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The insolvent reinsurer.

The very thought of a captive's reinsurer becoming insolvent is one of those events that can cause risk managers to awaken in the middle of the night in a cold sweat. Suddenly, the protection dearly sought and relied upon has been lost. Visions of unreimbursed claims, the captive's consequent failure and the resultant threat to the risk manager's livelihood can prevent peaceful slumber. The mind races and the body tosses and turns until the morning comes.

Much of the risk manager's concern stems from a fear of the unknown, for example, what is the process of a reinsurance insolvency and what should the risk manager do in the event his or her captive's reinsurer should fall upon hard times. Although the insolvency of a reinsurer can be an unfortunate and expensive experience, once a plan of action has been devised, the risk manager should at least be able to sleep better.

There is no way that a risk manager can prevent the insolvency of the reinsurer of its captive however, much can be done to minimize the risk. Careful analysis of the financial condition of the reinsurer before a relationship is developed is essential. Price alone should never dictate which reinsurer to select what the risk manager really wants is impeccable security.

Most managers of captives have established security review procedures that, when followed, should minimize the risk of insolvency. Risk managers should also follow similar procedures. What is most important is to know your reinsurer - get the financial data, practice due diligence and do not take anyone's word for granted. Some of these statements may be viewed as heretical, but risk managers should be confident that their reinsurers will be riscally sound when the claims come rolling in.


Once the reinsurer is chosen, the risk manager's responsibilities do not end. The financial condition of the reinsurer should be constantly monitored. Be atuned to hints of trouble - slow payment of claims, mistakes on bordereaux (written reports of individual cessions), excuses of "computer glitches." At the first sign of these problems, follow up. This could save the company from more trouble in the future.

If, despite taking care in selecting a reinsurer and monitoring its financial condition, the reinsurer of the captive should fail, the risk manager's troubles can be minimized if an emergency plan has been developed to cope with the situation. This plan must be based upon an understanding of what happens during an insolvency proceeding.

Like an insurer, a reinsurer is a creature of state law. The receivership of any U.S. reinsurer is therefore governed by the law of its state of domicile and not by the Federal Bankruptcy Code. Most states' laws governing such receiverships are similar. The Commissioner of Insurance will petition the local state court for an order declaring the reinsurer to be insolvent and the insurance commissioner to be appointed as its receiver. If the reinsurer is to be liquidated, the receiver or his or her deputy will then marshal the reinsurer's assets, pay its claims and liquidate the reinsurer. State statutes establish the rules governing each of these activities, and, where there are ambiguities, there often are court decisions to provide guidance.

When a U.S, reinsurer fails, however, there is one significant difference from when a U.S. insurer fails - the state guaranty funds do not pay claims of the insolvent reinsurer's cedents. Thus, the only financial recourse policyholders of an insolvent reinsurer have is to take action against the assets of the reinsurer or, as noted below, in some cases, against third parties.

A second point to note with respect to the receivership of a U.S. reinsurer is that the receiver is more likely to engage in efforts to rehabilitate the reinsurer when the sole policy holders are other insurers. This can provide opportunities to risk managers that are not ordinarily available in the case of the liquidation of a primary insurer.

Where the insolvent reinsurer is not a U.S. corporation, the situation becomes trickier. Jurisdictions like the United Kingdom and Bermuda have well-developed rules governing insolvencies that differ markedly from those in the United States but that, if mastered, can provide risk managers with even greater opportunities to recoup their losses. It is important to secure expert advice immediately should an alien reinsurer fail, because opportunities can be lost through delay.


The first step a risk manager should take in the case of a reinsurer failure is to collect as much information as possible about the reinsurer and its relationship to the company. If the necessary due diligence in the reinsurer's selection has been performed, the information collected will already include the reinsurer's domicile and financial condition. This information is vital in order to know the rules by which the receivership will be played is it a U.S. jurisdiction or one that is abroad? Moreover, how insolvent is the reinsurer? Can it be rehabilitated or is it too far gone to save? Press reports may be the

only source of this information, but in the United States, financial examinations of the reinsurer may be available and should be sought. Inquiries of relevant officials should also be made, for this information will be important in planning a strategy to maximize recoveries.

The reinsurer's relationship to other reinsurers should also be known. Was this a stand-alone relationship or was the reinsurer part of a pool or syndicate, managed by a broker or captive manager? If the reinsurer is part of a pool or syndicate and the agreements between the pool and syndicate members are not properly drafted, it may be possible to argue that the insolvent reinsurer's share of the captive's risk must be borne by the surviving solvent pool or syndicate members. In addition, the pool or syndicate manager may have done something wrong and could be a target defendant in a lawsuit.

Who owns or controls the reinsurer is another related question that must be addressed. If the reinsurer is part of the holding company system, immediately seek out the services of an attorney. Under these circumstances, the risk manager is virtually guaranteed to be a target defendant in a huge amount of litigation. Suing the entity that owns or controls an insolvent reinsurer has become standard operating procedure for receivers, policyholders and claimants.

Another consideration is how the reinsurance was placed - directly or through an intermediary. If the captive dealt through an intermediary (or a series of intermediaries) the risk manager must ascertain whether there are any funds in the pipeline. Try to stop those funds flowing toward the insolvent reinsurer and get hold of those funds flowing to the captive. These funds may be given back at a later date, but their possession is a powerful bargaining counter when dealing with the receiver. Additionally, if dealing through an intermediary, questions of notice and procedure for dealing with the receiver could become confused. Consider whet-her to rely on an intermediary to handle all the correspondence, proofs of claim and notices with the receiver or to do so in-house. One consideration in making this decision is whether the captive contemplates suing its intermediary for negligence in choosing this reinsurer.

