March 2002: Aviation MGA sued for fraudPosted On: Mar. 15, 2019 10:42 AM CST
BURLINGTON, N.C. — A small managing general agency, little known before the Sept. 11 terrorist attacks, is facing allegations of fraud after producing an estimated $2.5 billion in aviation losses for three Japanese insurer clients.
The privately held MGA, Fortress Re Inc., which was formerly a major market for aviation reinsurance, faces a lawsuit by former client Nissan Fire & Marine Insurance Co. Ltd. charging that the MGA used accounting gimmicks to conceal years of losses while pocketing huge profit commissions. The MGA also funneled hundreds of millions of dollars more in premiums to an undercapitalized Bermuda retrocessional reinsurer owned by Fortress Re principals, the suit says.
The Bermuda company, Carolina Reinsurance Ltd., a key retrocessionaire of the three-member Fortress Re pool, paid out most of the money it received as dividends to Fortress Re officials, Tokyo-based Nissan charges.
Carolina Re was declared insolvent by at least $350 million and ordered into liquidation by a Bermuda judge in December.
Burlington, N.C.-based Fortress Re itself ceased underwriting last year after Sept. 11 losses drove one of its pool members, Taisei Fire & Marine Insurance Co. Ltd. in Tokyo, into bankruptcy. The losses also prompted Nissan to audit the MGA, which led, in turn, to the pending fraud lawsuit.
Fortress Re continues to perform runoff administration for various clients, excluding Nissan and Taisei, the MGA and its lawyers say.
Apart from the financial damage to its participants, the pool’s collapse has also contributed to turmoil in the aviation insurance market.
Fortress Re specialized in low-level excess aviation reinsurance, writing accounts covering numerous major airlines and providing large limits above ceding insurer retentions of as little as $50 million, aviation market sources say. The MGA’s withdrawal has left a void in the excess reinsurance market, forcing ceding insurers to take larger retentions and pay far higher premiums for what excess limits are available, market sources report.
Reinsurers “have not rushed in” to replace Fortress Re’s capacity, confirmed Steve Breen, senior vp with Willis Re in New York.
Fortress Re officials deny Nissan’s charges, and the agency said in a statement that an “exhaustive review of Fortress’ records” by auditors for Nissan and Taisei “has not revealed any impropriety.”
“Nissan still has not offered any evidence to support its hollow allegations of mismanagement of funds by Fortress,” according to the statement.
Referring to Fortress Re’s years of reported profits, MGA officials assert that the complaint “presents a classic example of a reinsurer who—after profiting handsomely from risks it knowingly incurred…— cried foul after significant losses from those risks were realized for the first time.”
A Greensboro, N.C., federal judge has ordered Nissan and Fortress Re to arbitrate their dispute but is allowing Nissan to pursue legal action against Fortress Re’s owners.
Though widely known in the aviation market, the 16-employee Fortress Re was a relatively obscure agency for most of its nearly 30 years of existence before Sept. 11.
Formed in 1972 as a unit of Penn General Agencies Inc., Fortress Re was spun off to its management in 1979. It has since been controlled by its chairman, Maurice D. Sabbah; members of Mr. Sabbah’s family; and Fortress Re President Kenneth H. Kornfeld, according to court records. The MGA’s current shareholders are Leeor B. Sabbah— Mr. Sabbah’s daughter—and Mr. Kornfeld, according to Fortress Re filings.
Since 1993, the MGA had operated a three-member pool made up of Nissan and Taisei, each of which took 26% of the reinsurance assumed through Fortress Re; and another Tokyo-based insurer, Aioi Insurance Co. Ltd., which took 48%.
Under its contracts with the pool members, Fortress Re had nearly total control of its business, with authority to underwrite and bind coverage, settle claims and place retrocessional coverages for pool members.
In addition to management fees and commissions for retrocessional placements, Fortress Re received a contingent profit commission of 33.3% of the pool’s net profits calculated at the end of each pool year, court records show.
Although the pool faced some strains before last fall—including the unwillingness of some cedents to accept Taisei’s security and questions about Aioi’s future commitment to the pool—its fortunes took a disastrous turn following Sept. 11.
A month after the suicide hijackings of four United Airlines and American Airlines jets, Taisei filed for corporate reorganization in Japan, citing 74.4 billion yen ($565.1 million) in losses on Fortress Re business.
