The Elephant in the Courtroom

In March of this year an eleven day hearing was conducted in New York Supreme Court for Nassau County to consider the rehabilitator’s petition to liquidate Executive Life Insurance Company of New York (ELNY) and approve his proposed restructuring plan.  The court issued a decision on April 17, 2012 approving the rehabilitator’s petition, determining that ELNY is insolvent, ordering it liquidated, and approving the proposed restructuring plan. 

In an article appearing in the June 2012 issue of AIRROC Matters, the magazine of the Association of Insurance and Reinsurance Run-Off Companies, I contend that the court’s approval of the petition and plan is far from a final resolution of the long ELNY saga.  The Court’s ruling is more about the allocation of pain than a solution to the underlying problem.  My article, The Elephant in the Courtroom, examines this underlying problem -- the lack of accountability in the receivership process in New York -- an issue that that remains unaddressed by the court ruling, the order of liquidation or the restructuring plan.

The full article can be viewed online at the AIRROC websight at http://www.airroc.org/magazine.aspx.

 

Insolvency Process in New York -- Encore!

Last month I posted the final installment in my series of articles on the insurance insolvency process in New York. Since completing the series I have received a number of requests for the entire series. To accommodate these requests I have combined the series into one document and have posted it in pdf format on my web site, which can be accessed here: www.pbnylaw.com.

As I state in the introduction to this article, since the Mid-1980s I have represented managements, shareholders, policyholders, claimants, reinsurers (both as creditors and as debtors) and purchasers of insurance operations in liquidation or rehabilitation in New York. During that time I have observed the handling (or mishandling) of the receivership process spanning the administrations of five Governors and eight superintendents. Each new administration has vowed to “do something” about the system, and in particular address the “mess” at the Liquidation Bureau. What has been clear from these efforts over the years is that the “mess” has been largely misunderstood and the entrenchment and resilience of the Bureau grossly underestimated.

It is hoped that this article will help those trying to wend their way through the maze of the insolvency process to pursue their interests in an insolvent estate; and in the process spotlight the myths and misunderstandings surrounding the roles -- statutory or de facto -- of the superintendent, the Insurance Department, the Liquidation Bureau and the security funds.

If you have a problem in accessing the article through the link above, please e-mail me at pbickford@pbnylaw.com, and I will send you the article by return e-mail.

The Liquidation Process in New York - Part VII: It’s a Wrap!

The last glimmer of hope for enlightened management of the insolvency process in New York by the current administration was dimmed at the end of February!

In Part II of this series (“The Right Stuff,” posted September 12, 2008), I applauded the one estate being run openly and efficiently by an agent of the receiver, free from the stifling and secretive bureaucracy of the Liquidation Bureau. This one estate, United Community Insurance Company, demonstrated that the tools necessary for an efficient, open and accountable process exist in the law today, requiring only the will of the administration to use that authority. Unfortunately, it appears that this will does not currently exist. Direct control of the United Community estate has been turned over to the Liquidation Bureau effective March 1st. There are no more agents of the superintendent as receiver independent of the Bureau!

But let’s look at the bright side! In the parlance of the market, you have to find the bottom before you can start to rebuild. With that possibility in mind, it is time to wrap up this series of articles on the receivership process in New York with some thoughts on how that rebuilding can occur.

As has been pointed out repeatedly (some may say ad nauseum) throughout this series, the receivership process in New York lacks meaningful transparency and accountability. Yet the tools to address these deficiencies are, for the most part, already in place. Following are some thoughts on the steps that can be pursued to restore confidence and integrity to the process, focusing on three principal areas:

• Estate Management
• Third Party Participation, including the Courts, Regulators, Policyholders, claimants and creditors, Guaranty funds, and Reinsurers
• Legislation

Estate Management

As discussed on numerous occasions in this series, the Liquidation Bureau’s talk about transparency belies reality. The first step to achieving true openness, however, is relatively simple and uncomplicated: communicate material information on a regularly basis to all groups legitimately interested in an estate, including its policyholders, creditors, reinsurers, guaranty funds, the courts and, yes, even its shareholders. To accomplish this, the superintendent as receiver need simply direct all of his agents (unfortunately, at the moment that is only the Liquidation Bureau) to:

• Prepare regular periodic reports on a standard format, including a narrative on developments and standard (i.e. statutory) financial and cash flow statements;

• File those reports with the appropriate receivership court and post them on the agent’s web site;

• Invite input from all interested parties particularly policyholders, claimants, creditors, guaranty funds, and reinsurers; and

• Hold regular conferences with the receivership court, with notice to all interested parties.

The receivership process should be about finding the greatest value for the policyholders, claimants and creditors of an estate. For this to be achieved, the process needs to be truly open and communicative with these parties and not just pay lip service to their concerns.

Third Party Participation

The Courts
For the most part, the liquidation and rehabilitation courts in New York have been minimally involved in the oversight of management of the estates before them. Although it often seems that the courts grant undue deference to the receiver, it would be unfair to characterize them as merely rubber-stamping the requests of the receiver. The courts have a difficult job with a matter that is not the typical court case, and which often has no clear time frame to reach a conclusion.

There have been a number of exceptions, however, including New York Supreme Court Justice Shackman for the Constellation Re estate, Justices Kirschenbaum and Cahn for the various insolvent New York Insurance Exchange syndicates, and more recently Justice Stallman for the Midland Insurance Company estate and Justice Williams for the United Community Insurance Company estate Upstate. The involvement of these judges demonstrates the value that an attentive judge can bring to bear on the effective management of an estate.

However, even the most involved judges are limited to addressing only those matters before them, and if the receiver is not providing the judge with meaningful and timely information on a regular basis, and other interested parties are not able or willing to pursue matters with the court, the courts can only provide limited protection from systemic abuse.

The Regulators
A continuing regulatory role by the Insurance Department – separate and apart from the Liquidation Bureau or any other agent of the superintendent as receiver – would help ensure that the estates will be run openly and pursuant to the same standards and rules promulgated by the regulators for the rest of the insurance industry. In other words, when the superintendent of insurance is appointed receiver of an insolvent insurer, the same standards he applies to the rest of the industry should be applied to his own conduct of the business of the company in receivership.

The regulatory oversight of a licensed company should not end with the entering of an order of liquidation or rehabilitation. It makes no sense that when an insurance entity is placed in receivership the commissioner ceases to be the regulator and becomes the manager of an unregulated insurance business. Why shouldn’t the superintendent as receiver be held to the same standards that he imposes on the rest of the industry as its regulator? Why shouldn’t he apply his own rules to himself? (For a fuller discussion of this point, see my November 2004 article presented at a conference on insurance insolvency titled “Who Protects us from the Receiver?” A pdf copy of this article can be accessed at http://www.pbnylaw.com/publications.html.

Policyholders, claimants and other creditors
Creditor representatives played a major role in the successful release of Constellation Reinsurance Company from liquidation in 1992, forcing the addition of significant value to the plan. Yet through the final hearing before Supreme Court Justice Shackman the Liquidation Bureau protested the involvement of the very people it was purporting to protect. Although he deferred to the Bureau by not formally approving the creditors’ committee, Justice Shackman allowed the active participation of the creditors’ representatives in all phases of the proceedings – much to the chagrin of the Bureau but to the benefit of the policyholders and other claimants. This attitude of the Bureau towards interested third parties is unproductive and contributes significantly to the outside distrust of the Bureau.

The Bureau’s justification for its position – that the involvement of third parties would interfere with the administration of an estate and be a waste of estate assets -- is disingenuous in view of the Bureau’s lack of openness and accountability.

Guaranty Funds
Guaranty funds as a group generally become the largest creditor as they pay claims against an estate. While the Bureau is quick to pass off claims to the guaranty funds of the various states, it is not very quick to provide meaningful or timely information on the status of the estate, the likelihood of immediate access to funding for the payment of claims, or the long-term prospects for distributions. Cooperation of the funds of the various states is essential for the efficient and cost effective management of an estate, and the receiver’s agents must bring the funds into in dialogue on an estate at the earliest possible moment, and to keep them involved over the life of the estate.

Of course, as described in Part III of this series [posted October 9, 2008], the property/casualty funds in New York are not separate entities as they are in all other states: rather they are bank accounts funded by the rest of the industry and administered by the superintendent of insurance as receiver. This bank account approach concentrates all the authority in the receiver’s agent (the Bureau) and eliminates the insight and perspective of the people that have to pay the assessments to meet the guaranty funds’ obligations.

