|Will Equitas come back to haunt the big companies? |
By Stephen Fidler
Published: November 8 2004 20:44 | Last updated: November 8 2004 20:44
In a stream of agreements over the past year, a series of mainly US companies has settled billions of dollars worth of claims with Equitas, the company set up in 1996 to save the Lloyd's insurance market from meltdown. Lloyd's nearly collapsed under claims from the US on policies written before 1993 stemming mainly from asbestos and other pollution-related illnesses. It established Equitas to reinsure these liabilities and give Lloyd's a new start.
Equitas has now secured agreements with some of the world's biggest companies, including Exxon, Ford, General Electric and Halliburton. It has resolved roughly two-thirds of the liabilities it was born with, says Scott Moser, Equitas's chief executive. Most of the companies declare themselves "pleased" with their agreements - as did Halliburton this year after Equitas agreed to pay it £575m ($1.1bn) to resolve all outstanding claims.
Meanwhile, Lloyd's has on the face of it gone from strength to strength. Premium-writing capacity has grown from £10.3bn in 1997 to £14.9bn at the start of this year. "From our point of view we have succeeded in what we intended to do. It has worked very well," says a Lloyd's spokeswoman.
Yet the solution to avoid the collapse of Lloyd's, which Lloyd's calls "reconstruction and renewal" (R&R), remains deeply controversial.
Richard Astor, an English barrister who has studied Lloyd's in detail for more than 10 years, says R&R created a "surreptitious underclass of Lloyd's policy holders" that includes those companies now settling what he argues are cheap deals with Equitas.
Lloyd's has promoted Equitas as the only recourse to policy-holders by promoting a combination of "mythology and misunderstanding", he says. Insurance regulators in the US and UK have stood by, Lloyd's brokers have done little for claimants and some US lawyers have given poor advice to clients to settle with Equitas.
Equitas's aggressive negotiating stance is also encouraging cheap deals that could store up problems for those agreeing to settlements, say he and others (see below).
Companies settling with Equitas may enjoy an immediate boost to the bottom line. But as part of the settlement, they agree to Equitas buying out the relevant insurance policies. It means that many of these companies themselves now carry the risk if in years to come they are bombarded by asbestos and other claims from people who may not even yet be ill.
Marc Mayerson, an insurance lawyer based in Washington, says the companies are being short-sighted. "What they are doing is sacrificing the long term for short term gain. From the corporate managers' perspective, they are able to bring in dollars today and look good. In eight to 10 years, when the claims start coming in, the chickens will come home to roost."
Equitas was created by Lloyd's to reinsure all outstanding liabilities on Lloyd's general insurance policies written before 1993. Its aim was to create a "ring fence" behind which the 350-year-old market could continue to operate without being dragged down by past errors.
And what past errors. Lloyd's had suffered multiple blows, the hardest of which was its huge exposure to US asbestos and other pollution and health related claims. The volume of these long-tailed liabilities - so called because of the time they take to emerge and be settled - was increased by big US court judgments.
In five disastrous years of account, from 1988 to 1992, the cumulative losses of Lloyd's climbed to almost £8bn. Each Lloyd's "name" - individual underwriter - lost an average £287,000 but because losses were spread unevenly, some lost far more.
In the long tradition of Lloyd's, each individual name's liability was unlimited and each stood to lose everything. Lloyd's boasted, as indeed it still does, that the assets of the names were only one link in what it called a "chain of security" (see chart).
But Lloyd's was facing an avalanche of claims that threatened to overwhelm these resources. The losses were also scaring off new capital, the lifeblood of the market, because of the unique mechanism in which Lloyd's passes risk from one generation of under- writers to the next, called reinsurance-to-close.
Nobody would be enticed to bring new capital to Lloyds, for fear of being saddled with the gargantuan costs of old claims, either by inheriting bad risks from the past through reinsurance-to-close or through being forced to stump up money to bolster the "chain of security".
To avoid insolvency, Lloyd's had to find a way of separating the past from the future. After interim steps such as barring reinsurance-to-close for pre-1993 non-life claims, Equitas emerged as the central part of Lloyd's solution. Lloyd's would package all of the market's non-life liabilities for 1992 and all preceding account years under one re-insurance contract.
They would be then ceded to the new Equitas venture, which would become the world's largest run-off reinsurance company - so-called because it exists only to deal with past claims and writes no new business. (Technically, the liabilities were ceded to Equitas Reinsurance which passed them on to its wholly-owned subsidiary Equitas Ltd.) Equitas was also made the claims handling agent, making it the first port of call for claimants.
