy
its depositors, while shedding its underperforming portion, like
a snake shedding its skin. With the government left literally
holding the almost empty bag.
This concept became even further refined during the savings
and loan crisis of the 1980's. Once again, with government assistance
and approval, savings institutions were allowed to extricate
themselves from the consequences of their own poor business judgment
and some bad breaks in the economy. The rationale and driving
force behind the governments providing a safety net to banks
was twofold: first, to protect the depositors and second, to
help break what could be a catastrophic death spiral in the US
In recent years, a concept has arisen in the insurance industry
which purports to mirror the good bank/bad bank model. There
are significant differences, however, in the driving forces behind
the model, in the methods by which it is accomplished, and in
the true beneficiaries of the model. These differences argue
that the current wave of liability based restructurings in the
insurance industry cannot be considered true good bank/bad bank
The purpose of my chat with you today will be to explore the
concept of liability based restructurings in the P&C industry
from the following 5 perspectives:
- My first point is that the "good bank/bad bank" model
is too simple to describe what is happening in our industry.
At best, "good bank/bad bank" is a handy nickname
for LBR. More important than the nickname we give it, however,
the trends that cause it.
- The trends leading up to the industry shake out, (the Darwinian
concept that only the strongest survive) are the same trends
that force some carriers into restructurings.
- Each major restructuring and its beneficiaries has been unique.
- As interesting as the LBRs themselves is the industry reaction
to them (the mainstream perspective on the concept of LBR
and the ethical debate among carriers.)
- Finally, is there an efficient and responsible way for a
carrier to ring fence and run down the books of business
not to renew? Is there a role for the runoff specialist in
Let's examine the good bank/bad bank model for a moment. We said
it originally consisted of the government assisting in preventing
financial institutions from going under in order to benefit
depositors and the economy. As William Latza, Esq. recently
observed in The Int'l Insurance Monitor there are significant
differences between a bank restructuring and an insurance restructuring.
In the insurance arena, while government certainly regulates
the industry, it is not obligated directly to policyholders.
Instead, the industry guarantees itself via insolvency funds.
In the good bank/bad bank scenario, bank auditors can go in
and assess the bank's situation concretely. They can, in effect,
take a snapshot at a point in time which will tell to the penny
how badly the bank's assets are underperforming. The assessment
of the depth of the problem is finite. Auditors can determine
pretty closely how much money to set aside to fix the problem.
For an insurer, unfortunately as we all know, the liabilities
are in the future. They are assessable only via actuarial projection
and it is never known with comfort or certainty whether the
funds made available will truly pay the last claim before the
lights are turned out.
It is ironic but true that in some situations the most severely
troubled carriers have the most difficult future liabilities
to assess, consisting of heavy asbestos pollution and health
hazard exposures. So even if there were one single entity, like
the government which could come in to save a troubled carrier,
the determination of the financial requirement could be very
uncertain. The final difference between banks and insurers is
that no established model exists for severing off the "bad
bank" portion of an insurance company. Each liability based
restructuring is a new ballgame with new rules, new players,
and a different set of umpires! Therein lies the problem in CNAs
view. I'll touch on this later in my remarks.
Let's take a moment to look at the activity that has occurred
in recent years.
According to AM Best, over only a 2 year period from 1991 -
1993 the number of P&C carriers in the US decreased by 14%.
In 1996 alone an astounding $21 billion changed hands in the
form of outright purchase of one company by another or the issuance
of notes, IPOs and stock offerings to fund acquisitions. Almost
40% of this included the reinsurance segment, for a long time
perceived to be of the more stable segments of our industry.
What are the trends which fuel this activity and what are the
current predictions for the future?
First, let's face it. Return on equity in the property casualty
segment of the insurance industry has consistently been lower
than those of other businesses. The 10 year average for ROE for
the P&C industry from 1986-1995 is 9.6% on a stat basis and
10.5% on a gap basis. Compare that to 15.1% for diversified financial,
13.2% for banks, 11.8% for utilities and 12.9% for fortune five
hundred companies. A desperate struggle within the P&C industry
has ensured, in an attempt to overcome the historically low profitability
of the segment.
