Help

BI’s Article search uses Boolean search capabilities. If you are not familiar with these principles, here are some quick tips.

To search specifically for more than one word, put the search term in quotation marks. For example, “workers compensation”. This will limit your search to that combination of words.

To search for a combination of terms, use quotations and the & symbol. For example, “hurricane” & “loss”.

Login Register Subscribe

EQUITAS SHIELD QUESTIONED

UNCERTAINTY OVER RESERVE ADEQUACY SHOULD CONCERN BUYERS: ATTORNEY

Reprints

LONDON -- Time will tell whether Lloyd's of London's 2-year-old reconstruction and renewal plan will achieve its goal of shielding policyholders and Lloyd's investors completely from potential losses, an attorney warns.

Philip Hertz, a senior associate in the insolvency practice of the law firm Cadwalader, Wickersham & Taft in London, contends that because of uncertainty surrounding the ultimate size of long-tail liabilities reinsured by Equitas Holdings Ltd., the ability of the market to achieve its aim is also uncertain.

Speaking at a London conference, "Current Issues in Insurance and Reinsurance," Mr. Hertz said that "the only real conclusion that can be made is that the level of reserves in Equitas will continue to be of concern in the future to policyholders and ceding companies with exposure to Equitas, as well as the ongoing market."

Equitas was set up in 1996 to reinsure the market's pre-1993 liabilities. Should the reinsurer's reserves in the future prove inadequate to meet its liabilities, then Equitas would be forced to pay only a proportion of policyholders' claims, and names, the individual investors in the market, would be liable for any unpaid balances.

An Equitas spokesman who attended the conference said that he could not dispute Mr. Hertz's claims of what might happen if reserves prove inadequate, but stressed that Equitas was founded on sound reserving principles and that the likelihood of it failing to have adequate resources diminishes as Equitas continues to bolster its reserves and solvency margin. A Lloyd's spokesman was unwilling to comment on Mr. Hertz's assertions.

If Equitas in the future does not have the resources to meet policyholders' claims in full, Mr. Hertz said, Equitas would pay claims on a proportional basis, which means the individual investors in Lloyd's would not achieve the finality of their liabilities intended with the creation of Equitas.

Asked afterwards about the probability of any of this happening, Mr. Hertz said he believes there is little doubt that it will happen eventually. "It's just a question of when," he said.

Lloyd's is thinly reserved even when looking just at asbestos, pollution and health-related liabilities, but it wrote general liability cover stretching back years and so faces additional big exposures, such as tobacco- and the Year 2000-related risks, stated Mr. Hertz. For this reason he contends the day will come when Equitas can no longer pay claims in full, though he did not predict how soon that might occur.

While policyholders theoretically could try to recover from names any additional sums they are owed, Mr. Hertz acknowledged that in reality this could prove difficult.

As the names liable for meeting such long-tail claims would be those who were on the syndicate involved during the year when the coverage was originally written, policyholders may not be able to locate them, Mr. Hertz said. The risk is highest for policyholders with a claim on long-tail business going back to the 1960s. Even if the name is not dead or bankrupt, the policyholder would face the potentially prohibitive cost of suing each name individually, he said.

In addition to possibly exposing old names to liability, Mr. Hertz said a shortfall in Equitas' reserves could also break through Lloyd's efforts to "ring fence" the market's pre-1992 losses from Lloyd's current assets and from causing losses to names underwriting in later years.

Unpaid claims could breach two Joint Asset Trust Funds set up in 1993, one to back U.S. reinsurance and the other to back U.S. surplus lines business, according to Mr. Hertz. Each fund must be maintained at not less than $104 million, while their combined value at the end of 1997 was $224 million.

"If either the reinsurance or surplus lines JATF falls below the requisite levels because of claims on 1992 and prior business, the ongoing market will be required to top it up in order to continue to do the type of U.S. business it supports," he cautioned.

The attorney also maintained that notwithstanding the immense effort put into accurately estimating the reserves required for Equitas and the fact that Equitas' surplus in the year ending March 31, 1997, has increased 5% to L617 million ($977.6 million) from its 1996 launch, "the inherent uncertainties in Equitas' long-tail business -- principally the APH (asbestos, pollution and health) business -- is still a source of concern for some in the market."

He claimed this view is confirmed in part by the October 1997 rating reports produced for Lloyd's of London by the three leading credit rating agencies, Standard & Poor's Corp., A.M. Best Co. and Moody's Investors Service Inc. All the agencies said in their reports that although Equitas is a separate company, if it runs into financial difficulties it could pose problems for Lloyd's (BI, Oct. 6, 1997). The rating agencies maintained either that Lloyd's would be obliged to make good any shortfall in Equitas' accounts or that because the market perceives Lloyd's and Equitas as one entity, Lloyd's couldn't avoid adverse fallout from problems within Equitas.

Another conference speaker, Rafael Villarreal, vp and senior analyst for Moody's in London and an author of its October 1997 report on Lloyd's, said the fact that the success of the market's R&R plan is dependent on bringing finality to claims against names is not a very solid foundation.

Mr. Villarreal expressed concern about the timing and magnitude of Equitas' cash flows.

Equitas' anticipated payment of between L6 billion and L8 billion ($10 billion to $13.33 billion) within five years could deplete funds, prevent the capital appreciation needed, and trigger a proportional claims payment policy, Mr. Villarreal warned.

While this is Mr. Villarreal's estimate of payments, Equitas has said it has no disagreement with the figures.

As of Mar. 31, 1997 Equitas had L12.7 billion in assets ($20.12 billion) and L12.1 billion ($19.17 billion) in liabilities, giving it a surplus of L617 million ($977.6 million).

"This could create a tiered ranking, giving economic seniority to short-tail policyholders," he added.

Mr. Villarreal said the weaknesses of Equitas include the absence of its own cash flows, weak capitalization in relation to its risk profile, potentially greater volatility than anticipated in investment values, and the subordination of policyholders' claims to protection of names.

Equitas' spokesman disagreed with Mr. Villarreal's assumptions as to what might trigger a move to proportional claims payment.

The spokesman said, "As long as we pay what the reserving (procedure) projected is needed to pay for these short-tail claims, we will have the money left over to pay the long-tail claims."

The spokesman added that those behind Equitas "believe our investment strategy is appropriate for the book of business that we have reinsured, and we have always said that we would consider investing a small portion of our portfolio in other types of instruments than fixed income when it is appropriate to do so."

He said that in addition to the 5% increase in surplus cited by Mr. Hertz, Equitas' liabilities have decreased as it has paid claims, so that the ratio of surplus to net outstanding liabilities increased to 0. 071 to 1 as of March 31, 1997, from 0.056 to 1 at the start.

"We hope as time passes to continue to improve our solvency margin to give assurance to both reinsured names and to policyholders," he added.