LONDON-The first report and accounts of runoff reinsurer Equitas Holdings Ltd. are heavily qualified by the auditor and the size of the company's surplus has been brought into serious question.

The company's executives say they are not surprised, given the nature of the beast.

Underwriters in Lloyd's of London, who reinsured their syndicate accounts into Equitas, say they believe the new company is better off than the accounts show.

The Lloyd's underwriters are concerned, however, that a negative spin greeting Equitas' accounts could tarnish the ongoing market.

Last week, Equitas published its first financial report, for the period ended Sept. 4, 1996, the date when the company officially started business. The report gives a detailed view of Equitas' position at the time of startup, after Lloyd's members paid 95% of premium owed to assume their liabilities.

Equitas was set up to run off an aggregate of 740 Lloyd's syndicates' years of account, covering 1992 and prior years. It was designed to segregate Lloyd's massive liabilities, allowing the market to end litigation over those losses with its membership and move forward.

Equitas began business with 11.2 billion pounds ($17.4 billion) in premium, less than the 14.7 billion pounds ($22.8 billion) that had been originally forecast as of Dec. 31, 1995. The reduction reflects claims paid by syndicates and investment income during the eight-month interim up to Sept. 4, totaling 2.7 billion pounds ($4.2 billion).

Equitas also did not accept 700 million pounds ($1.1 billion) in premium because it decided not to reinsure the runoff business of Syndicate Underwriting Management Ltd., which manages the runoff of Lioncover Insurance Co. Ltd. Equitas may reinsure Lioncover in the future. Lioncover is the reinsurer set up by Lloyd's for syndicates formerly managed by PCW Underwriting Agencies Ltd., which collapsed in 1982.

Altogether, Equitas' assets total almost 16 billion pounds ($25.1 billion).

Equitas' accounts show that it has a surplus of 588 million pounds ($921.6 million), which is reduced from 880 million pounds ($1.4 billion) by certain factors. The surplus results from the ability to discount liabilities at a higher average interest rate than what was used to set Equitas' premium in Lloyd's reconstruction and renewal plan. The surplus reduction is due to a number of factors, including 122 million pounds ($191.2 million) for a provision against questionable syndicate assets.

The surplus takes into account estimated liabilities from one of the largest claims overhanging Equitas, namely Exxon Corp.'s claim related to Exxon Valdez spillage and cleanup. The settlement of the claim, estimated to be about $500 million, occurred after Equitas' accounts closed Sept. 4 (BI, Nov. 4, 1996).

Also taken into account are 70 specific health hazard risks, including those overshadowing the tobacco industry.

Coopers & Lybrand's extensive qualifications indicate that uncertainties leave open the possibility that liabilities could exceed surplus.

For example, there are "significant uncertainties" in the accuracy of

outstanding claims of 14.8 billion pounds ($23.2 billion) and in the reinsurance recoveries of 1.5 billion pounds ($2.4 billion), according to the audit. Equitas has the benefit of 248,500 reinsurance policies with approximately 2,900 reinsurers.

The audit also found "uncertainty" in the assumptions made in discounting claims reserves. Investment yields might vary or the claims might be paid more quickly than expected, which would inflate the actual claims payments.

Equitas' liabilities before it went into business were assessed by the Reserving Project, a main component of the larger project conducted to assess the feasibility of the company that is now Equitas. The project estimated the reinsuring syndicates' long-tail liabilities such as asbestos and pollution by analyzing global insurance claims and calculating Lloyd's market share.

"This involved the use of many assumptions which have a significant effect on the quantification of the provision for claims outstanding and related reinsurance recoveries," the audit said. "The estimation of provisions for such claims is inherently uncertain."

Any increases or decreases in such equations "could be material enough to exceed the amount of the shareholders' funds, which amount to 588 million pounds," the audit said.

If the company's assets are "insufficient" to meet its liabilities, then Equitas could invoke a proportionate cover plan. Under this plan, Equitas is "entitled to pay claims at a reduced rate" to policyholders.

This means that policyholders would be paid a fraction of their claims instead of being paid in full, which buyers of Lloyd's policies usually expect.

However, Equitas executives are not daunted by Coopers & Lybrand's qualifications.

"Clearly no company likes to see a qualified audit report. We're not at all complacent about the fact that our audit has been so qualified. Having said that, we are not surprised either," said Jane Barker, Equitas finance director.

There is a "fundamental uncertainty" in the types of liabilities reinsured by Equitas and the assets to pay those liabilities which will always be there, she said.

It is also true that the estimated liabilities calculated by the Reserve project to estimate Equitas' premium "was unaudited and some of the data wasn't verified and there was some questionable quality," Ms. Barker said. Auditors often qualify unaudited data whether it's right or wrong, she added.

It is likely that the auditors also will qualify the company's first year-end accounts, for the year ending March 31, when they come out in the fall, warned Ms. Barker. This would be the first time Equitas releases its operating costs, estimated to be about 220 million pounds ($344.8 million) annually. The company has 637 employees, which will rise to 770 this year.

Equitas hopes to allay the fears of the auditors on the quality of the data that was used to estimate liabilities and reinsurance recoveries in the 1998 accounts, she said.

Some Lloyd's underwriters, however, are concerned about the negative view the accounts portray. Regulators, policyholders, new syndicate capital providers and Lloyd's members might take one look at the accounts and the qualification and believe that Equitas is on the brink of insolvency, they say. If Equitas did go broke, the market could be encumbered with new levies to pay.

"I think the qualification (by the auditors) is unfair," said one senior Lloyd's underwriter who did not wish to be named. The assumptions made to estimate Equitas' liabilities were very conservative and could result in as much as another 1 billion pounds ($1.62 billion) not reflected in the surplus, he said.

For example, Equitas has probably paid claims out more slowly than was forecast, which would give rise to increased investment income, said the underwriter.

Ms. Barker does not know whether in the first seven months the claims payments have been slower or faster than predicted, because they have not been audited yet. Results will be available in the autumn.

However, "if experience had been distinctly bad, we would have had to flag the problem in this statement," added Equitas Chief Executive Officer Michael Crall.

People in the market also should remember that when Equitas was being considered, there was concern that the company would be overfunded and members would have to pay too much in premium, noted Ms. Barker. "Equitas couldn't start life with an enormous surplus. R&R wouldn't have happened," she added.

Another Lloyd's underwriter added, "The balance sheet is not as bad as it looks. Equitas has plenty of money."

The negative spin is "bad for the market," the underwriter commented. "We need a confident Equitas."

Others wondered whether Equitas was casting a dim light on its situation in order to force policyholders to commute claims.

"We have probably spent more time concerned about names' reaction than we have about policyholders," Mr. Crall replied to the criticism. "We've attempted frankly to take a very 'neutral, give-them-the-facts kind of approach. Given that that is unusual in the corporate world, it may appear that we may have been negative. But our attempt was to be straightforward, factual, open and forthcoming, and to describe the good and the bad in dispassionate terms."

"We are not trying to put a spin on this, because we are not trying to sell anything," added Ms. Barker. "And we're not trying to be complacent either. We're trying to tell everyone, 'This is where we started, with a surplus of 588 million pounds.' This is what we were given; we didn't lose something along the way."

"The good news is that we started as we expected to start. We have been going for seven months and nothing in that time period has arisen to say that we should have started differently," according to Mr. Crall