Second, there is nothing new under the sun, even though we in
the industry continue to believe that our new twist on a commodity
product will sell like proverbial hotcakes. Industry segments
are overcrowded and undifferentiated. Price cutting and the struggle
for market share have led to drastically underpriced lines and
have left carriers expense ratios dangerously high and cruelly
exposed to slashing. Unfortunately the "cut the fat" mentality
can lead to a cutting of muscle and bone. When that happens,
carriers cannot recover enough to bounce back even if the market
ever turns hard. And, once they have weakened themselves, their
customers who have been so price sensitive as to drive them into
this condition in the first place, are now engaging in a flight
to quality and insisting on dealing only with insurers who are
well capitalized. Third, globalization (especially in the reinsurance
industry but in the P&C industry as well) creates both a
sometimes false sense of new horizons and a false sense of urgency.
As the world gets smaller, and as domestic markets become more
competitive, globalization is seen by some carriers as a way
to grow, especially in overseas markets that are as yet unsullied
by the outrageous liability and APH tort explosion we have seen
in the US. As more and more carriers move into this unfamiliar
environment, more and more carriers will be forced to do the
same to compete. Unfortunately, to create a world class non domestic
operation requires three things which are in short supply in
our industry; 1) true international expertise, 2) the wherewithal
to withstand slow and steady growth (the new kid on the block
often doesn't get the most preferable business until he proves
himself) and 3) enough money to fund number 1 and 2 above.
The fourth trend that we see is plain bad luck. The past several
years have brought higher than usual catastrophe frequency. For
some carriers this has been worsened by their own unfortunate
choice of territorial concentration.
The fifth trend, as mentioned earlier, is that claims costs
and transaction costs are ballooning. The tort explosion especially
in the area of product law and the introduction of junk science
into the courtroom have created an upward pressure on average
settlement figures for most carriers for bodily injury claims.
Even in a line as simple as auto physical damage, studies have
shown that a new car can be purchased for about $20,000 while
to rebuild that same car from parts could cost upwards of $50,000.
We've all had the experience of the fender dent that looks like
$100 but turns out to be $1000. A subspecies but perhaps the
most serious of the claims cost/transactional cost problems is
APH claims. For the reinsurance industry the APH component is
a single biggest black hole that exists, because the tremendous "bulge" in
costs potentially caused by APH is only now entering the reinsurance
system. In addition, transaction costs for claims have continued
to grow over the past several years. Many carriers have organized
themselves to combat this trend by increasing the scrutiny on
outside legal expenses as well as other vendor expenses. However,
the trend continues apace.
These are just a few of the trends that have contributed both
to the industry consolidations and equally to the decision of
some companies to engage in liability based restructuring.
What are the advantages to a carrier to engage in a liability
based restructuring or to a purchaser to use a liability based
restructuring to buy the choicest parts of an acquired company
and partially shield itself from responsibility for the less
First, the insurer differentiates the "bad bank" or "bad
company" component of its liabilities - usually APH in nature.
It is able to estimate these, acknowledge the financial hit once
and for all, and reserve a set amount of funds to pay the claims
arising from this segment. Second, as I said earlier, the insurer
having come out of the closet, so to speak, about its bad bank
component, is able to manage the runoff in a specialized way
which maximizes cash and preserves capital. Third, separating
out the clean, go forward, " good bank" component improves
the earnings and competitiveness of this segment. Higher quality
business and more investors are likely to be attracted.
It has been said that an effective liability based restructuring
is not just a survival move, but is in fact designed for multiple
beneficiaries. First, through proper assessment of liabilities
and creative and adequate funding, it preserves the business
for the shareholders and employees benefit. Second, if properly
done, it secures the rights of past and current policyholders,
claimants and creditors.