The failure of the life funds, which are separately run, to provide independent guidance is more a matter of inertia than anything. Life insolvencies have been few and far between over the past two decades, so that when a situation arises, there is no tested infrastructure in place to address the matter. This could be easily rectified by the superintendent invoking his authority over the life funds to require them to meet regularly, provide appropriate, publicly available reports, and establish procedures and protocols for the handling of claims, collection of assessments and involvement in plans for insolvent insurers.

Legislation

All of the foregoing changes and improvements can be accomplished within the existing statutes. But the law should be revised to address some of its weaknesses, shortcomings and foibles, which have been addressed in the various parts of this series. Among the matters that should or could be addressed through legislation are the following – in no particular order of importance:

• Require the same standard of reporting (both as to timeliness and form) as is required of licensed insurers (i.e. based on statutory accounting principles); granting authority to the superintendent – as regulator – to waive by regulation or circular letter certain redundant, excessive or unnecessary requirements.

• Confirm the authority (and requirement) of the Insurance Department to maintain regulatory oversight over estates in receivership.

• Strengthen and standardize the requirement for regular, statutory statements and standardized reports to the liquidation or rehabilitation courts.

• Grant discretion to the Courts to recognize representatives of interested parties, including policyholders, creditor, guaranty funds and reinsurers.

• Eliminate the newly enacted audit requirements, and substitute a realistic oversight regimen over the receivership process and the agents of the receivership.

• Either eliminate the Liquidation Bureau altogether or clarify its status, standing and oversight.

• Place the p/c guaranty funds under the control of a separate entity with industry participation – similar to the funds in other states.

• Strengthen the reporting requirements and oversight of all the guaranty funds, p/c and life.

• Ultimately, allow for the appointment of receivers other than the superintendent of insurance, who would be held accountable on the same basis as any other licensee.

In other words, let the professional managers manage, and the regulators regulate!

Final Thoughts

Through this series of articles I have attempted to show the errant path taken by New York’s receivership process over the past several decades, and the need to repair and reshape the process. The system is not irrevocably broken, but it continues to move down a path that can only lead to eventual total mistrust and abuse. In view of the severe economic issues facing our industry today, the threat of massive insolvencies are not out of the question, and New York is ill prepared to handle such an event.

Throughout my 23+ years representing creditors, policyholders, reinsurers, managements, and other interested parties of insolvent insurance companies, I have been told by a succession of Liquidation Bureau personnel that my proposals to open up the process to greater scrutiny and oversight, and to allow the active participation of third parties, would interfere with the administration of the estates by placing an unnecessary burden on the receivers and add significant cost to the estates. The reality is quite the opposite. I seek nothing more than to apply the same rules of business conduct to insolvent companies as are applicable to solvent ones.

Finally, the cocoon of secrecy that the Bureau has wrapped itself in over the years, and which is being enhanced by the current administration under an Orwellian ruse of transparency, has resulted in a bloated, unresponsive and arrogant bureaucracy deeply mistrusted by those most directly affected. It does not have to be that way.

POSTSCRIPT: Last week The Liquidation Bureau announced a plan to seek a private buyer for Midland Insurance Company, which has been in liquidation in New York for 23 years. Definitive action on this estate is long overdue, and the plan may prove to be an appropriate course of action. However, one cannot help but question whether the plan is an admission by the administration that the Liquidation Bureau is not equipped to or capable of performing the responsibilities of a receiver for a substantial company - a sobering thought given the current financial climate.

By the way, in announcing its Midland plan, the Liquidation Bureau inaccurately claims that it “would be the first sale of a U.S. insurance company in liquidation.” Not so! (See, e.g., New York’s own Constellation Re).

The Liquidation Process in New York - Part VI: Oscar Season

If there were such an award, the current administration of the New York Liquidation Bureau would win the Orwellian Double-Speak Oscar. The Bureau has taken every public opportunity to promote a new era of openness and accountability, and to paint itself as the champion of the interests of policyholders and insureds. However, reality can be quite the opposite as this series has shown.

As previously detailed, under the banner of transparency the Bureau has actually reduced the scope of its reporting (for example, by issuing consolidated rather than the statutorily required individual statements for companies under its management), and has succeeded in obtaining legislation requiring the preparation of untimely reports at the expense of the estates that will be of little or no value as an oversight or management tool while needlessly tying the hands of estate managers in the future.

But these actions pale in audacity to its recent unprecedented use of the courts to further insulate itself from outside scrutiny and accountability!

As discussed in this series, the Bureau acts as the agent for the superintendent of insurance in his separate and private role as liquidator or rehabilitator, marshalling assets, paying claims and, in the case of rehabilitation, managing the business and acting to remove the causes of insolvency to restore the company to the marketplace. The courts have held that the liquidator or rehabilitator “stands in the shoes” of management so that, in theory at least, the Bureau and its employees are subject to the same standards of care and responsibility as any manager of any insurance entity.

Of course, given the circumstances of taking over an insolvent company, the law provides for certain protections for the estate, such as providing the courts with the authority to issue injunctions or orders “necessary to prevent interference with the superintendent or the proceeding, or waste of the assets of the insurer, or the commencement or prosecution of any actions, the obtaining of preferences, judgments, attachments or other liens, or the making of any levy against the insurer, its assets or any part thereof.” (Insurance Law § 7419; emphasis added)

These powers are clearly intended for the protection of the estate and its assets, and to allow for an orderly administration of an estate. They are not intended, and have not in the past been used overtly for the personal protection of the rehabilitator or liquidator and his agents – until now.

Since the start of the current administration in January 2007, there have been four liquidation and two rehabilitation orders issued. Each of these orders has included the following provision that did not exist in any such order entered into prior to 2007:

“The Superintendent as [rehabilitator] [liquidator] of [the company], his successors in office and their agents and employees are relieved of any liability or cause of action of any nature against them for any action taken by any one or more of them when acting in accordance with this Order and/or in the performance of their powers and duties pursuant to Article 74 of the New York Insurance Law;"

By adding this paragraph to the form of court order of liquidation or rehabilitation, the Bureau seeks to obtain immunity without any basis in the law, and for which there is no precedent in any of the hundreds of liquidation and rehabilitation petitions filed in the past. This immunity, by the way, is no garden-variety immunity from mere negligence. It bestows absolute immunity – including for gross negligence or intentional acts committed while acting as liquidator or rehabilitator of an estate.

Once again the current administration of the Liquidation Bureau has acted counter to its own pronouncements of openness and accountability. The Bureau repeatedly states that it is protecting the interests of policyholders and claimants of insolvent estates, and has publicly invoked its “fiduciary” role more than a few times. In the law, of course, fiduciaries are held to a higher standard of care than mere managers. Not only is the Bureau not prepared to assume even the most basic standard of care for its actions or inactions, the Bureau seeks to escape any and all responsibility.

Add this unprecedented immunity to the lack of existing institutional oversight or regulation, and you have the perfect setting for unbridled and undiscoverable abuse.

“And the Double-Speak Award goes to . . .”

__________________

A Note About the NAIC Insurance Receivers Model Act (IRMA):

Some readers familiar with IRMA might think: “What’s the big deal? IRMA provides immunity for receivers and their agents.” While IRMA provides a couple of immunity options – a limited and an absolute immunity -- only two states (Texas and Oklahoma) have adopted IRMA. The immunity provisions were and remain controversial, as many industry observers do not understand the logic in exempting receivers and their agents from responsibility for their actions, particularly for their gross mismanagement or worse.

But most significantly, immunity for receivers is a protection granted by law, and not to be taken through an unsuspecting court in a largely unopposed setting. This taking, combined with the lack of institutional oversight, is quite contrary to the “open and accountable” mantra of the administration.

The Liquidation Process in New York - Part V: The Legislative Cure – Masking the Disease?

Can you imagine a domestic New York insurer going to the Legislature with a proposed bill that would increase the insurers reporting requirements and expand its regulatory oversight? At the very least, one would expect the Legislature to look at the request with skepticism and seek to understand the motives behind the request. One would certainly not expect the Legislature to pass the bill or for the Governor to sign it without any significant airing of the problems and discussion of the proposed solution. That, however, is essentially what happened last year when the Liquidation Bureau presented the Legislature with a bill requiring annual audits of the Bureau and the estates under its management. The bill, as requested by the Bureau and without any significant public airing, was passed by the Legislature last June and signed into law in September [Laws of 2008, Chapter 540, amending §7405(g)].