Into Equitas was put a £14.7bn re-insurance premium, funded by members, Lloyd's agents and brokers, trust funds and the Lloyd's central fund. The arrangement was approved by the British government and US regulators in 1996.
Many observers at the time regarded the funding as insufficient, particularly after the amount put into Equitas was reduced, it appeared, to encourage names to accept the deal. Richard Stewart, a former insurance superintendent for the state of New York who now runs a consulting firm specialising in insurance, describes R&R as an example of "trying to save an insurance company with policyholders' money".
Many observers thought, and still think, the set-up had worked. "With the creation of Equitas, the syndicates writing in the market for 1993 and forward were freed from the problems of the past; they were writing on a 'clean slate'," an examination team from the US National Association of Insurance Commissioners concluded in 1998.
But this conventional interpretation is challenged by Richard Astor, the English barrister. He says that the Lloyd's-Equitas deal was purely a "back-office" transaction of no relevance to policy-holders. No insurer can extricate itself from contractual liability to policy-holders just by claiming to be impoverished.
There were no new contracts agreed with policy-holders and no change to the law to accommodate Equitas.
In other words, he says, the creation of Equitas did not deprive policy- holders of their recourse to Lloyd's. All the assets of the current Lloyd's enterprise, including all relevant trust funds and today's entire central fund, therefore remain accessible to pre-1993 non-life policyholders, he argues.
Lloyd's contradicts this, arguing that R&R successfully ring-fenced the pre-1993 claims from its ongoing operations. "All roads lead to Equitas," says the spokeswoman. A claimant can pursue a claim in the courts naming a pre-1993 syndicate instead of Equitas - but it would be Equitas that guides the litigation in the court and it would be the one to make any ultimate payment.
Mr Astor says that the Lloyd's position has been echoed by Lloyd's brokers and US lawyers advising the companies settling with Equitas. The conventional wisdom "appears to have taken hold among US lawyers simply as a result of Equitas telling them so," Mr Astor says. Many American lawyers have also failed to apprise themselves about a highly technical area of law.
Brokers have gone along with Equitas too. Mr Stewart notes that most brokers get financial rewards from new business, not from claims. "Brokers are lovers, not fighters," he says.
Insurance regulators on both sides of the Atlantic have also been accommodating, in part because they seek to avoid insolvencies on their watch. "They have this batting-average idea and have got sucked in to arrangements like Equitas and other run-offs," Mr Stewart says.
Edward Muhl, the former New York insurance superintendent, was confronted with the consequences of Lloyd's potential collapse on the first day he took office in January 1995. The following year he said that if he had removed Lloyd's accreditation "the insurance world as we know it would change."
The end of Lloyd's would have left 300 insolvent insurance companies in the US, 51 in New York state alone. All the main US airports, including Kennedy, Newark and La Guardia, would have lost coverage as would the New York Port Authority and the Long Island Railroad. "This had the potential to be the most cataclysmic event that the insurance world had ever seen," he said.
He described Equitas as "the best solution to a difficult process. Equitas, in my opinion, is the best chance for US policyholders to receive full payment on all of their claim activity."
In the UK, the exact conditions of the UK government's approval of Equitas have never been made public. In 1996, the Department of Trade and Industry issued notices to Equitas, later inherited by the Financial Services Authority.
The FSA still will not provide details of these conditions. "The FSA cannot disclose information related to the business or affairs of an authorised person (including Equitas) unless that information is already available to the public from other sources, or is in summary form, or unless the authorised person consents," it says.
The regulators' tolerance continues to be a key to Equitas's operations. As a UK company, it submits neither to US statutory accounting nor US Generally Accepted Accounting Principles. Some estimates suggest that under these US rules Equitas would have been insolvent five years ago. But instead Equitas has the flexibility, for example, to discount its liabilities over the period that it expects to pay them, leaving the figure - at £460m at the last count - below its assets number.
Mr Moser denies Equitas is allowed the flexibility to manipulate its accounts. "Our discounting simply reflects the fact that we have assets now that are going to be used to pay our liabilities some time in the future," he says.
The regulators will continue to be accommodating to Equitas, says Mr Stewart. "I think the US and UK regulators will go along with anything that doesn't look criminally complicit," he says. That is unless the high-profile investigation by Eliot Spitzer, the New York attorney-general, against insurance companies and brokers does not alter the picture. A spokesman for Mr Spitzer's office says investigators are interested in issues related to Lloyd's and Equitas, but there are other priorities now and no investigation is under way.