If liability based restructuring is in fact an improvement move
for a carrier and not just a survival move, what has caused the
controversy and discussion and difference of opinion within the
ranks of P&C carriers with regard to this concept? First,
some peer carriers have expressed a concern that creating separate
and discrete pools of assets, namely the good company and bad
company concept, will create a stronger "good" company
but a much weaker "bad" company. This concept certainly
provides advantages to the shareholders of the company which
restructures, but it is questionable in the minds of some peer
companies whether the benefit to the policyholders is equally
good. There is also a concern within the industry, that the trend
towards liability based restructuring will force all carriers
into this mode in order to be competitive. In addition, I believe
there is some lingering concern on the part of some carriers
that if the bad company portion of a liability based restructuring
happens to fail, the guarantee funds which draw on all carriers
will be required to come in and pick up the slack. The primary
difference between the acceptability and unacceptability of a
liability based restructuring seems to be in the opinion of most
carriers, regulators, and the trade press, the question as to
whether the parent company of the runoff carrier will be willing
to step in and guarantee payment of all claims including asbestos
pollution and health hazard claims. Such a guarantee will preclude
the possibility the "good company" portion of the restructuring
walking away from its responsibilities and leaving the policyholders
and rest of the industry holding the bag. The position of my
company, CNA, on this matter is that of our chairman. Dennis
Chookaszian has called upon the NAIC to study this matter, and
to come up with a set of standards and regulatory guidelines
to govern this type of transaction. We are far from convinced
that LBR is the way to go for the industry. But we are particularly
concerned that in the absence of widely accepted standards, LBR
will be carried out under a patchwork quilt of regulation, with
these transactions migrating to the most favorable regulatory
Let us take a quick look of the most well known liability based
restructurings of the past several years and examine the similarities
Close the doors on Friday with problems, re-open them on Monday
with a clean slate - does it get any better than this? Well,
it may not turn out to be as easy at that for the Cigna Corporation.
In an attempt to satisfy its long-term goals, the Cigna Corporation
has vividly illustrated "good company/bad company".
As stated earlier, in the world of finance, this is not a new
ploy. With a little stretch of the imagination, the same has
been happening in the insurance and reinsurance industry for
some time. Transactions involving offshore entities in the Cayman
Islands, Turks and Caicos and Bermuda were the "mother" of
this type of transaction.
In 1995, the Cigna Corporation announced the creation of the
Brandywine operation which is thought to be the largest transaction
of its kind in the U.S. insurance/reinsurance industry. The motivation
appears to be Cigna's desire to recognize its growing and significant
environmental and asbestos exposures and to obtain an "A" rating
from the A.M. Best Company.
Under this plan, Cigna took advantage of a law, unique to Pennsylvania,
which it believes will allow it to separate the Insurance Company
of North America, the old INA into two parts. The bad part, the
one containing the APH exposures, was then merged into Century
Indemnity Company (Century was to be the primary entity in the
runoff operation). The transaction was backed by increased reserves,
capital contributions and various reinsurance arrangements. The
good business, the non APH part was to remain with Cigna.
This deal has not yet received full regulatory approval. Cigna
is facing stiff opposition. In order to get the required regulatory
approval, Cigna will have to prove that it has adequately funded
the runoff liability. This will be no easy task and the process
has already come under fire by leading industry players such
as AIG's Maurice Greenberg and others who have gone on record
with the opinion that the deal is unfair and, in the long run,
does not protect policyholders.
As we understand the plan, should the funds supporting the Brandywine
operation prove insufficient, the recourse for policyholders
and cedants will be back through the Cigna Corporation which,
under the Pennsylvania law, limits the amount that the Cigna
active operation may be liable for. Opponents to the plan look
for Cigna to take a more significant, if not total role, in any
Dependent upon the outcome of the various litigations on the
subject, the real advantage, should one exist, is that Cigna
is striving to obtain and maintain its Bests Rating. This rating
is crucial to Cigna in that its current "A-" rating
is the minimum which Cigna can maintain and still attract quality
Property and Casualty business.
While the Cigna transaction is still being played out, it will,
most likely, be the benchmark upon which future deals are handled.
However, there are several others which have either passed muster
or are in the process of doing so.
Some would say that the Talegen deal was the first out of the
blocks while others may not deem this to be a pure "good
bank/bad bank" example. However, as we see it, the restructuring
of the former Crum & Forster Companies by Xerox Financial
contains several of the hallmark's of a good/bad scenario. Between
January 1993 and December 1995, the entities were reformed into
four independent operating groups consisting of 17 subsidiaries.