So what could be so bad about requiring the Bureau to conduct annual audits? Why wouldn’t the revised law “provide greater transparency for policyholders and the public and to improve the Bureau’s fiscal accountability” as proclaimed by the Bureau’s August 7, 2008 press release? As Shakespeare wrote, let me count the ways!

A Failure to Provide an Oversight Function

First and foremost, providing for audits assumes that an oversight function already exists. It does not. As discussed in earlier installments of this series, the moment an order of rehabilitation or liquidation is signed, the superintendent of insurance becomes the receiver responsible for managing the estate and ceases to be its regulator – a void that is not addressed by the law. Providing for audits without providing for oversight responsibility, therefore, is placing the proverbial carriage before the horse.

Supporters point out that the new law provides that the audits be provided to the insurance department and the Legislature, therefore making them publicly available. But for what purpose and effect? Once an order of rehabilitation or liquidation is signed, the insurance department ceases regulating the insolvent company and has been given no charge – statutorily or otherwise – to conduct any review or analysis of the audited statements. Because the Court of Appeals has determined that the Liquidation Bureau is not a state agency, in large part because it does not involve the management or use of state funds, the state comptroller has no audit authority over it. It is also doubtful that the Legislature intends to assume any responsibility for the oversight of the estates or the Liquidation Bureau. And if members of the general public sought to fill this oversight void by challenging the reports or their methodologies, I suspect they would be ignored or summarily tossed for lack of standing.

Curiously, the law does not provide for submitting the reports to one entity with statutory authority over insolvent estates – the courts. In fact, the law does not provide for any regular reports or statements to be filed with the liquidation or rehabilitation court. And if the court were provided with the audited statements, it would most likely be quick to point out that its function is limited to ruling on matters put before them by the receiver, and not to act as the regulator of the estate or its managers.

A Failure to Address the Reporting Deficiencies

Secondly, the new law perpetuates and further imbeds the reporting deficiencies of the current law. Rather than following the §307 standard for all other licensed companies (filing statutory statements by March 1 with the statements audited by June 1 each year – see Part IV-A of this series), the current law allows statements to be filed for each estate subject to rehabilitation or liquidation “upon whichever standard the [estate] conducts its financial affairs.” Also, these statements do not have to be filed until the end of April, and are unaudited. These statements have proven to be of little value to policyholders, creditors, regulators, legislators, guaranty funds, investors or other interested parties, or even as a management tool to the Liquidation Bureau itself. Unfortunately, the new law not only fails to address these reporting deficiencies, it perpetuates them and wraps them in the protective cloak of an audit.

Most significantly:

• The new law dilutes the reporting requirements even further by allowing for combining the statements of the individual estates rather than requiring separate statements for each company in liquidation or rehabilitation. This combining is directly contrary to the whole receivership concept. Each estate is a separate entity with a distinct book of business under the supervision of a designated Supreme Court Justice. The idea of combining the results of these separate entities is new with the current administration and serves no useful disclosure purpose. Parties interested in one estate may have no interest in another estate, and reviewing combined statements would be of no help to interested parties in determining such things as the cost or effectiveness of the management of an estate, its success in marshalling assets, the likelihood of distributions to policyholders, guaranty funds or other creditors, or the prospects for new investor interest.

• Rather than seeking reporting consistency, such as by requiring reports to be filed on a basis consistent with other licensed companies under §307, the new law maintains the old reporting standard (“upon whichever standard each corporation conducts its respective financial affairs”). The new law, therefore, perpetuates the Liquidation Bureau’s open ended ability to prepare statements on some hybrid or mixed (or unknown) accounting basis, which has been one of the main reasons for the lack of meaningful and reliable information about the various estates and the Liquidation Bureau itself over the years.

• As stated before, there is no statutory requirement for the filing of any kind of regular, periodic report – financial or otherwise – with the liquidation or rehabilitation court.

• The new law provides for the filing of the audited statements by August 1 of each year without any explanation why auditors would need two more months than all other licensed companies are allowed under §307. By the time anyone can review and consider the consequences of these statements, they will be significantly out of date thereby diluting any value or insight they may have provided.

• The bill memorandum in support of the new law stated that the cost of the financial statements and audit opinions “will be below $300,000 annually.” That is for about 30 estates plus the Bureau itself – about $10,000 per audit. Based on the original engagement letters as posted on the Liquidation Bureau’s web site and subsequently removed, the cost of the 2006 audits was estimated to exceed $1.1 million and to be completed by Fall 2007. Those engagement letters were only for 2006, and the Bureau subsequently expanded the engagement to cover 2007 as well (although the engagement letters for 2007 were never posted). The 2006 audits were not completed until October 2008, and the 2007 audits, promised by year-end 2008, are still not completed. The full cost of these audits – all of which are fully borne by the creditors and policyholders of the estates – is unknown, but scary to anticipate. Believing that 30 plus audits can be done annually for “less than $300,000” is even scarier.

• The new law requires an audit of every estate “subject to liquidation or rehabilitation” no matter the size, age or status of the estate. There is no discretion or de minimus exception, which is likely to result in totally unnecessary and disproportionately costly audits for some estates, particularly those at the end of the liquidation process or with minimal remaining assets or exposure. Even §307 exempts small companies from the audit requirement.

Summary

Financial audits have their place and can be useful control and management tools. However, without having first established a meaningful oversight function; without having first established a consistent, recognized reporting standard; and without providing for timeliness of the reports; these audits are nothing more than a costly waste of estate assets for appearances sake – a rush to fix a problem without understanding the problem.

If there is a theme to this series of articles it is that the problems with the liquidation process in New York are systemic. The new law does not address these systemic problems. On the contrary, it protects the past through an audit of what is rather than an examination of what should be. The new law gives all the appearances of providing “greater transparency and accountability” while in fact it further imbeds the current deficiencies of the receivership system and makes the task of future, meaningful change that much more difficult to recognize and achieve.


Audit Endnote

On October 29, 2008 the Liquidation Bureau issued a press release proclaiming:

“NY LIQUIDATION BUREAU ISSUES FIRST COMPLETE
INDEPENDENT FINANCIAL AUDIT IN ITS 99-YEAR HISTORY
Bureau Receives Unqualified “Clean” Opinion from Auditor on its 2006 Financial Data”

The full 128-page report is posted on the Bureau’s web site, including the auditor’s opinion letters. Very impressive! The audit firm, Amper, Politziner & Mattia LLP, is a respected mid-level accounting firm and there is no reason to believe that they performed their review other than thoroughly, diligently and competently. Although the original engagement letters (posted and subsequently removed from the Bureau’s web site) were more akin to a review than an audit – primarily because the sampling and access to records was to be provided by Bureau personnel not the auditors – it is reasonable to assume based on the opinion letters that the scope of the engagement was expanded and changed before the completion of the audits.

One wonders, however, what the Bureau was seeking to convey by its proclamation of a “clean” 2006 audit. Without getting into a discussion of what constitutes a “clean” opinion, it is interesting to note that the “clean” year 2006 pre-dates the current administration, which has repeated castigated the prior Bureau leadership as having been fraught by incompetence, greed and corruption. If that was the case, how was it possible for the report to be “clean”? Yes, the current administration could take credit for cleaning up the mess created by their predecessors, but then the 2006 report would not have been “clean” – 2007 or 2008 maybe, but not 2006. Is it possible that their predecessors were not as evil as pictured? Is it possible that the problems with the Bureau are the system and not the personnel?

The Liquidation Process in New York - Part IV-A: Information Highway or By-way?

The current administration has repeatedly stated its intent to be more transparent in its operation of the liquidation process in New York. The Liquidation Bureau has demonstrated this intent by issuing numerous press releases on its activity and has posted significant information and documents on its web site (www.nylb.org). Most recently it has posted the long-awaited audit of the Bureau and the estates under its management for calendar year 2006, and has sought and received significant press coverage of this event (“NY Liquidation Bureau Issues First Complete Independent Financial Audit In Its 99-Year History … Bureau Receives Unqualified ‘Clean’ Opinion from Auditor on its 2006 Financial Data” – Press release of October 29, 2008). The administration has also touted the passage of the legislation it proposed requiring the audit of the Bureau and the estates it manages in the future (“Bureau Sought Change to State Insurance Law to Provide Greater Transparency” – Press release of August 7, 2008).