Also take into account how long the captive was reinsured by this reinsurer and how significant this reinsurer was. This will determine the importance of the insolvency of the reinsurer and how much of the company's limited resources should be dedicated to the insolvency proceeding, investigation and litigation, if any. If the insolvent reinsurer was a participant in your program for many years, its insolvency is likely to be sufficiently important to dedicate significant resources to ensuring that recoveries are maximized. If it is a new addition to your company's program, however, it may not pay to expend these resources. If your dominant reinsurer should fail, pull out all the stops. If it is a minor part of a following market, it may not be cost-effective to do so. The response to the two preceding questions will also determine how big a creditor your company is, which could dictate, in the case of the insolvency of a U.K. or Bermuda reinsurer, whether your company would qualify for membership on the creditors' committee that selects the receiver.

All of the contracts between your company and its reinsurer should be collected and read, for they may provide ideas for possible additional claims. They will also warn of possible claims that may be brought against your company by the receiver for, say, retrospectively rated or experience-based premiums, and hence, opportunities for offset. Also review all reinsurance agreements involving layers in excess of the insolvent reinsurer. There may be a possibility of arguing that the excess reinsurer must "drop down" to cover the losses that the insolvent reinsurer is unable to pay.

Did your captive's reinsurer put up letters of credit or trust funds to provide payment security and allow for reinsurance credit on your annual statement? If so, quickly take action to secure these amounts. It is not unheard of for the receiver to try to "liberate" these funds to add to the pot he or she holds for all creditors. Court action may be necessary. It may also be advisable to negotiate with the receiver to maintain the letters of credit or trust funds intact. Remember, without such security, all credit for this reinsurance is lost, which could have catastrophic consequences for your captive's surplus. Some attorneys advise drawing down the letters of credit immediately, putting the funds in escrow and then negotiating with the receiver.

It is also very important to determine the status of your company's account with your reinsurer. How much is your company owed now and how much will be owed? Include everything, particularly incurred but not reported losses (IBNR). A characteristic of a troubled insurer is that its records are the first thing to disappear. It is likely that the receiver will be forced to rely upon your company's records to determine the account's status with the reinsurer. The better your records, the better your chances are of prevailing should there be a dispute over how much is owed. A further reason is to ascertain your net position vis-a-vis the reinsurer, taking advantage of any offset available against the reinsurer. The laws governing offset are not uniform from state to state, and there may be an opportunity to recoup significant amounts owed to your company through a maximization of offset.


In order to take an active role in the insolvency proceedings, a risk manager's first step will be to learn who is doing what to his or her reinsurer, where the receiver (if appointed) is located, the status of the insolvency proceeding (rehabilitation, liquidation or something else) and what role to play in that proceeding. For example, if there is a court order, get a copy of it and read it. It will provide all necessary information including who the receiver is, dates before which proofs of claim must be filed and whether contracts have been canceled. This order is very important because it sets forth the rules of the road regarding the receivership.

The next step is to prepare and file a proof of claim. Usually these forms are obtained from the receiver, but don't expect them to be sent automatically - the receiver works off the insolvent reinsurer's records, which usually are a mess. Thus, it is always a good idea to ask for a proof of claim. When completing the proof of claim, it is important to claim all possible amounts that are and may in the future be due to your company, including the reinsurer's share of your IBNR. These amounts may be subsequently disallowed, but often they are not and, in any event, they are valuable bargaining counters with the receiver - especially should there be arguments over the amount of offset.

Remember not to credit the receiver with any amounts your company may owe to the insolvent insurer. File a gross claim; let the receiver claim any amounts it believes are owed. If unsure of the amount of the claim, file the form anyway and state that the amount is "undetermined and subject to audit" or similar words that will allow more time to get a better fix on the amount owed. And remember to reserve your right to amend your claim.

Open a channel of communication with the receiver. This can be done direcdy or through an intermediary or attorney. It will be vital, should it become necessary to negotiate such things as: rescinding a reinsurance agreement; commuting a reinsurance agreement; or negotiating or cornpromising your claims.

It is an unfortunate fact of life that today's society is such a litigious one. However repugnant it may be, the risk manager would be doing a disservice if he or she failed to analyze whether any claims exist against third parties arising out of the reinsurer's insolvency. These potential defendants may be related to the insolvent insurer, e.g., the owner of the reinsurer or its directors or officers, the professionals hired by the reinsurer and upon whose advice the directors relied (accountants, investment counselors, actuaries or lawyers), or the managers of the insolvent insurer. Potential defendants may also be the negligent intermediary who placed your program with this reinsurer, the excess reinsurer who may be forced to "drop down," or, in some rare and extreme cases, a dishonest regulator.

Remember, there is no guaranty fund protection. If your reinsurer wrote much direct business, your chance of collecting anything from the receiver may be nil. Your only choice may be to search for a deeper pocket.

What has been covered here so far is necessarily only the tip of the iceberg. Guidance through the various types of receiverships and assistance in the evaluation of your options should be sought at the earliest opportunity. A receivership is a time consuming and lengthy process, often taking more than a decade to complete. Each insolvency, however, provides opportunities for the informed risk manager that can turn the nightmare, if not into peaceful slumber, at least into a satisfying sleep.
COPYRIGHT 1993 Risk Management Society Publishing, Inc.
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Author:Johnson, James F.
Publication:Risk Management
Date:Aug 1, 1993
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