The restructuring included reserve strengthening, capital infusion
and an additional $1.5bn in excess of loss reinsurance to protect
the various books of business.
Industry sources feel that Xerox Financial's motive for the
re-structuring was to enable it to divest itself of the operations
using the concept that the sale of the parts will be greater
than the whole. Prior to the sale of Coregis, it had been assumed
that the investment firm of Kohlberg, Kravis Roberts & Co.
("KKR") would buy the Talegen group for an estimated
$2bn. This deal fell through in mid-1996. It is anticipated that
Xerox Financial still intends to sell the group or its components
in the future.
To an extent this concept has worked, witnessed by XEROX's sale
of Constitution Re to the Exor Group in 1994 and the sale of
the Coregis Group in 1996.
Still, the re-structuring saw the creation of The Resolution
Group ("TRG") which is designed to be an In-house runoff
manager today and a third-party runoff manager tomorrow. The
speed at which TRG turns to third-party business many depend
upon the success of Xerox in selling the components of the Talegen
Also to be considered is the 1995 deal involving Trygg-Hansa
and Zurich surrounding The Home Insurance Company. In this deal,
Zurich led a group of investors which were interested in the
good renewal business but not in the vast amount of APH runoff
claims it would leave behind in The Home. In order to give regulators
comfort the deal resulted in some $440 million being added to
The Home's reserves before the restructuring to pay future claims.
Also, as part of the deal, Zurich arranged for approximately
$1.3bn of reinsurance over and above the base deal in order to
provide that extra cushion needed to satisfy the regulators.
Unfortunately, the best laid plans don't always build the best
structures. In March of this year, The Home was placed in Supervision
by the New Hampshire Department when its reserves had fallen
to approximately $250 million and it became clear that its reinsurance
would be substantially exhausted before the proverbial lights
were turned out on the last claim.
While the Cigna, Talegen and Home situations were designed for
a particular reason (ratings/divestiture), others exist which
need to be explored. This would be in the area of solvency. There
are cases, which we have seen, where the runoff generated by
past business is holding a company hostage. The company's solvency,
as a result of the runoff liabilities, is in question. The ongoing
business of the company is profitable but, due to market conditions,
will be insufficient to "write" their way out of the
hole created by the past sins of the company.
A possible solution would be for the company to enter into a
Good Company/Bad Company transaction whereby the good ongoing
book of business either remains with the company or is sold to
another entity while the bad business (the runoff liabilities)
is sold off to either the company assuming the ongoing business
or to a third party runoff manager which, if properly funded,
can aggressively runoff the liabilities for a profit. This is
precisely what Lloyds has done with the establishment of Equitas.
Much has transpired in the past 309 years during which Lloyd's
took its place as the world's leading insurance market. The phrase "Insured
at Lloyd's of London" became a household word associated
with celebrities and sports figures insuring their virtues with
Lloyd's. Yet very few knew what Lloyd's really meant or that
it consisted of Underwriting Managers, Syndicates, Names and
most notably, unlimited liability. Once, to a select group, being
a "Name" at Lloyd's was synonymous with royalty. In
the recent past, the same term conjures up thoughts of communicable
As regards reinsurance, the security of Lloyd's was once the "bar" to
which all comparisons were made. But by 1992, questions were
starting to be raised regarding the solvency of Lloyd's. What
caused the downfall of this once great institution? While there
are undoubtedly many factors, several come to mind such as Piper
Alpha, Exxon Valdez, U.S. Hurricanes Hugo and Andrew, the San
Francisco Earthquakes and Winter Storms in Europe, the U.K. and
the U.S. These catastrophes brought on a five year period of
The effects of the LMX spiral were also brought into play. The
spiral is a unique phenomenon to Lloyd's and, in theory, is caused
by Syndicates reinsuring Syndicates in a complex retrocessional
matrix. In reality, it caused a domino effect which took on a
life of its own.
