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CIGNA Corp.'s proposed restructuring of its property and casualty business into two companies, one a continuing "good company" and the other a runoff "bad company," in my opinion is one of the most flawed and frightening pieces of gimmickry to be foisted on policyholders and the public in recent years. This deal threatens to undermine the insurance promise-that is, the pledge inherent in an insurance contract that the insurer will be there to pay its claims if and when they come due-and to leave policyholders high and dry.
The very real danger is that the Pennsylvania insurance commissioner will turn a blind eye to this and the other flaws and give it the regulatory seal of approval. In so doing, the commissioner will further public policy hurtful to consumers and taxpayers and establish a precedent encouraging any insurer with significant asbestos and environmental liabilities to pursue a transaction to shed themselves of these uncertain liabilities.
As an actuary, I feel obligated to discuss the actuarial ramifications of the deal CIGNA proposes, but given the paucity of information that the company and the Pennsylvania Insurance Department have made available, this is difficult to do.
Neither I nor anyone else not working for CIGNA or the Insurance Department has been able to review the Tillinghast report done for the Insurance Department, the Milliman & Robertson report done for CIGNA or the William M. Mercer report done for Houlihan Lokey Howard & Zukin, an investment banking firm advising CIGNA. I have reviewed the testimony of CIGNA, Milliman & Robertson and the other technicians employed by CIGNA, however, and it is clear to me that the actuarial calculations are highly imprecise, representing at best a very sophisticated guess.
Consider the caveats in the M&R testimony. I have never seen such a heavily caveated document. Including so many caveats is an actuary's way of saying, "I'm not sure. Could be almost anything."
Among the caveats are:
M&R did not construct its own model.
M&R did not develop independent estimates.
M&R says the report is "not intended to be relied upon" by anyone but INA Financial, though it was "made available" to the state regulators.
M&R states that it "reviewed" the CIGNA reserving procedures for reasonableness, but made no reserve estimate on its own.
M&R states that its reserve work is not "for purposes of certification."
M&R never reviewed the non-asbestos and environmental reserves.
M&R admits to the "high degree of uncertainty" in the asbestos and environmental estimates, which it characterizes as greater than for other P/C lines.
I could cite more examples, but you get the idea. The actuarial calculations are very suspect and there is a very real chance that the costs will exceed the projections, perhaps by a significant amount.
This should come as no surprise. If this were not the case, there would be no controversy because the company would have the costs quantified and covered and the rating agencies and the rest of us could relax. Indeed, if CIGNA is right and the runoff company is adequately capitalized, why not test that in the normal way-reinsure it? CIGNA's unwillingness to either stand behind this runoff company with a parental guarantee or find a private-sector solution, such as reinsurance, belies the certainty it claims for its projections.
There would be no need for this proposed split if the estimates were seen as reliable by the financial markets and the rating agencies. But both recognize the great uncertainty in these estimates, uncertainty proved by the track record of CIGNA in understating these reserves consistently over the years. Presumably the company used "state of the art" reserving techniques all along, and yet CIGNA has repeatedly failed to adequately reserve. This record alone should sound loud regulatory warning bells.
The central issue of the CIGNA restructuring is not actuarial, however. That there is a risk of the runoff company failing cannot be denied. The real public policy issue here is, is this division injurious to the policyholders? The answer is yes. It would be terrible public policy to allow this proposal to go forward.
In this respect it is critical to point out that the import of this issue is not limited to Pennsylvania; the issue of how to handle looming asbestos, environmental and other latent injuries is vital to all Americans. The precedent set in Pennsylvania can affect the insurance market and regulation across the country.
If CIGNA is allowed to cap its contractual obligations, which is the whole point of this transaction, other insurance companies with uncertain asbestos and environmental liabilities will want at least equal treatment. They would owe it to their stockholders to follow suit or bargain in their states of domicile for something even more favorable. A competitive campaign to seek the lowest possible cap on liabilities through imaginative "state of the art" evolutionary developments is not out the realm of possibility.
Consider the impact on regulation. Companies domiciled in states that required them to honor their obligations might seek to move to more "friendly" jurisdictions. To Pennsylvania perhaps?
Crystal ball gazing aside, the question at hand is simple and fundamental: If the CIGNA transaction is approved, does the contract of insurance mean anything anymore?
Instituting a policy limit, or cap, years after the policy was issued undermines the public's trust. The consumer buys insurance to shift the risk. This deal undoes that deal. The contract of insurance does not say, "We promise to pay you up to the limit of this policy (unless we cut a deal with our regulator to cap it down the road if we get more claims than we expected)." Would Pennsylvania, once a leader in consumer protection and still highly regarded, approve such policy language prospectively? Of course not. But that is exactly what it will do retrospectively by allowing the CIGNA deal to proceed.
CIGNA policyholders are first in the line of those to be harmed by this transaction. But the line is long. It includes other insurance companies that reinsure CIGNA and who would have to pick up excess claims via state guaranty funds. It includes taxpayers who back up these guaranty funds when they are triggered through premium tax offsets. The line includes consumers who could see insurance prices rise to cover guaranty association claims.
And it includes the third party claimants who have been injured by companies CIGNA insures and who would suddenly find their claims placed in the runoff company. Who is representing their interests in this deal? What happens to these claimants when the runoff company fails? Are they tossed into the guaranty funds to face the inevitable delays and limits on their claims, while the "active" CIGNA merrily watches and rejoices in its retained A.M. Best Co. rating? What becomes of them if the guaranty funds run out of money?
These public policy issues are neither theoretical nor speculative. They are real, they involve real people, and they are of the utmost importance. As structured, the CIGNA transaction puts the interests of shareholders over policyholders and over third-party claimants of policyholders. This is the most fundamental of its flaws.
Fortunately there is still time to correct this situation before any real harm is done. The Insurance Department has set Jan. 12 as the deadline for public comment, after which it will make a decision.
Here are four steps that should be taken (the first steps are up to Pennsylvania):
1.Halt this process until the steps below are taken.
2.Bring the CIGNA transaction and the matter of "good company/bad company" splits generally before the National Assn. of Insurance Commissioners for immediate consideration. The resolution of the CIGNA case will affect regulation of insurance nationwide. This decision must be coordinated among the states to head off the potential of a regulatory competition that could undermine consumers' contractual rights for years to come.
3.Pennsylvania and the NAIC should work toward assuring that corporate entities fully back their obligations, at least through regulation that assures that assets are not diverted between corporate entities to the detriment of policyholders and claimants.
4.If divisions are allowed, the resulting companies should either be backed by the full assets of the corporation or by reinsurance secured in the private market prior to the division. This private market test will determine the reliability of any projection, actuarial or otherwise, since the real test is who will bet their assets on it, not who can put on the slickest public presentation.
The proposed CIGNA restructuring should not be allowed to go forward at this time. If the transaction is completed, it will represent the failure of a major insurance company to live up to its obligations to its policyholders and the failure of a leading state regulatory department to protect the very constituents whose interests it was established to watch over. Policyholder and public trust will be shattered.