But does this seeming plethora of information constitute true transparency – in the open and helpful sense? Does it provide meaningful information to interested parties in insolvent estates including policyholders, creditors, other claimants, reinsurers, guaranty funds, regulators, courts and legislators? What does the law require and are the receiver and his agents complying with those requirements? What information is required to be made available by the security funds in New York? Is information available from the security funds consistent with the statutory requirements? How helpful is the Freedom of Information Law (FOIL) to anyone seeking additional information about an insolvent estate or a security fund?

In order to present this material in manageable bites, I have divided the subject into two parts: in this Part IV-A I will cover the reporting requirements and practices of the rehabilitator and liquidator, including the Liquidation Bureau. My next installment (IV-B) will then cover the reporting requirements and practices of the security funds.

Licensed New York insurers are required by statute to file financial statements on a statutory accounting basis with the Insurance Department on or before March 1 of each year (Insurance Law §307(a)(1)). Within five months of the end of a calendar year, each licensed insurer (other than companies with minimal premium volume) are required to file audited financial statements, which statements together with the auditor’s opinion, are to be made publicly available by the Department ((§307(b)(1)). In addition to the reporting requirements, the superintendent of insurance has the power to examine the affairs of an insurer “as often as he deems it expedient,” but at least every 3 to 5 years depending on the business of the insurer (§309).

But what happens to these reporting and examination requirements when an insurer is placed into liquidation or rehabilitation in New York? Interestingly, the liquidation and rehabilitation article of the insurance law (Article 74) is silent on the subject. Under a plain reading of the law, so long as the insolvent insurer remains licensed it should continue to be subject to the statutory reporting requirements as solvent insurers. The statute does not provide for automatic withdrawal or stay of the license or licenses of insolvent insurers. Liquidators may argue that once an order of liquidation is entered, that entity ceases to be a licensed entity. This argument is not supported by the law as written and is further belied by the common practice of liquidators treating licenses as tangible assets that can be sold. Even if you accept that argument for companies in liquidation, the same argument is not applicable to companies in rehabilitation, where the specific charge of the rehabilitator is “to conduct the business thereof, and to take such steps toward the removal of the causes and conditions which have made such proceeding necessary as the court shall direct.” (§7403).

The other argument posed is that under Article 74 the courts assume responsibility for the conduct of the liquidators and rehabilitators of an estate, thus taking the place of the regulators. However, while the law requires court approval of the material actions or plans of the liquidator or rehabilitator, it does not remove the applicability of §§307 and 309, and it does not provide the court with the necessary authority or tools to perform regulatory oversight of an estate. For example, none of the statutorily required reports discussed in this article are required to be filed with the rehabilitation or liquidation court. In fact, there is no statutory requirement for the liquidator or rehabilitator of an estate to file any report on the status of an estate with the court except for a final report to close the estate. (Note: I referred in my last installment to the requirement in §7422 that the expenses of an estate are subject to the court’s approval. A review of the docket of any of the significant estates under the Liquidation Bureau’s management shows that this requirement is followed more in the breach than in the practice).

Only one of the current estates in liquidation files regular annual statements on a statutory basis (and that estate is the one estate not managed by the Liquidation Bureau). The two estates in rehabilitation have started filing statutory statements, but no estate – liquidation or rehabilitation – prepares and files with the superintendent annual audited statements within five months of the end of the calendar year (Note: the recently enacted statutory requirement for annual audited statements of the Bureau and each estate under its management has less strenuous requirements in terms of time and content and does not specifically eliminate the requirements of §307. That legislation, which is not effective until December 31, 2009, and which directly conflicts with existing law, will be addressed in a later installment of this series).

Furthermore, once an insurer is placed in rehabilitation or liquidation in New York, the insurance department ceases to continue the regular periodic §309 examinations of those entities even though the insurance law does not exempt those entities from such examination. While I have been informed that there have been instances of insurance department examination of companies in receivership in the distant past, the practice has evolved that once a company is ordered into liquidation or rehabilitation, the insurance department ceases to be the regulator of that entity – perhaps to avoid the inherent conflict of the superintendent regulating himself.

Assuming for the moment that insolvent estates are no longer subject to §§ 307 and 309 (as seems to be the unstated position of the Liquidation Bureau and the bureaus of the insurance department responsible for the regulation of licensed companies), what reports are they subject to? There are only two other reporting requirements in the Insurance law regarding estates in liquidation or rehabilitation: §§ 206 and 7405(g).

§206 requires the superintendent to include in his annual report to the Legislature “Lists of . . . insurers organized, admitted, merged, withdrawn, or placed in liquidation, conservation, or rehabilitation” (§206(a)(5); and “Tables relative to liquidation, conservation or rehabilitation proceedings by the department for prior years including the preceding calendar year” (§206(b)(3). The 247 page annual report for 2007 (obtainable in pdf format from the Department’s web site at www.ins.state.ny.us/nyins.htm) has 10 pages devoted to the receivership process: 4 pages of narrative about the Liquidation Bureau, 2½ pages listing all the estates under its management, and an income and disbursements sheet for each of the three p/c security funds. There are no statements or other financial data for any of the estates.

The other applicable section, §7405(g), requires the rehabilitator or liquidator to submit to the insurance department an annual report for each estate in rehabilitation or liquidation within 120 days of the end of the calendar or fiscal year for that estate, which report is to be prepared “upon whichever standard the corporation conducts its financial affairs” and “shall include a financial review of the assets and liabilities of the corporation, the claims accrued or paid in that period, and a summary of all other corporate activity and a narrative of the actions of the rehabilitator or liquidator respecting such corporation.” The report, therefore, need not be on a statutory basis, and need not be a full and complete financial report. Also, even though §307(a)(1) requires licensed insurers to file on a calendar year basis, the §7405(g) reports do not have to be on a calendar year basis. The last sentence of §7405(g) is also interesting. It states that the report under this section “shall be separate and apart from other reports issued by the liquidation bureau of the department in the normal course of its business.” This statement seems to further support the conclusion that the law does not excuse the liquidator or rehabilitator from the filing requirements of §307 or from examination under §309.

Even if the rehabilitator or liquidator does not file §307 statutory statements by March 1 each year, at least you can get a copy of the §7405(g) report on an estate after April 30, right? Well, yes but not from the Liquidation Bureau. You see, the Bureau is not a state agency (as confirmed by the NY Court of Appeals last year) and therefore is not subject to the Freedom of Information Law (FOIL). Unless the Bureau voluntarily provides the report, it cannot be compelled to do so under FOIL. At this time, the Bureau does not voluntarily provide the report and has not posted in on its web site. All is not lost, however. Because the report is filed with the insurance department, which is subject to FOIL, a copy can be obtained from the department. However, even if you get the report, it is not going to be terribly helpful in analyzing an estate. With the exception of the estates in rehabilitation and the one estate in liquidation mentioned above, the reports are on a “modified cash basis” rather than on a statutory basis. Furthermore, while in the past there was a separate report on each estate as required by §7405(g), the new administration has presented the report on a combined basis with financial data in columns and only a brief narrative for each estate.

Simply put -- the reporting and compliance requirements of the law for licensed insurers have not been applied to companies in receivership in New York even though there appears to be no exemption from these requirements. Information about estates in receivership -- whether in rehabilitation or liquidation -- is minimal and of limited value to interested parties. And the Liquidation Bureau, despite its repeated expressions of openness and transparency, only posts what it wants to post, and only makes available what it wants to make available -- and only in the manner and format it wants you to see.

Next time, I will explore the reporting requirements for and practices of the New York insurance security funds to see if they are any more transparent than the receivers and the Liquidation Bureau – and some of the results may be surprising.

The Liquidation Process in New York – Part II: The Right Stuff

On July 7, 1994 a consensual order of rehabilitation was entered against United Community Insurance Company (UCIC) in Upstate New York. Less than a month later, on August 3, 1994, the then superintendent of insurance, Sal Curiale, filed a petition to liquidate UCIC with the New York Supreme Court in Schenectady. The management of UCIC, having just consented to rehabilitation, vehemently opposed the petition and the issue of the actual financial condition of the company became the subject of an evidentiary hearing and the hiring by the court of an independent actuary. In the meantime, the New York Liquidation Bureau was effectively dismantling the company under the rehabilitation order.

