LONDON-Commercial policyholders of Independent Insurance Co. Ltd. face big rate increases as they scramble to replace their policies following the company's collapse last week.

Independent was put into provisional liquidation last Monday due to uncertainties over the adequacy of its loss reserves and its reinsurance arrangements. PricewaterhouseCoopers, as provisional liquidator, is conducting a detailed financial investigation and hopes to put Independent into a scheme of arrangement for running off the company.

Meanwhile, the United Kingdom's Serious Fraud Office, an independent government department charged with investigating allegations of serious or complex fraud, announced last Thursday that it is conducting an investigation into Independent, following a referral of the matter from the government's Financial Services Authority.

Watson Wyatt, the company's outside actuary, advised Independent's board last month that it could not form an accurate actuarial assessment of the insurer's reserves. Uncertainty also surrounds the discovery by Watson Wyatt of claims not entered into the company's accounting systems.

Two senior directors, including the insurer's finance director, also have said that they had not been told about some of Independent's reinsurance contracts (BI, June 18).

Michael Bright, who had previously set up an insurance division for the Edinburgh-based investment company Noble & Co. Ltd., formed Independent in 1986 by combining Noble's insurance operation with the U.K. business of Northbrook, Ill.-based Allstate Insurance Co.

The nascent Independent grew quickly to become an important property/casualty insurer for small and medium-size companies in the United Kingdom, Ireland and Australia. At the end of 2000, Independent had about 40,000 commercial policyholders. At that time, its gross written premiums totaled L965.4 million ($1.44 billion); of that, personal lines business accounted for less than 20%.

Mark Batten and Daniel Schwarzmann, partners in PwC's insurance restructuring practice and the heads of the team constructing a scheme of arrangement for Independent's creditors, were unwilling to quantify the size of the insolvency. But Mr. Batten said "the company would have run out of money in a couple of months" had it not entered provisional liquidation.

Only claims filed under compulsory classes of commercial insurance, such as employers liability insurance covering occupational accidents and illness, will be covered by the Policyholders Protection Board. Personal lines policyholders will be largely protected by the PPB, an industry-backed guaranty fund established by the U.K. government.

Multiline insurer Royal & SunAlliance is negotiating with PwC to transfer Independent's council-tenant, or municipal housing, coverage. The deal, Mr. Schwarzmann, would allow those Independent policyholders to "seamlessly" become RSA customers.

But Independent's collapse leaves other policyholders scrambling for coverage in a market that has tightened significantly. Many insurers recently have lost their appetite for writing U.K. commercial liability insurance.

In addition, some Independent policyholders will face higher-than-average price hikes if they were among those who bought long-term policies at prices far below those offered by other insurers.

The London Fire & Emergency Planning Authority is a long-term Independent policyholder. Bob Cope, the assistant director of finance for the LFEP, said the municipal firefighting authority is "probably looking at a doubling of premium" for its liability coverage.

Mr. Cope said the authority is fortunate because it has no outstanding claims with Independent and it was already seeking new coverage because its three-year policy with Independent is due to expire June 30.

The LFEP, with the help of its broker, Heath Lambert P.L.C., has secured two weeks of temporary coverage with another insurer, which Mr. Cope did not identify.

Heath Lambert expects the collapse of Independent will "result in a further hardening" of the market, according to a statement given to Business Insurance.

"Individual premiums will also depend on client risk profile, claims history and the appetite other underwriters have for a particular class of business," Heath Lambert's statement said.

Heath Lambert said it will determine on a case-by-case basis whether clients will have to pay fees or commissions on the replacement coverage.

Lloyd's of London underwriter Andrew Beazley said brokers are scrambling to find replacement coverage in the market. Mr. Beazley said that while plenty of capacity is available policyholders seeking coverage, the main difficulty for buyers will be the steep rate increases they will face.

The LFEP's Mr. Cope admitted that the authority insured with Independent because "they were very competitive, streets ahead of their competitors." Mr. Cope said he does not blame his broker for the situation; he noted that the authority made its own assessment of the insurer's viability.

"Independent satisfied all our financial checks and was able to handle our level of business. It was not a traditional company-Mike Bright was a different sort of player-but we never had any concerns about its financial standing," he said.

Now many are asking why no one predicted Independent's troubles since it seemed to have been writing business at much more competitive prices than its peers, most of whom were losing money on such business.

Rating agencies, including Standard & Poor's and A.M. Best Co., had begun revising their ratings on Independent in recent months, after the company announced poor results and purchased additional stop-loss reinsurance.

But S&P affirmed the company's financial strength rating of A- as late as April 19, when Mr. Bright resigned as Independent's chief executive officer. On June 14, after Independent had "temporarily" stopped underwriting both new and renewal business-following its failure to raise additional capital due to concerns regarding its reserves and reinsurance-S&P lowered its ratings to BB from BBB+. A.M. Best Co. lowered its rating to B- from B++.

If Independent is put into a scheme of arrangement, as the provisional liquidator hopes, creditors will receive a percentage of their claims in accordance with the company's assets and liabilities. Commercial policyholders will be treated as nonpreferential creditors.

In hindsight, several factors should have alerted observers to potential problems, said Roger Hill, an analyst with UBS Warburg.

"The company wrote long-tail business; it grew rapidly; it was based around one strong person, Mr. Bright; there were some unsettling things in its accounts, such as negative cash flow; and it was making profits ahead of its peer group," Mr. Hill noted.

But despite concerns, there is a limit to what analysts can learn, particularly regarding such matters as complex reinsurance contracts, Mr. Hill said. He predicted that, in the future, analysts will ask for more details about insurer's reinsurance arrangements.

Chris Hitchings, an insurance analyst with Commerzbank Securities, said that most analysts' research reports had pointed out that Independent "was making money out of business most companies couldn't make money out of."

The "assumption could be that Independent was not showing its true results or that it was, indeed, selecting good policyholders," Mr. Hitchings said. But "if a company offers a rate much lower than others," he said, "you take a risk."

Mr. Hitchings noted that he has never analyzed Independent stock because he did not believe he could recommend it as a sound investment.

"The U.K. liability insurance market has been through a severe technical downturn, and there will be casualties. Independent is the largest and most spectacular and, hopefully, the last. But there are still lots of bleeding insurers out there, and some Lloyd's syndicates won't make it," Mr. Hitchings predicted.

"If there is a lesson in this, it is that if something looks too good to be true, it probably is," he said.

Sarah Veysey contributed to this report.