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and circular letters, lists of reports of examinations completed, and lists of insurers organized, admitted, merged withdrawn, or placed in liquidation, rehabilitation or conservation.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.

Insurance Exchange Update

Because of the recent interest in reviving the insurance exchange in New York, and the numerous requests I have received for materials on the old New York Insurance Exchange, I have posted a new section of articles, studies and publications relating to the old Exchange to my website. these materials can be accessed at www.pbnylaw.com/publications.html.

One of the articles at this site is my 2004 article presented at a Practicing Law Institute seminar on run-offs and commutations, "What Ever happened to the New York Insurance Exchange (and why do we care?)." In that article I stated that the Exchange's Security Fund's plan for the distribution of about $81.8 million against obligations of $112.5 million had been approved by the Court in February 2004, but that no distribution had been made under the plan as of the date of the article in November 2004. Several people have asked whether a distrbution was ever made. the answer is yes, but it required some pressure to accomplish.

In December 2004, I brought a further motion before the Court to force the Security Fund to comply with its own plan and distribute the funds available for distribution immediately. As a result of this motion, in early January 2005 the Security Fund made a distribution of $81.6 million, or 72.05% of approved claims. this was followed in June 2005 with a second and final distribution of an additional $4.1 million, or 5.29%, to the same claimants. Following these distributions, which constituted substantially all of the assets of the Security Fund less administrative and closing expenses and reserves, the Security Fund filed a final report with the Court. the Court approved the final report and discharged the Security Fund from any further obligations to claimants in May 2006.

Judicial Authority in Liquidation Proceedings

Like an old prospector, it is always a thrill to find a small but valuable nugget in a large pile of rocks. In this case, the large pile of rocks is the 27 page decision of New York Supreme Court Justice Michael D. Stallman in a January 14, 2008 decision In the Matter of the Liquidation of Midland Insurance Company (printed in the New York Law Journal on February 14, 2008).

The case centered around motions by a reinsurer of Midland, Everest Reinsurance Company, seeking to lift the standard injunction barring suits against the Liquidator alleging that “the procedures of the New York Liquidation Bureau in handling, determining, and settling insurance claims violates provisions of the reinsurance contracts between Midland and Everest.” (Decision at p.1) The provisions Everest alleged were violated by the Liquidator’s agents included “(1) notice of a claim to Everest; (2) an opportunity to associate with Midland and to cooperate in the defense and control of any claim which may involve Everest’s reinsurance; (3) access to Midland’s books and records; (4) a right to investigate; and (5) a right to interpose defenses in the Midland liquidation (interposition rights).” (Decision at p.11)

Most of this very thorough decision was consumed by a point by point rejection of each of Everest’s claims, either because Everest failed to show any substantive evidence of error by the Liquidator’s agents, the remedy for any shortcomings existed within the framework of the existing liquidation process, or the issue had not risen to the point of a breach. The decision also strongly supported the Liquidator’s “clear, exclusive fiduciary powers over handling claims” (Decision at p. 20) and the exclusivity of the liquidation court in denying Everest’s motion for leave to sue. It seemed like a substantial sweep for the Liquidator and a complete loss for Everest. Then came the nugget!

Although the Court strongly supported the Liquidator’s control over the handling of claims, it did not dismiss the interposition rights of reinsurers. In seeking a balance between the control of the claim process by the Liquidator and the exercise of the interposition rights of reinsurers, the Court stated: “Thus, the only logical approach is to permit Everest and other reinsurers to exercise their contractual interposition rights after the Liquidator has allowed a claim, but prior to the Court’s approval of a claim.” (Decision at p. 22). The problem was that there was an earlier Court order on claims allowance procedures for Court approval that, in Justice Stallman’s view, conflicted with the reinsurers’ interposition rights.

“To give effect to the contractual interposition rights of Everest (and of other similarly situated reinsurers), this Court is constrained to modify the procedures for judicial approval of allowed claims, to permit reinsurers to assert defenses available to Midland or to the Liquidator to any claim allowed by the Liquidator which is either partially or wholly reinsured, and to establish a process in which those defenses can be adjudicated as part of the judicial approval process, involving a hearing before a referee equivalent to that provided where an objection is filed to the Liquidator’s disallowance of a claim. Otherwise, the Liquidator is placed in a position where compliance with [the prior] order could result in a violation of Midland’s reinsurance
contracts, jeopardizing reinsurance recovery.” (Decision at p. 24)

Therefore Justice Stallman, on his own volition, ordered a revision of the prior claim allowance procedures invoking his broad supervisory powers under the liquidation Article of the New York Insurance law!