When the new superintendent, Ed Muhl, reviewed the stalemate in early 1995, he made an extraordinary decision: he appointed a special agent from outside of the Liquidation Bureau to assess the financial status of UCIC and to handle the rehabilitation or liquidation of UCIC, whichever was warranted. The special agent put together a small team of experts and a plan of action and advised the court of those plans. The special agent determined to the satisfaction of the court that the company was insolvent and an order of liquidation was entered on November 9, 1995 -- more than 14 months after the petition had been filed – and this time with the consent of UCIC’s owner and board of directors.

The management of the UCIC estate by the special agent and his team since 1995 has been an example of how efficiently and transparently an estate can be managed for the benefit of policyholders and creditors in New York under the existing statutory scheme. This was accomplished by the special agent working closely with the various state guaranty funds, creditors and reinsurers, by staffing commensurate with the actual needs and activity of the estate, and by being accountable to the liquidation court through regular conferences and reports. UCIC is the only company in liquidation in New York that has consistently filed with the liquidation court annual statements prepared on a statutory accounting basis. While dividend declarations by estates in liquidation in New York are rare, UCIC has paid dividends over the years totaling 35% of recorded liabilities. Information on the estate is regularly provided by the special agent to the liquidation court and all interested parties, including representatives of the principal creditors, reinsurers and guaranty funds.

The Liquidation Bureau, however, has done its best over the years to downplay the record of UCIC and bring the estate into the fold of the Bureau. For instance, if you look up UCIC on the Bureau’s website you will find no reference to the special agent (the contact person listed is an employee of the Bureau and not the special agent), an indication that no dividends have been paid, and no reference to any filed documents other than the order of liquidation. If it were not for the level of involvement by the liquidation court, creditors, and guaranty funds fostered by the special agent over the years, this estate would have years ago become just one more mishandled estate in the Bureau’s quiver.

What was extraordinary about Superintendent Muhl’s decision to use a special agent outside of the Liquidation Bureau was not that it was outside of the statutory scheme – quite the opposite. The UCIC case is extraordinary because it is squarely within the statutory scheme, and it is the only estate that actually follows the original concept of the statute. (For a discussion of the statutory scheme and its history, see Part I of this series, posted on August 19, 2008). It is the only estate that works closely with the court, files regular reports, prepares its annual statements on a statutory basis, and gets all its expenses and actions approved with full disclosure to all interested parties. This feat could not have been accomplished, however, without the foresight of Superintendent Muhl to understand the scope of his authority as receiver, and the pro-active participation of the court.

The original statutory scheme recognizes that each estate is different and allows the superintendent to bring the appropriate expertise to bear on each individual circumstance. Unfortunately, the Liquidation Bureau by its very nature (a fixed staff of 500 people, most of who are protected by a union contract) is a one-size-fits-all operation with a voracious appetite but little flexibility. The result is a statutory process that has been high-jacked by a non-statutory entity accountable to no one.

It will take more than adding layers of reports and audits to this already cumbersome operation to provide efficient and transparent management of insolvent estates. It will take a return to the actual intent and structure of the statutory scheme!

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Postscript: The legislation sought by the Liquidation Bureau as a “reform” action, requiring the annual audit of the Bureau and the estates under its management, was signed into law as Chapter 540 on September 4, 2008. A future installment in this series on the liquidation process in New York will address this law and why it will move the Bureau even further from proper oversight, and make the administration of insolvent estates even more costly and inefficient. The next installment in this series, however, will cover the State’s statutory insurance [in] security funds.

The Receivership Process in New York – Part I: What exactly is the Liquidation Bureau anyway?

As promised in my last post, here is the first in a series of articles on the receivership process in New York: starting with a discussion of the liquidation bureau – what exactly is it?

It is easier to state what the liquidation bureau is not. According to the New York Court of Appeals, it is not a state agency (and therefore not subject to audit by the state comptroller). According to the records of the Secretary of State, it is not a corporation. And according to the Insurance Law . . . , well let’s just say its status is undefined.

As I stated in my last posting, before 1993 there were no statutory references to a liquidation bureau in the Insurance Law including the receivership article, Article 74. In 1993, subsection (g) was added to Section 7405 (Order of liquidation; rights and liabilities) requiring the superintendent as receiver to prepare an annual report on the status of each company in liquidation or rehabilitation. The last sentence of this new section states that "This report shall be separate and apart from other reports issued by the liquidation bureau of the department in the normal course of its business." This is the only reference in the Insurance Law (actually the only reference in the entire New York Consolidated Laws) to a liquidation bureau.

The Bureau's existence may be assumed, but its status and mandate are not defined anywhere in the law. The home page of the Liquidation Bureau’s web site states:

The New York Liquidation Bureau (NYLB) is a unique entity. [No debate there!] Receiving no funding from taxpayers, it carries out the responsibilities of the Superintendent of Insurance as Receiver, and acts on his behalf in the discharging of his statutorily defined duties to protect the interests of the policyholders and creditors of insurance companies that have been declared impaired or insolvent.

The bureau's web site also states that it has “performed this function since 1909, when the New York State Legislature passed the law mandating that the Superintendent assume the separate responsibility of Receiver.” However, the law does not establish a bureau to carry out this function. The law requires that the superintendent be designated as rehabilitator or liquidator to take control of the assets of an insolvent company and liquidate or manage the estate. It also permits the appointment of deputies and assistants to support the superintendent in this role as receiver. It was clearly anticipated that these appointments would come from the key employees of the insolvent company itself -- those with the greatest knowledge of the business and operations of the company being liquidated -- and would be engaged only for the duration of the receivership process.

The hiring of employees of the insolvent company, and the temporary nature of these appointments, was succinctly summarized in a 1915 report to the New York State Constitutional Convention Commission on the Organization and Functions of the Government of the State of New York (at page 118) -- just a few years after the statute referred to in the Bureau's web site:

The practice is to retain such of the employees of each company which comes into liquidation as may be necessary to attend to the details of its affairs, and to dispense with them as rapidly as consistent with the proper conduct of its business.

The current statute is consistent with this historical record of the temporary nature of the receivership of insurance companies. Rather than authorizing the establishment of a permanent bureau, current Section 7422 authorizes the superintendent to appoint deputies and others to assist in the performance of the receivership function, "and all expenses of conducting any proceeding under this article shall be fixed by the superintendent, subject to the approval of the court, and shall be paid out of the funds or assets of such insurer."

Article 74 clearly views each insolvency as a separate proceeding with the superintendent acting as receiver under the supervision and control of a Supreme Court judge for that estate. Nowhere in the law is there any provision for the establishment of a permanent agency or bureau to carry out this function, and there is no central judicial oversight designated to coordinate the handling of all pending receivership proceedings collectively.

The limited role and temporary nature of the agents assisting the receiver for a particular estate has evolved into a permanent liquidation bureau, particularly over the past thirty years. This evolution occurred without a statutory, judicial or regulatory mandate to do so. As the number and size of insolvencies increased dramatically in the late 1970s and into the 1980s, the liquidation bureau grew into its own self-operating permanent bureaucracy, flying under the radar and accountable to no one – not the legislature, not the courts, and not the regulators.

The Bureau today has half as many employees (over 450 employees) as the entire New York Insurance Department, and most of them are protected by union contracts. The Bureau also purports to have a budget of over $100 million, but this "budget" is not subject to any independent oversight. Although Section 7422 requires court approval of expenses for an estate, there is no requirement in the law – including the much touted new legislation that would require annual audits – that the supervising court be provided with any regular, interim financial or status report. More significantly, no one court would be looking at the bureau or its budget as a whole.

The current administration has made a lot of noise about reforming the bureau and making it more “transparent.” It is doing this, however, by making the bureau even more permanent contrary to the mandate of Article 74 and the statutory receivership scheme.

In my next posting in this series I will discuss a current example of how the system could and should work under the existing statutory authority. In subsequent postings I will also discuss the role and structure of the security funds and how they have helped perpetuate the liquidation bureau’s independence and freedom from oversight, and why the current administration’s reform efforts will not only fail to achieve the advertised accountability and transparency, but will in fact further fortify the bureau against substantive change while significantly increasing the cost to policyholders and creditors of insolvent companies.

TRANSPARENT TO WHOM?

Aside from the scientific definitions, there are two principal meanings of “transparent” –

• Open as in frank or candid; or
• Easily seen through.