The bankruptcy temporarily scuttled a planned merger of Taisei and Nissan with Yasuda Fire & Marine Insurance Co. Ltd. Nissan and Yasuda signed a new merger agreement last month, though, and plan to combine to form Sompo Japan Insurance Co. Ltd. later this year.
Nissan will report a net loss for fiscal 2001 as a result of its Fortress Re exposure, and Standard & Poor’s placed Nissan’s A+ rating under review with positive implications because of the Yasuda deal.
Aioi, meanwhile, has projected losses of 126.1 billion yen ($957.7 million) from Fortress Re, a primary factor in S&P’s decision earlier this month to downgrade Aioi’s rating to A from A+.
Following the Sept. 11 attacks, Nissan terminated its contract with Fortress Re. It also dispatched auditors from PricewaterhouseCoopers L.L.P. to examine the MGA’s records, including more than 170 assumed reinsurance contracts along with ceded reinsurance placed on behalf of the pool, Nissan court filings say.
After reviewing PwC’s report, Nissan in January demanded arbitration and simultaneously filed its lawsuit in U.S. District Court in Greensboro, charging Fortress Re and its top officials with breaches of fiduciary duty and fraud.
According to the complaint, Fortress Re inflated the pool’s reported profits for at least the past four years by using “artificial accounting methods,” including financial reinsurance that transferred no insurance risk and required full repayment of losses over time with an interest component. The arrangements allowed Fortress Re to take “grossly inflated” profit commissions in the interim, Nissan charges.
PwC estimated the Japanese insurers’ total exposure on Fortress Re business at $2.5 billion, comprising $1.46 billion for future claims other than Sept. 11 losses, excluding the effect of financial reinsurance; $843 million for future Sept. 11 claims; and $188 million for future amounts due under the financial reinsurance contracts. Fortress Re reported only about $178 million of these exposures, Nissan alleges.
Between 1982—when Nissan began assuming business through Fortress Re—and last year, the MGA reported $1.58 billion in net profits to pool participants and took $528 million in contingent profit commissions, the complaint says.
The PwC analysis found, however, that the pool was actually only breaking even over that span and was consistently losing money in the past four years, despite Fortress Re’s reports to the contrary, Nissan alleges.
Nissan also contends that Messrs. Sabbah and Kornfeld used Bermuda-based Carolina Re to siphon more money away from pool members.
Formed in 1984, Carolina Re’s shareholders have included Mr. Sabbah; his wife, Zmira Sabbah; and Mr. Kornfeld. Mr. Kornfeld is a current shareholder, according to Fortress Re filings.
Shortly after its formation, Carolina Re began assuming a 6% quota-share retrocession of the pool’s business. That amount gradually rose, and the Bermuda company has assumed 25% of the pool’s risk since 1992. Based on PwC’s projection of $2.5 billion in losses to Fortress Re participants, Carolina Re would be on the hook for more than $600 million in claims, the suit says.
An unaudited Carolina Re balance sheet shows that the reinsurer had capital and surplus of $62 million as of Dec. 31, 2000.
Most of the money taken in by Carolina Re over the years was paid out again in dividends to Mr. Sabbah, members of his family and Mr. Kornfeld, Nissan charges. Based on net profits reported to pool members between 1984 and 2000, Nissan estimates that Carolina Re booked about $470 million in underwriting profits over the 16-year period, of which at least $408 million was distributed to shareholders including Messrs. Sabbah and Kornfeld, the suit says.
Fortress Re pool members knew of Carolina Re’s involvement in the program: The details of its ownership and role with the pool were spelled out in a tax case filed by Taisei and decided by a U.S. Tax Court judge in 1995.
Nissan argues, though, that it would have pulled out of the pool much sooner if it had known of Carolina Re’s allegedly huge dividend payments.
The lawsuit charges Fortress Re, Mr. Sabbah and Mr. Kornfeld with breaches of fiduciary duty, negligence, fraud and other wrongdoing.
Mr. Sabbah’s wife and daughter are also named in charges of improperly diverting Nissan funds and unjust enrichment.
In a Feb. 25 order, U.S. District Judge N.C. Tilley Jr. referred most of the charges against Fortress Re to arbitration but allowed discovery proceedings to begin on the charges against the individual defendants.