The failure of several major Syndicates spread doubt as to the "forever" nature
of Lloyd's. The failure of these major players created a great
threat for the Lloyd's Central Fund (the backbone of the operation
which used member funds to pay for names who would not or could
not respond to claims presented and approved for payment). Lloyd's
'promise to pay' meant that if a Lloyd's Syndicate were to become
insolvent, any claims would be settled on it's behalf from the
Lloyd's Underwriting Fund, which is contributed to by Lloyd's
Syndicates and within which a constant reserve fund is maintained.
With unlimited liability a precondition of Lloyd's membership,
the Names behind every Syndicate were consequently pledged to
cover all losses, and in particular the cost of the recent heavy
Lloyd's losses. These were eligible to be paid for entirely by
the affected Names, from their own declared funds.
The advent of the age of Asbestos, Environmental and other Mass
Tort claims was beginning to be felt in the early 1990's. The
stress this would bring to the already shaky infrastructure of
Lloyd's had to be recognized and dealt with.
What then was Lloyd's to do? In order for Lloyd's to maintain
its image as the leader of the insurance/reinsurance marketplace
and in order to prevent the catastrophic effect of a Lloyds failure
on the UK economy, something drastic had to be done to save this
In a business plan published in April 1993, Lloyd's Chairman
David Rowland announced the formation of the NEWCO reconstruction
project which was advertised as a ring fence of 1985 and prior
policies. Under this plan, the liabilities of the "old" years
were to be estimated to ultimate, discounted for the creditability
of outwards reinsurance as well as the time value of money and
charged to the names as a one-time premium (estimated at £15bn
or $23bn) in exchange for certainty if not finality.
To accomplish this task, Lloyd's conducted the largest actuarial
analysis ever contemplated in the industry. As can be imagined,
the challenge of amassing the kinds of data necessary to come
up with one single number per name which would be sufficient
to fund what was to become the ultimate "Good Bank/Bad Bank" scheme
ever envisioned was enormous.
Politically, the road faced by Lloyds was much tougher than
that faced by Talegen, The Home or Cigna. When the reconstruction
plan was announced, action groups of which up to 40 were identified,
consisting of names, regulators and other debtors of Lloyd's,
were formed and litigations commenced against both Syndicate
Underwriting managers and other Lloyd's names to prevent the
plan from being successful. Finally, in the spring of 1996, a
plan was approved and, on September 4, 1996 was taken to a vote
with the membership of Lloyd's. The plan, which ultimately passed,
included the following provisions:
- First, a reinsurance and runoff facility named Equitas was established.
- Members would receive credits totaling £3.2bn
which would be offset from their estimated Equitas Premium.
- Lloyd's three-year accounting rules would be suspended
allowing existing names to recognize profits of approximately £2bn
or $3bn to use as an offset to their Equitas reinsurance
- Members could resign from the Society of Lloyd's.
This last item, means that names would be free from the control
of Lloyd's. This is of critical importance to policyholders
and cedants since, if Equitas were to fail, recourse would
to the names, who would not be under the central control of
Lloyd's. It would become the debtors responsibility to identify,
and collect any shortfall resulting from a failure of Equitas.
All, in all, I think that it is safe to say that Lloyds and
Equitas have created the largest
In addition to the Good Company/Bad Company scenario we have
seen other creative ways of restructuring emerge over the past
few years. One of these products in the Novation. A Novation
legally transfers liability from one party to another. This may
seem like a rather simple transaction. In practice, a Novation
comes under a significant amount of scrutiny, either by regulators
protecting the rights of policyholders or cedants, protecting
their security. The consolidation of the Crum & Forster Companies
into the group known as Talegen was done via a Novation. In order
to understand the draw of such a remedy, it is important to see
where the prospects come from.
Many companies seeking Novation are survivors of the reinsurance
debacle of the late 1970's and early-to-mid 1980's which saw
depressed pricing, lack of underwriting control and subsequent
litigation in the areas of latent concerns giving rise to coverage
which was never anticipated when the reinsurance was arranged.
This was a period of diversification where off-shoots were created
to "take advantage of" the capacity crunch and reap
the benefits of high premiums and higher interest rates.
Many of these entities have either stopped writing business
or have decided to pursue other segments of the market and are
now encumbered with the handling and administration of these
older books of business which, in many cases, hinder the operation
from moving forward profitably. In most of the cases that we
have seen, these entities are adequately reserved for the purpose
of our discussion. These companies are seeking solutions years
after the last contract or certificate expired.