“Thus, pursuant to its supervisory powers under Insurance Law § 7419(b), the Court directs the Liquidator to review the claims allowance procedures and to formulate changes to the claims allowance procedures and protocols of the Liquidation Bureau. The Liquidator shall report to the Court within 120 days with proposed changes.” (Decision at p. 24)

After more than twenty years of involvement in insurance receivership proceedings in New York, I can confirm the rarity indeed for a liquidation court to actually exercise its supervisory powers on its own volition. Others can dissect the holdings of the decision on the motions by Everest, the authority of the Liquidator, the rights of the reinsurers and policyholders; and others can speculate on the prospects for appeals by the Liquidator or Everest. I will enjoy the moment of a judge actually taking the time to consider the process beyond the four corners of the motions before him to exercise his authority for the benefit of the process as a whole.

(If you cannot find a copy of Justice Stallman's decision and would like one, e-mail me at pbickford@pbnylaw.com)

HAS THE TIME COME FOR A NEW INSURANCE EXCHANGE?

For almost a year now, the New York Superintendent of Insurance, Eric Dinallo, has been stating publicly that he is considering re-opening the old New York Insurance Exchange. He points out that the statute (NY Insurance Law Article 62) is still on the books, and perhaps an exchange facility could be used to address areas of coverage that lack adequate capacity. Does such a resurrection make any sense?

For those of you too young to remember, the New York Insurance Exchange was opened in 1980 as a Lloyd’s type marketplace with business submitted to member syndicates through member brokers. It was publicly touted as the US answer to Lloyd’s and, after a slow start, blossomed over the next several years, with over $300 million in GWP in 1983. By the end of 1984 the Exchange was the eighth largest US reinsurer by premium volume and fifth largest in surplus. By November 1987, however, the Exchange was closed and all its syndicates either in run-off or liquidation. For more information on the brief mercurial life and rapid demise of the Exchange, see my 2004 article “What Ever Happened to the New York Insurance Exchange (And Why Do We Care)?”
(www.pbnylaw.com/articles/newyorkinsuranceexchangearticle11-04.pdf)

The question is, if the Exchange was such a failure in the 1980s, why consider re-opening an exchange today? My short answer is another question: Is Lloyd’s still a relevant market today? Given the renewed vibrancy of Lloyd’s over the past decade after its own financial tribulations (see Equitas), a Lloyd’s type facility not only can work, it can thrive. The financial woes of the New York Exchange and Lloyd’s bore many similarities, but the major difference was that Lloyd’s had three centuries of developed institutional and market support and New York did not. Done right, however, an exchange should be able to thrive in the US as well. The keys, of course, are defining and following through with "doing it right."

To assist in this consideration, I offer a few principles that, in my view, should form the basis of any proposal to go forward:

• The concept should be industry rather than regulator driven. The regulators can provide the forum and support for the development of a plan, but the primary force needs to come from inside the insurance and financial services industries if there is to be any lasting success.
  
• The capital requirements for syndicates will need to be significantly greater (by many multiples) than the requirements of the old exchange.
  
• There will need to be a strong commitment on the part of both the regulators and the industry to self-regulation and control of the market: with the regulators allowing the facility to develop rules controlling the operation and security of the market; and with the industry having the will to enforce its rules and its financial security requirements – a major failing of the old exchange.
  
• And a new exchange will need to take full advantage of the technical developments over the decades since the original exchange, including instant communications, virtual trading capabilities and real time access to and use of transactional and other data.

There are many other issues that will need to be addressed by any group studying the possible resurrection of an insurance exchange, not the least of which are the types or lines of business to be allowed on a new exchange and the tax and regulatory considerations that force most new insurance capital off shore. But all of those issues can be considered within the framework of the foregoing principles.

Superintendent Dinallo appears to be taking a studied view and careful approach to the exchange resurrection prospects. It will be interesting to see if his interest can translate into real consideration. I, for one, hope so.

(For the record, I was the Vice President, Secretary and General Counsel of the New York Insurance Exchange from its opening in 1980 through 1985. I am also the author of Exchange: A Guide to an Alternative Insurance Market, NILS Publishing Co., 1987.)

Wrapped in FOIL!

The New York Freedom of Information Law (Article 6 of the New York Public Officers Law) is a wonderful tool, and the New York Court of Appeals recently made the tool even more useful!