Quite often in political double speak the term is intended to convey the first meaning, while in reality the only transparency is in the motive.

I offer as a case study the recent legislation passed by the New York Legislature shortly before the end of session that would require the audit of the Liquidation Bureau and of each of the estates in liquidation or rehabilitation (the Bill, S6535-A, was passed by both the Senate and Assembly, but as of this date had not yet been sent to the Governor for signature). The Sponsors Memo accompanying the legislation claiming that the legislation will “shed sunlight on the financial health” of the estates in receivership and on the Bureau itself. Although the Bureau and the estates under its control desperately need proper oversight and examination, this legislation provides neither.

There are three principal defects in the legislation. First, it does not provide for a consistent, industry recognized standard of review; rather it allows for the examinations to be “upon whichever standard each corporation conducts its respective financial affairs.” Those of us that have dealt over the years with insolvent estates know that this will simply mean the continuation of the use of separate, inconsistent, confusing and sometimes unrecognizable financial reporting standards that are of little or no value to significant financial analysis.

Second, the reports do not have to be filed until August of the year after the year being examined, which effectively renders the reports out of date by the time they are issued (licensed companies, as most know, have to file their statutory statements by March 1 each year, and their audited statements by June 1).

The third significant issue is the cost. The “Fiscal Implications” section of the Sponsors Memo states that “[i]t is estimated that [the cost of the financial statements and opinions] will be below $300,000 annually.” That is for the audit of roughly 25 separate companies plus the Bureau itself for an absurd average of less that $12,000 per audit. In fact, last fall the Bureau engaged audits of the estates under its control at an estimated cost, without any unforeseen complications, of between $1.0 and $1.1 million – almost four times the amount in the Sponsors Memo. Furthermore, given that these audits were to have been completed by year-end 2007, the fact that they still have not been completed seven months later would suggest that “unexpected circumstances” have been encountered, and the fees will be even greater than the estimates.

What is the significance of this gross understatement of the fiscal implications? Simply this: These fees are paid from the assets of the various estates, which already are financially insolvent with insufficient funds to meet their policy obligations. While appropriate audits of the Liquidation Bureau and the estates it manages are warranted, these audits should provide value to the oversight of the Bureau and the estates. By not requiring a consistent, recognized reporting standard on a timely basis, the legislation does not provide that value and is a waste of estate assets.

The Sponsors Memo states that the legislation was “developed by the Liquidation Bureau, in consultation with the Legislature.” If a licensed insurer came to the Legislature with a request to require it to prepare and file additional reports, I am sure that the request would be viewed with great skepticism. The Legislature should have viewed the transparent motive behind the Bureau’s request in the same light.

With the legislation as passed, the Bureau can now claim that it has met the call for greater transparency, while in fact that transparency -- as in open, frank or candid -- is illusory and obtained at the cost of the estates, their policyholders, creditors, reinsurers and investors.

FOOTNOTE ON THE SUPERINTENDENT'S REPORTS

In response to yesterday’s entry on the two statutorily required reports of the New York Superintendent of Insurance, I was asked how many of the 961 Insurance Department employees work for the Liquidation Bureau. The answer is none, nada, nil, zero. The Liquidation Bureau is not a state agency and its employees are not state employees (See Dinallo v. DiNapoli, NY Court of Appeals, No. 111, October 11, 2007, discussed in my October 12, 2007 web entry).

The Superintendent’s report as receiver does not include any information on the Liquidation Bureau’s staffing or budget. The “consolidated” statements contain some information on salaries and expenses relating to estates in liquidation, but this information does not include all estates, and there is no presentation on the Bureau itself. The Superintendent’s Annual Report to the Legislature, at page 237, states that the Liquidation Bureau has “a staff of 450 and a budget of $100 million.” There is no further information, however, on the details of this staffing or the expenses.

TWO REPORTS OF NOTE

Two annual reports of the Superintendent of Insurance required by New York’s insurance law have been issued in the last few weeks: one of which is readily available and the other that is available only through a request under the Freedom of Information Law.

The readily available report is the 2007 Annual Report of the Superintendent of Insurance to the New York Legislature required by Section 206 of the Insurance Law. This 268 page report, which is available as a pdf document through the Department’s website (http://ins.state.ny.us/), is cram full of information about the insurance business in New York and the regulation of the business. For instance, the report contains consolidated summaries of the statements filed by insurers showing such things as the number and kinds of authorized insurers by class of business, total assets, liabilities, premiums written and insurance in force. On the regulatory side, the report includes summaries of new regulations and circular letters, lists of reports of examinations completed, and lists of insurers organized, admitted, merged withdrawn, or placed in liquidation, rehabilitation or conservation.

If you dig statistics, as I do, you may find some of the data on the Department itself to be most fascinating. For instance, did you know that for the calendar year 2007 the Insurance Department:

Employed 961 people of whom 647 were located in New York City, 289 in Albany and 25 elsewhere?

Employed more attorneys (69) than actuaries (61) or investigators (43)?

Issued 153,909 licenses during 2007 to adjusters, agents, brokers, consultants, reinsurance intermediaries and service contract registrants?

Collected receipts totaling $742,245,640.94 and incurred Department expenses of $188,250,888.74?

Much of this information is required by the laundry list set forth in Section 206, although the report has evolved over the years into a very comprehensive annual almanac. If you are interested in researching the business of insurance in New York or in the minutia of the activities of the New York Insurance Department, this report is a great place to start.

The second report of note is the 2007 Annual Report of the Superintendent of Insurance as Liquidator or Rehabilitator required by Section 7405(g). This report is required to include a financial review of the assets and liabilities, and the claims paid or approved for each domestic insurer in liquidation or rehabilitation, and a summary of all other corporate activity and a narrative of the actions of the liquidator or rehabilitator for each company. (This statutorily dictated report should not be confused with the “2007 Year-End Report” posted by the New York Liquidation Bureau on its web site back in January, which basically rehashes all of the Bureau’s 2007 press releases).

The report required by Section 7405(g) – while not nearly as comprehensive as reports required by solvent companies -- is the only meaningful information required to be compiled by the Superintendent of Insurance about the companies for which he acts as receiver. Yet this report cannot be found on the web site of either the Insurance Department or the Liquidation Bureau, and can only be obtained by making a Freedom of Information Law (FOIL) request to the Insurance Department.

The justification for this restrictive availability, I have been told, is that the information contained in the report is unaudited. However, even though the Liquidation Bureau has announced that it is having audits of each estate performed (a process that has been ongoing almost as long as the period being audited), there is no requirement in the law for audited statements of companies in liquidation or rehabilitation. The Section 7405(g) report is the only statutorily required statement of the receiver, and limiting its accessibility does not appear to be within the intent and purpose of the statute.

Furthermore, despite the Bureau’s repeated published statements about being more transparent, the Report actually appears to be a step backwards from prior administrations. For some reason the current administration decided to present the data on the individual companies in liquidation (with one exception) on a consolidated basis rather than by separate statements. While this approach may show the totality of the Bureau's realm, it is not consistent with the statutory requirements or the reality of the process where each estate is a separate and distinct entity.

The report can be obtained by making a FOIL request of the New York Insurance Department. You can get it without cost using the Department’s online FOIL request form indicating you want it sent via e-mail. Hard copy costs 25¢ per page. Do not direct a request to the Liquidation Bureau – it will deny the request on the basis that it is not a state agency subject to FOIL. Once again, so much for transparency!

What does it mean to Stand in the Shoes of an Insolvent Insurance Company?

The courts in most jurisdictions – including New York -- have consistently held that a receiver “stands in the shoes” of the insolvent company and does not get to change the contractual or legal obligations of the insolvent company simply because an order of rehabilitation or liquidation has been issue. It is not clear, however, if the current management of the New York Liquidation Bureau accepts that they are private managers of insurance entities and are not imbued with the super powers of a governmental agency. The courts continue to do their part to remind the Bureau of its role, but judging from the number of times they need to do so, it does not seem that the message is getting through.

Last October the New York Court of Appeals confirmed that the Bureau was not a state agency (Dinallo v. DiNapoli, October 11, 2007, Decision 111). Although this was a position espoused by the Bureau itself, the Bureau’s motive was not to restrict its powers but to avoid scrutiny by the state comptroller (See my web entry for October 12, 2007). In finding that the Bureau was not a state agency, the Court also restated the broadly accepted principle that the receiver “for all practical purposes takes the place of the insolvent insurer.” (Decision at p.3). It is this limiting role that the Bureau seems to have a problem accepting.