In a Novation, a company would legally assign the liabilities
and the handling of its assumed book of Reinsurance (whole or
in-part) to another entity for a premium equal to the amount
of the agreed case reserves and the assuming Reinsurer's view
of the IBNR as well as a factor for the time value of money and
the estimated cost for the run-off and administration of the
The Novation has the effect of removing the liabilities emanating
from Assumed Reinsurance from the company's balance sheet. It
also has the benefit of removing the administrative burden from
the company's staff. While the financial effects associated with
this type of transaction are generally more costly than other
methods available, the company, in effect, walks away from the
book permanently. We believe that this scenario is preferable
to a company since, at the end of the day, the company would
have no liability, contingent or otherwise, derived from the
Novated book of business.
In some cases the size of the portfolio makes it necessary to
carve the book into sections that can be absorbed by an assuming
market. If it is necessary to perform this type of exercise,
the plan used to segregate the book should be well thought out
and consistent in such a way as to make the resulting sections
attractive to potential buyers. If, for example, the book were
to be divided into three possible packages with two containing
a better selection of the business, the third portion may prove
to be the victim of adverse selection and therefore not readily
salable in the marketplace. We believe that once the regulatory
obstacles are overcome that the transfer of liabilities via Novation
will become more widespread in our industry.
Some industry players believe that many runoff books, if managed
properly, can actually yield some profit arising from hidden
assets embedded within them.
CNA's purchase of CIC in 1995 did not create a good company/bad
company split. CNA purchased CIC whole and entire and stands
behind all liabilities whether the books of business are ongoing
or discontinued. CNA did choose, however, to establish a business
unit to manage CICs discontinued liabilities bringing to bear
the specialized skills of runoff management.
Since I am responsible for the runoff of all CNAs discontinued
liabilities arising from the CIC purchase, I'd like to examine
for a minute the role of the runoff specialist in handling the
discontinued liabilities of an insurance carrier.
Whether a company actually restructures or merely places special
emphasis on the stewardship of discontinued lines of business,
there is an advantage to setting up a force of professionals
dedicated to the management of the asset known as runoff liability.
A professional runoff manager can perform a number of integral
tasks to protect this asset. One of these is to investigate,
manage and settle claims in a prompt, efficient manner. One of
the first tasks of successful runoff management is to build credibility
with its policyholders, cedants and reinsurers. The ramifications
on its success as a runoff manager can be significant should
the runoff manager not "get out of the box" on the
The importance of professional runoff service can not be over-emphasized,
whether employed to service a restructured company or employed
to service a unit of discontinued business wholly backed by the
parent company as in CNA's case.
A few critical activities of the Runoff Manager are:
- To commute where the result benefits the estate. While performing
commutations on a global basis can maximize efficiency as well
as reduce the administrative workload, this may not be as easy
or as practical as it seems. Faced with the possibility of various
books of business, bringing it all together in a commutation
package may be a monumental task considering that the original
liabilities and reserve analysis was never reconciled to cedants
records and outwards reinsurance will require broker assistance.
At the end of the day, the work involved will be worthwhile in
considering a quicker and more efficient final runoff.
- To learn how to do a professional audit on cedants and use
this technique to resolve disputes.
- To maximize reinsurance recoverables and collections. A
dedicated collections unit with special emphasis on Aged Recoverables
and special incentive should be established.
- To maximize investment returns. The management of cash is
the primary way to self-fund a runoff.
- To develop a three to five year plan to consolidate the
accounting and claim procedures. The cost for maintaining these
services in the long-run is prohibitive and will ultimately
inefficient. Control consolidation via a specific plan to both
productivity and minimize negative.
- Finally, to pay attention to the human resources issues.
Staff should be recruited and motivated with the approach that
management is a professional career discipline in itself.
As long as there are fallible human beings writing insurance
there will be runoff specialists needed.
These tasks are not easily accomplished. The resources of the
professional runoff manager will be hard pressed to meet this
challenge. But paying attention to these critical facets of runoff
management is the only way to turn a runoff liability into an
Return to Articles