Government Agencies are required to make their records available to any citizen upon request, with a few exceptions. One exception is a privacy exemption allowing an agency to deny access to records that “if disclosed would constitute an unwarranted invasion of personal privacy.” Earlier in December the Court of Appeals issued a decision that held that the burden of demonstrating that the privacy exemption applies is on the agency, not the requesting party (In the Matter of Data Tree, LLC v. Edward P. Romaine, & Co., December 18, 2007, Court of Appeals No. 2007/173, http://www.nycourts.gov/ctapps/decisions/dec07/dec07.htm ). The Court of Appeals also found that generally “FOIL does not require the party requesting the information to show any particular need or purpose”, although the Court noted that “motive or purpose is not always irrelevant”, such as where it involves an “unwarranted invasion of personal privacy” or to obtain lists of names and addresses to be used for “commercial or fund-raising purposes” (p.7).

These findings are not the most interesting aspect of the case, however. The most interesting finding – at least to those of us who have been denied access to information for this very reason -- is that reformatting electronic data to meet a specific request is not necessarily the creation of a new record. Acknowledging that “an agency is not required to create records in order to comply with a FOIL request”, the Court of Appeals nevertheless concludes:

"As stated earlier, the term ‘records’ means, among other things, ‘computer tapes or discs.’ Disclosure of records is not always necessarily made by the printing out of information on paper, but may require duplicating data to another storage medium, such as a compact disc. [Footnote omitted] Thus, if the records are maintained electronically by an agency and are retrievable with reasonable effort, that agency is required to disclose the information. "(p.9) . . . "A simple manipulation of the computer necessary to transfer existing records should not, if it does not involve significant time or expense, be treated as creation of a new document. "(p.10) (Emphasis Added).

Although the decision leaves room for an agency to argue time and expense, the New York Court of Appeals has clearly issued the message that the burden will be on the agency to justify a denial of access to government records.

Halleluiah and Happy New Year!

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.

Principles to Live By

On November 5th the New York Superintendent of Insurance, Eric Dinallo, issued a press release and a draft regulation that Mr. Dinallo states “would make the New York Insurance Department the first in the nation to establish principles-based regulation.” The press release states that the aim of principles-based regulation is to “reduce unnecessary regulatory and administrative burdens . . .”, and sets forth the principles for both the regulated and the regulators (the proposed regulation just sets forth the principles for the regulated -- I guess they figure a regulator cannot issue a regulation regulating itself). To see copies of the press release and proposed regulation go to http://ins.state.ny.us and look under the heading “New Item”.

In essence, the proposal sets for rules to live by, both for the regulated companies and for the regulators. The rules themselves are mostly common sense rules that, it could be argued, are what is supposed to be the case in any event – such as Principle #1 for the companies: “A licensee shall lawfully conduct its business with integrity, due skill, and diligence.” Commentators have already taken shots at the principles, basically arguing that they could even lead to more regulation or litigation as regulators start to “define” the elements of the principles more narrowly than under current rules. One only need look at the body of law and disagreement over that simple document of principles called the U.S. Constitution to understand the possibilities.

On the other hand, any attempt to reduce or simplify the regulatory process should be welcomed by the industry, and it should diligently pursue this initiative with the Superintendent to try and make it work. For the most part those of us that have dealt with regulators for decades are understandably skeptical, particularly when it comes to regulatory initiatives. However, I believe the Superintendent should be given a chance to put some meaningful substance to the bones of the principles.

There is one principle that should be added to the Regulators list. The Regulators should be required to acknowledge that licensees are for-profit entities and that their owners are entitles to a fair return on their investment. Mr. Dinallo has frequently stated in public forums that he is anxious to bring new investment into the industry. A starting point for investors would be to know that if they do so successfully, they can and will be rewarded. If the regulators cannot make this principle commitment, why should investors make a principal commitment?

A Lesson in Insurance/Reinsurance Economics

Vincent J. Dowling, Jr., (Dowling & Partners, http://www.dowling.com/) an outspoken analyst of the insurance industry, was the keynote speaker at the annual meeting of ARIAS-US* last week. Speaking before an opening session crowd of over 650 arbitrators, company (cedant and reinsurer) representatives, lawyers and industry consultants, Mr. Dowling made a number of thought provoking statements that started the proceedings off to a rollicking start. One of his more interesting observations for the arbitrators present was that reinsurance recoverables as a percentage of policyholder surplus in the US is down from 50% in 2001 to 30% today (perhaps helping to explain the anecdotal perception among the arbitrators present that the number of arbitrations has ebbed the last couple of years). While he regaled the audience with criticisms of the arbitration process, his most provocative comments were aimed at the investment community, concluding that the property/casualty insurance and reinsurance business is and will continue to be a “lousy” business “for the invest-able future.”
For instance, Mr. Dowling stated that:

* Underwriters’ reported financial statements are always wrong.