Granted, the receiver has certain necessary powers to assist in the marshalling of estate assets and court protection from unwarranted assaults, but these powers are not intended to alter contractual relationships or create obligations that did not exist pre-receivership. For instance, in Matter of Midland Ins. Co., 79 NY2d 253, 265 (1992), the New York Court of Appeals stated that “liquidation cannot place the liquidator in a better position than the insolvent company he takes over, authorizing him to demand that which the company would not have been entitled to prior to liquidation. . . . Those rights were not altered merely because a liquidation order was entered.” Notwithstanding this clear pronouncement, the Bureau frequently attempts – even in the Midland Insurance Company estate -- to alter contractual rights of others under the guise of acting as a “fiduciary” or under some implied or threatened super authority.

In January 2008 the Midland liquidation court (Justice Stallman) issued a lengthy decision that, while supporting the primary claim handling authority of the liquidator, also took the Bureau to task for not adequately protecting the interposition rights of reinsurers, and requiring the Bureau to revise the claims protocol in this regard (See my February 21, 2008 web entry on this decision). Now Justice Stallman has again reminded the Bureau of the limitations of its authority and power to define the rights of others – this time regarding the Bureau’s attempt to apply New York law across the board to all Midland creditors.

In a recent 24-page decision (In the Matter of the Liquidation of Midland Insurance Company, Motion Seq. No. 69, April 15, 2008), Justice Stallman has directed that the law applicable to each policy is not New York law in all cases; rather the applicable law is to be determined following the ‘grouping of contacts’ approach of the Restatement (Second) of Conflicts of Laws. The decision rejects the Bureau’s interpretation of the Appellate Division finding in the Lac d’Amiante du Quebec claim in Midland (269 AD2d 50 [1st Dept 2000]) that all creditors are to be treated equally requires that New York law must apply to all Midland contracts. Instead the Court turns to the Foster Wheeler Corp. holding (36AD3d 17 [1st Dept 2006]) that the “grouping of contacts” principle of the Restatement (Second) of Conflicts of Law applies in New York and is consistent with the principles of the Uniform Insurers Liquidation Act (Insurance law Section 7048 et seq.) for the equitable administration of estates. Furthermore, the court found that the establishment of nine statutory classes of claimants in the 1999 amendment to the priority of distribution scheme under Article 74 eliminates any basis for applying the equal treatment reading of the Lac d’Amiante decision.

The decision is an interesting read, but the bottom line is that the court rejected equating equal treatment with equitable treatment, and again confirmed that “standing in the shoes” does not mean trampling the contractual rights of others.

EXECUTIVE LIFE REDUX

This is an update to last week’s posting (see December 5, 2007 posting below) about Executive Life Insurance Company of New York (ELNY). I expect to continue issuing postings on this topic to raise questions about the premises behind the New York Liquidation Bureau’s bail out plan for ELNY so long as the Bureau continues to publicly tout its plan using justifications that are contrary to the facts.

This week’s issue of Business Insurance (http://www.bi.com/) published a follow-up article on the ELNY deal reporting on statements by the head of the Liquidation Bureau, Mark Peters. According to the article, “ELNY would receive roughly $650 million to $750 million in cash contributions” from both state life guarantee associations and from certain p/c companies “that bought ELNY annuities to fund structured settlements of liability claims.” The p/c companies include Allianz, Fireman’s Fund, Allstate, State Farm and Travelers.

The article goes on to state: “The contributions will be enough to offset the $2 billion deficit that ELNY is predicted to face in 12 to 15 years, regulators say. The deficit results largely from an overly optimistic assumption in ELNY’s 1992 rehabilitation plan that the estate would earn 10% annually on its invested assets, Mr. Peters said. The actual return was between 7% and 8%. The Liquidation Bureau is now assuming a future annual return of just over 6%, he said. Most of ELNY’s contracts will run off within 35 years, with the last contract expiring in about 70 years, he said.”

Let’s see what’s wrong with the foregoing statements:

Inadequate interest rate assumptions cannot begin to account for the purported deficit. The assets simply have not decreased substantially in the past 16 years. In fact, prior to 2002, there was NO reduction in reported assets – all policy claims were being paid from current earnings.

The 1992 plan of rehabilitation does not include interest rate assumptions. It discussed an investment strategy summarized as follows: “. . . principal and interest realized upon maturity or recovery of ELNY's bonds [none of which defaulted, by the way], as well as other cash flows derived from investments contained in ELNY's portfolio, will be reinvested in long-term (thirty (30) year) investment grade corporate bonds and in Standard and Poor's 500 common stocks. The reinvestment in common stocks will be limited."

The 1992 plan of rehabilitation specifically stated that that the cash flows from investments “are projected to be sufficient to cover current [covered annuity] payouts for at least ten (10) years.” That is what happened. So how was the strategy wrong?

By the beginning of 2002 the number of outstanding contracts had already declined by over 40% (now over 50%), yet the asset base remained constant. Over-stated interest assumptions simply cannot explain the Bureau’s publicly announced conclusions.

So if it is not the interest rate assumptions causing the purported deficit, what is causing it? Potential investors have made proposals to the Liquidation Bureau over the past several years supported by pro forma statements using interest rate assumptions at or below the Bureau’s current assumption without showing any significant deterioration based on known liabilities. These investment proposals all failed to obtain the Bureau’s “approval” because of continual increases in liabilities – not because of a decline in the assets. This precipitous increase in liabilities – which is not mentioned at all in the Bureau’s statements about ELNY -- is counter-intuitive to the conservative actuarial assumptions in place for the life of the estate, the nature of the business, and the decline by half in the number of active policies.

A couple of other points are also worthy of note. It is interesting that this publicly touted agreement with the industry is not publicly available, and all the participants are unable to discuss the agreement because they were each required to enter into a confidentiality agreement with the Bureau. If the bail out plan is so beneficial for everyone, why does the Bureau feel compelled to keep it hidden?

In the Business Insurance article, Mr. Peters also stated that the bail-out plan “would be cheaper for the insurers [how this is so is not explained] and avoids the ‘chaos’ that would come with a liquidation.” One thing that liquidation accomplishes is to remove the company from the hands of the people that caused it to become insolvent. Because ELNY was solvent when it was placed in rehabilitation, if it is now insolvent it became insolvent under the Liquidation Bureau’s watch. Can anyone imagine the industry voluntarily contributing $750 million to bail out a company's management so that it could avoid liquidation and remain in charge?

EXECUTIVE LIFE -- FACT OR FICTION?

New York’s Governor Spitzer issued a press release on Monday (December 3) followed by a widely reported press conference announcing an agreement in principle “that will protect nearly 11,000 accident victims and other individuals receiving annual payments from structured settlements and pensions.” The release goes on to praise the Superintendent of Insurance and the head of the Liquidation Bureau for aggressively pursuing an agreement with the life and property/casualty companies and the guarantee funds that “resolved a significant deficit from a defunct insurance company.” (The press release can be found on the Insurance Department’s web site at http://ins.state.ny.us/press/2007/)

Before jumping on the bandwagon of kudos to the Governor, the Superintendent of Insurance and the Liquidation Bureau, however, there are a number of factual issues that one might want to consider.

The “defunct” company in question is Executive Life Insurance Company of New York (“ELNY”), which was placed into rehabilitation in 1991. According to the 1992 court approved Plan of Rehabilitation, ELNY was placed in rehabilitation because of the New York Insurance Department’s concerns that the adverse publicity regarding the seizure of its parent company, Executive Life Insurance Company of California, could result in an excessive number of cash surrenders. It was NOT placed in rehabilitation because it was insolvent! In fact, ELNY has never been determined to be insolvent. Consider also the following:

• At year-end 1994 (the first year the Liquidation Bureau was required to publish financials for the estates under its control), ELNY had almost 24,000 annuity contracts in force and reported assets of $1.65 billion.
  
  
• At year-end 2006, there were only 11,300 policies in force and reported assets of $1.37 billion – a 53% decline in outstanding policies and only a 17% decline in assets.
  
  
• In that 13 year period 1994 through 2006, ELNY continuously met all outstanding policy obligations to the tune of almost $2 billion.
  
  
• Throughout that same period, ELNY had the same major life insurer as administrator, the same nationally known actuarial firm as its actuarial consultant, and the same prominent financial firm as investment advisor.
  