The FSA has also made clear that Lloyd's has not entirely shielded itself from the pre-1993 disaster. Lloyd's and "all current members have a contingent liability (albeit small in some cases) which could crystallise should the reinsurance by Equitas fail", it said in a consultative paper issued in April.
Lloyd's seems to take the position that its assets are not on the line for any failure of Equitas, that there will be no further "bail-out" of individual names. But it refuses to say this publicly.
Pressed on the point a spokeswoman says: "Lloyd's has said on many occasions that it committed substantial assets to the setting up of Equitas. Should Equitas fail, policyholders would maintain their rights to pursue individual names for their proportions of the claims left unpaid by Equitas."
The implication appears to be that policy-holders would be left on their own to chase down individual names for the fraction of the claim they owe. Mr Astor contends that such a procedure would be impractical and unprecedented.
Mr Moser says he has no opinion about what would happen if Equitas failed. "I am quite sure that Lloyd's believes there is no right to go after their assets . . . and I'm certainly well aware of people who say there would be rights. All we have said about this is that we don't think there is a clear cut single answer and what will happen is clearly going to be the result of what third parties, and regulators and courts do. There is no point in trying to speculate as to what that outcome could be."
The legal basis on which Lloyd's policy-holders have been driven towards Equitas remains untested in the English courts. If Mr Astor's position was sustained, the consequences for Lloyd's would be far-reaching, financially, commercially and legally.
So, more than eight years since R&R, Lloyd's and Equitas continue to exist in legal, accounting and regulatory limbo which neither is in a hurry to clarify.
But if claimants seek to test the law and get at the funds in the current Lloyd's enterprise, Lloyd's and its army of sophisticated lawyers will be ready to repel the assault, says Graham McKean, a broker at BMS Associates who was also a Lloyd's council member in 1996. "If you want to try your luck at Lloyd's while Equitas is there presenting an easy target, see what the court says. I don't think anybody at Lloyd's would stay awake at night worrying about it," he says.
Is enough money being paid out to companies?
Are big companies settling their insurance claims too cheaply with Equitas?
The facts are hard to find. Companies decline to talk about any part of their negotiations, citing confidentiality clauses in their agreements with Equitas.
But Richard Stewart, a former New York insurance commissioner, says that Equitas "has established a public record for running off claims as late and as cheaply as possible".
Equitas says it will only pay asbestos claims if the policyholder provides specific medical evidence of injury and demonstrates that the injury was related to the policyholder's asbestos products or operations.
"For many claims, the requirement cannot be met," Mr Stewart says. "Its effect is to delay payment or to force the policyholder into a deeply discounted settlement."
A 1999 speech by Scott Moser, then Equitas claims director and now its chief executive, suggested deeply discounted settlements were justified because claims would otherwise be tied up in litigation for 10 years. Settling would also avoid years of legal fees.
When asked about that this month, he told the Financial Times: "What I'm discussing there is the fact that a very large number of claims that are presented to us involve a claimant who is asking for far more money than he or she is entitled to. The process that I described in that speech, is whether it makes sense to work that out rather than litigate it for a decade."
In fact, Equitas had paid £15bn in claims and always settled them in full, he said.
Equitas seeks settlements to "buy out" insurance policies of claimants. It says such buy-outs eliminate some of the company's most volatile liabilities, volatility that the settling companies now inherit.
Mr Moser says Equitas has to negotiate firmly, given the adversaries it faces.
"I think it's fair to say that we have very aggressive adversaries who make claims for far more than they're entitled to and often we have to be aggressive in defending ourselves. But the concept that we hold is: be fair but firm and settle the claim as soon as it can be settled at a fair price."
Graham McKean of BMS Associates, a Lloyd's broker, says that all run-off insurance companies - entities that exist to pay claims only and not attract new business - are hard-nosed. "Compared to some that have a scorched earth approach to settlement, Equitas is not that bad," he says.
Mr Moser points to the companies that have decided to settle: "The major settlements we're doing are with the biggest most sophisticated companies in the world: Chevron, Dow Chemical, Exxon, Ford, General Electric, Halliburton, Travelers, Swiss Re, Zurich Re. These are not people that Equitas is going to bamboozle.
"Do you think Exxon gave us a break? Do you think Chevron gave us a break? They felt sorry for us and they took less than they were entitled to? These aren't the kind of people who do that."