* Rating Agencies are the de-facto regulators of the industry.

* Investing in the insurance/reinsurance business is like a roach motel – easy to get in but impossible to get out.

* Bermuda is the “Better Mousetrap” for investors because of the regulatory climate and the ability to actually make an adequate return on capital.

* If you want to invest in the insurance business, control the customer – become an intermediary not an underwriter.

* New capital has managed to come in to the industry on short tail business, but has not yet figured out how to come in with enough capital for long tail business.

* We are in a soft market cycle and can expect another round of company insolvencies in the foreseeable future.

All of these statements were supported by lots of charts and schedules, all of which I am sure VJ would be delighted to share with anyone who asks.

* ARIAS-US (http://www.arias-us.org/) is an organization that “promotes improvement of the insurance and reinsurance arbitration process for the international and domestic markets.” I am an ARIAS certified arbitrator and umpire.

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.

Contingent Commissions – Legal After All?

When New York Attorney General Eliot Spitzer (now Governor Spitzer) went after the major insurance brokerage firms for bid rigging a few years ago, he also attacked contingent commissions as part of the scheme to direct business, characterizing these payments as equivalent to kickbacks. In the subsequent settlements with the major brokers, the brokers agreed to forego contingent commissions in the future, casting a pall over the practice by the entire brokerage community, not just the majors.

Now a recent Appellate Division case, Hersch v. DeWitt Stern Group, Inc. (2007 NY Slip Op 06567, App. Div. 1^st Dept., Sept. 6, 2007), has focused attention again on the propriety of contingent commissions. In the Hersch case, plaintiff had sued his broker for failing to obtain certain coverages, and several of the causes of action were based on breach of fiduciary duty for, inter alia, failing to disclose the existence of a contingent commission agreement. The Court found that the fiduciary duty causes of action should have been dismissed because contingent commissions are not illegal and, absent a special relationship, defendant had no duty to disclose the existence of the contingent commission agreement.

The Court based its finding that contingent commissions are not illegal on a 1985 Court of Appeals decision, Amusement Bus. Underwriters v. American Intl. Group (66 NY2d 878). The Court of Appeals in Amusement Bus. Underwriters, however, did not specifically hold that contingent commissions were legal. It was interpreting the terms of a contingent commission agreement, and the issue of the legality of the agreement does not appear to have been before the Court.

The Hersch Court’s finding that the broker had no duty to disclose the contingent commission agreement, also seems to fly in the face of a regulatory requirement for disclosure. Circular Letter 22 issued by the New York Insurance Department in 1998 imposes a regulatory requirement that all special or extra compensation arrangements between carriers and a broker must be disclosed to customers. The Hersch Court makes no mention of this requirement.

Given the significance of the issues it roils, the Hersch decision is remarkably short (three paragraphs). We will have to wait and see if the decision is appealed, but until the Court of Appeals rules otherwise, it appears that contingent commissions can once again be discussed openly in polite circles – at least in New York’s First Department.

Agencies and Arbitration

In a recently published article, "Is Arbitration a Trap for The Unwary Insurance Agency?", February 2007, I warn that arbitration does not provide a level playing field to insurance agencies in disputes with carriers, and urge the brokerage and agency community to expand the pool of qualified and available arbitrators knowledgeable on agency issues.

The impetus for the article was an arbitration between an agency with a small but profitable and fully reinsured program and the insurer of the program. The issues before the arbitrators included the circumstances of the termination and the treatment of the agency following termination. The arbitration resulted in an award by a majority of the three arbitrators denying the agency's claims, but without any explanation. The dissenting arbitrator, however, issued an unusual written dissent stating that the majority had failed to apply custom and practice in its decision, and misapplied the law. As I note in the article, this dissent should be required reading for all insurance agencies and program managers concerned with resolving disputes with their carriers. Because of its importance, a copy of the award and dissent in The Garn Group v. Arch Insurance Company dated December 7, 2006 can be accessed in pdf format through this link.

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!