  
• Over 90% of the outstanding obligations are fixed obligations under structured settlement agreements. There are no potential “long tail” obligations to cause a sudden and precipitous inflation of ultimate liabilities.

Notwithstanding these facts, the current administration has apparently “sold” the industry and the life guarantee funds on the premise that “ELNY would have a $2 billion deficit,” that continued payments to policyholders is at risk, and that an industry bail out is necessary and appropriate (Announcing a $2 billion deficit at this time is also curious in view of the fact that the Liquidation Bureau has engaged an audit of ELNY that is not expected to be completed until the middle or end of January 2008).

If there is in fact a $2 billion shortfall the big question is: How did it happen? It cannot be blamed on the former management of ELNY because the company was solvent when it was placed in rehabilitation. It has been under the Liquidation Bureau’s watch with the same prestigious advisors for over 16 years – through both Democratic and Republican administrations -- paying all obligations on a timely basis, and has received a number of investment suitors that have all been rejected by the Bureau.

Now we are being told that there is a $2 billion shortfall that can only be resolved on the backs of the industry. If true, someone needs to explain how that happened and hold those responsible accountable. Given the prosecutorial background of the Governor, his Superintendent of Insurance and the head of the Liquidation Bureau, can we assume that as bright a light will be aimed at the causes of this development as is being shined on the bailout agreement?

(In the interest of full disclosure, I have represented various investor groups over the past ten years interested in restoring ELNY to the marketplace. I do not represent any such group at this time, however, although I am aware of continued investor interest based primarily on the belief that any significant deficit defies fact and logic.)

Mission (Mis)Statement

One of my pet peeves about the New York Liquidation Bureau over the years has been its inability (or refusal) to acknowledge in practice the difference between liquidation and rehabilitation under Article 74 of the Insurance Law. Unfortunately the Bureau’s Mission Statement as posted on its web site perpetuates the problem (www.nylb.org/mission.htm).

The Mission Statement avers that the Liquidation Bureau acts for the Superintendent of Insurance to “. . . return rehabilitated companies to the marketplace or distribute the proceeds of the company in a timely manner to creditors.” Under §7403 the rehabilitator’s statutory function is to “conduct the business” of the company in rehabilitation, and to take steps “toward the removal of the causes and conditions” that made the rehabilitation necessary. There is no statutory authority for the rehabilitator to “distribute the proceeds of the company in a timely manner to creditors.” That can only be done in liquidation, which is a separate proceeding with different statutory rules.

If the New York Liquidation Bureau wants the insurance community to believe it has a new attitude about its role in rehabilitations, it might want to consider revising its Mission Statement to reflect the law.

For a more extensive review of the receivership process, particularly in New York, see my article, "Who Protects us from the Reciever?" at http://www.pbnylaw.com/articles/whoprotectsusfromthereciever-11-04.pdf.

NEW YORK LIQUIDATION BUREAU “FINDS” $18 MILLION

The lead article in today’s New York Law Journal reports that because of “newly discovered assets” of an insurance company that has been in liquidation since 1997, $18 million has been added to the strapped Public Motor Vehicle Security Fund (PMV Fund), which will allow the PMV Fund to pay approved claims that have been unpaid for many years because of a lack of funds, and to allow the Bureau to address the backlog of unprocessed claims.

The company is New York Merchant Bakers Insurance Company (“Merchant Bakers”). According to public records and other data obtained from the Insurance Department under the Freedom of Information Law, Merchant Bakers has not just been the largest drain on the PMV Fund; it has been the monster drain. For the five years from 2002 through 2006, the PMV Fund paid out over $131 million in claims, of which almost $95 million were paid to claimants of Merchant Bakers – more than 72% of the total. In fact, Merchant Bakers and one other company, Capital Mutual Insurance Company, which has been in liquidation since 2000, account for over 90% of the total payments from the PMV Fund.

I applaud the Liquidation Bureau for addressing long overdue claims against the PMV Fund. However, the impact of Merchant Bakers on the financially challenged PMV Fund over past decade underscores the need to separate the security fund function from the Liquidation Bureau. New York is the only state where the insurance security or guaranty funds are not separate entities from the receiver – usually with their own boards of directors or trustees including industry representation (after all, it is their money in these funds). In New York, however, the funds are basically bank accounts with the receiver as the authorized signatory (for a discussion of the liquidation process in the US, including the operation of guaranty funds see my article “Who Protects Us from the Receiver?” at www.pbnylaw.com/publications).

Perhaps if the PMV Fund had been a separate entity, it would have questioned the overly concentrated drain on the Fund by one or two companies, which could have led to solutions to the PMV Fund crisis. Perhaps, too, pressure from a separate entity could have helped the Liquidation Bureau “find” the $18 million in assets a lot sooner. The law Journal article does not explain where or how the $18 million was “newly discovered.” That could well be the real story here!

New York Liquidation Bureau Not a State Agency

The New York Court of Appeals unanimously decided yesterday that in his capacity as liquidator of insurance companies the superintendent of insurance is not a state officer, and that the New York Liquidation Bureau acting as the liquidator's agent is not a state agency. Furthermore, the Court determined that the assets of the estates under the control of the liquidator are private not state funds, nor are these assets funds held by a state officer or agency. Therefore, the State Comptroller has no authority to audit the Bureau or subpoena its personnel. A copy of the decision can be obtained from the Liquidation Bureau's website at http://www.nylb.org/ or by sending a request to me at pbickford@pbnylaw.com.

Although the case seems to put to bed the Comptroller's ability to force an audit of the Liquidation Bureau, there is an interesting footnote in the decision that reads as follows:

"This holding is not meant to imply that the Superintendent may not be subject to an independent audit. Although the Legislature does not have the authority under our holding in Blue Cross and Blue Shield to assign to the Comptroller the task of auditing the Bureau, it does have the authority to require the Bureau to retain independent auditors."

This footnote seems to leave the door open for the Legislature to provide for forced, independent audits of the Liquidation Bureau, a move the Superintendent may have anticipated in the Liquidation Bureau's press release on the decision where the Superintendent states:

"Although this case was about far more than transparency and outside oversight, transparency and accountability are nonetheless critical elements in successfully fulfilling the Bureau’s legal responsibilities."

The Superintendent then goes on to talk about all the actions, including a "top to bottom" audit of the Bureau and each of the estates under its control. I will be commenting more fully on these "transparency" and "audit" issue in future postings. For my earlier comments on this case, made following the Appellate Division ruling, see my entry for March 22, 2007.

Is the New York Liquidation Bureau a State Agency?

A recent Appellate Division decision has again raised the question of what exactly is the New York Liquidation Bureau -- a state agency, subject to all the oversight imposed on any other state agency, a private employees of the Superintendent of Insurance in his fiduciary role as receiver of insolvent insurers, or some other kind of hybrid?

As early as 1988 the lower courts of New York had held that the Liquidation Bureau was not a state agency and therefore not subject to the Freedom of Information Act. See Consolidated Edison Company of New York, Inc. v. The Insurance Department of the State of New York, 532 NY Supp.2d, 140 Misc.2d 969 (Sup.Ct., NY County, 1988). Thus when the State Comptroller sought to audit the activities of the Liquidation Bureau and issue subpoenas to Liquidation Bureau personnel, the lower court quashed the subpoenas under the Con Ed line of cases. The Appellate Division, First Department, however, has overturned this decision and reinstated the subpoenas concluding in a 3 to 2 decision that the Superintendent of Insurance is a State Officer, and the Liquidation Bureau is therefore carrying out the functions of a State Officer. Hence it is a State Agency subject to audit by the Comptroller. Serio v. Hevesi, 2007 NY Slip Op 01820 (App. Div., 1st Dept., March 6, 2007). The decision can be obtained from the New York Unified Court System web site at www.nycourts.gov/decisions, or by contacting me at pbickford@pbnylaw.com.

The core of the majority opinion is that as a State Officer, the handling of any funds under the Superintendent's control are subject to audit by the Comptroller. The dissent disagrees, however, stating that the funds of insolvent insurers are private funds "owned" by the creditors and policyholders of the estates, and are not State funds. In this capacity, the Superintendent is a fiduciary subject to the oversight of the Courts, not the Comptroller. The reach of the majority decision, however, could extend far beyond this one issue, and it is quite likely that the decision will be appealed to the Court of Appeals. Stay tuned!