RISKVUE ARCHIVE | RISK BITES

London Update

By David M. Greenwald

The once and future issue confronting London is asbestos. Claims development persists in the US, and long-term claims loom in Europe. Although Equitas continues to live to fight another day, many in the London Market are convinced that it is only a matter of time before Equitas becomes insolvent. The insolvent London companies continue to march through bar dates, and there are discussions afoot in the Market to put more solvent London companies into schemes of arrangement. And there is even talk of an Equitas II for liabilities in the 1993 to 2001 underwriting years. But not all is doom and gloom. The new Lloyd’s, comprised almost entirely of corporate capital, posted a $3.38 billion profit in 2003, had $24 billion of premium capacity in 2004, and has even decided to go to the capital markets for the first time in its history to float £500 million in longterm notes to shore up its Central Fund and its ratings.

Equitas

Equitas was established in 1996 to reinsure the vast majority of pre-1993 non-life liabilities within the Lloyd’s system. Equitas’ role dwarfs that of a traditional reinsurer in that Equitas has sole discretion to settle claims and run-off liabilities.1 It was created to act as a “firewall” between “old Lloyd’s,” comprised of individual Names, who were saddled with long-tail asbestos, pollution and health hazard liabilities, and “new Lloyd’s,” which now consists almost entirely of corporate capital.

Equitas most recent financials contain mixed news.2 Equitas again had to increase its reserves for asbestos liabilities, largely due to higher payments for mesothelioma victims. Equitas’ reserves for asbestos now total £4 billion on an undiscounted basis. And its statutory surplus decreased by £67 million to a wafer-thin £460 million. Equitas’ chairman candidly concedes in the annual report that Equitas’ “success cannot be guaranteed,” and that the entity’s auditors have again qualified their report.3 However, Equitas’ “solvency ratio” improved to its highest level since the entity was formed.

Perhaps the most significant news in the last several months has been the number and size of settlements that Equitas has reached relating to some of its largest asbestos-related exposures. In late 2003, Equitas settled with Halliburton for $575 million. In the last four months Equitas has announced deals with EnPro Industries ($118 million), Hercules, Inc. ($97 million), and CSR Ltd. ($41 million). Other settlements have been reached on a confidential basis and more are said to be in the works.

The key questions for policyholders are: How long will Equitas remain solvent? What will happen when it becomes insolvent? and Should a policyholder settle claims and commute policies today at a steep discount, or leave its coverage in place and pursue claims over time in hopes of recovering more in the long run?

Equitas’s contract with Lloyd’s underwriters provides that, in the event of insolvency, it may initiate “proportionate cover,” paying only a percentage of legitimate claims based on the degree of determined insolvency. There is also talk that Equitas may instead enter into a “scheme of arrangement” to wind up its affairs.4 In either event, there would likely be a cessation of payments for some time before policyholders would be paid on a partial basis.

Any form of Equitas insolvency is likely to trigger a barrage of litigation in which policyholders seek to obtain coverage from other sources, including the Names themselves, and the broader Lloyd’s enterprise. Although Lloyd’s has always stated that underwriters are severally and not jointly responsible for risks underwritten and, therefore, the Lloyd’s enterprise is not responsible in the event of underwriter defaults, that would be challenged in the courts. Lloyd’s has touted its substantial “chain of security” to assure policyholders over the years, and policyholders will look to that chain of security, including Premium Trust Funds and the Central Fund, to make them whole. As Fitch Ratings recently explained, even without a legal obligation to do so, the Lloyd’s enterprise may need to make good on “old Lloyd’s” liabilities: “Although the large majority of Lloyd’s current capacity would not be legally required to meet any shortfall if Equitas were unable to meet its liabilities in full, members may do so to protect the franchise.”5

“New Lloyd’s”

Following large losses in 2001 ($4.257 billion), Lloyd’s returned to profitability in 2002 ($1.343 billion) and increased profitability in 2003 ($3.387 billion).6 For the 2004 underwriting year, Lloyd’s has total underwriting capacity (premium) of £15 billion (approximately $27 billion). Lloyd’s recently was upgraded by AM Best from A- to A. Lloyd’s received an A rating from Fitch in October, and a BBB+ expected rating for a proposed £500 million subordinated debt offering.7

Post-1992 underwriting years, however, are not immune to the asbestos liabilities that plague the Equitas years of account. According to a Fitch report in March 2003, Europe’s asbestos experience substantially lags behind the US and may present large claims against insurers far into the future.8 Fitch conservatively estimates that ultimate European asbestos exposure to European insurers may be in the range of €32–80 billion.9 Some of those liabilities will impact post-1992 underwriting years because asbestos exclusions were not included in some European policies well into the 1990’s.

Perhaps as a result of these liabilities, and others, there is talk in the market of forming an “Equitas II” for the 1993 to 2001 underwriting years, during which Lloyd’s experienced substantial losses. Equitas II might also be used to reinsure Equitas, thereby extending the day when Lloyd’s would have to acknowledge insufficient funds to cover pre-1993 risks.

The Company Market

The insolvent London Market companies are quickly closing their books on their run-offs. The KWELM bar date was September 29, 2004. The next major bar date occurs in May 2005 for the Orion companies. Under English law, solvent companies with discontinued insurance business may also enter into schemes of arrangement to close their books once and for all. Recently, several solvent schemes, including one for the Prudential Assurance Co., Ltd., reached their bar dates. There is talk in the market that many more solvent companies with pre-1993 long-tail liabilities may also choose to enter into schemes of arrangement rather than continue to carry on with an indefinite run-off of the business.10

The significance to policyholders is that increasingly coverage for long-tail liabilities is being eliminated through schemes of arrangement, and this trend may continue for some time. It is important, therefore, for policyholders to analyze their London coverages, estimate current and ultimate claims (including IBNR (incurred but not reported) exposures), and evaluate the possibility of commuting old policies on a selective basis with London companies. Commutation may not be the right choice for every policyholder, but knowing what coverages exist and estimating likely losses will be very useful as more London companies close their books for good.

Notes

1 Reinsurance and Run-Off Contract (“RRC”) at §§ 9.2 and 9.4.
2 Equitas Report & Accounts for the year ended 31 Mar. 2004.
3 Id. at 3.
4 See generally PriceWaterhouseCoopers, “Solvent Schemes of Arrangement for Discontinued Insurance Business” at 2.
5 Fitch Ratings, Comment “Fitch Rates The Society of Lloyd’s and Assigns Expected Rating to Debt Issue,” 13 Oct. 2004. See also Fitch Ratings, Special Report “Asbestos: Too Hot to Handle for European Insurers?” 31 Mar. 2003, at 14.
6 Lloyd’s Press Release, “Lloyd’s Announces $3.387 Billion Profit for 2003,” 7 Apr. 2004.
7 Fitch Ratings, Comment, 13 Oct. 2004.
8 Fitch Ratings, Special Report, 31 Mar. 2003.
9 See id. at 9 (€32–80 billion may be significantly overstated due to government sponsored insurance).
10 See generally PWC Report.

ABOUT THE AUTHOR

David M. Greenwald is a partner in the Chicago office of Jenner & Block LLP. He is a member of the Firm’s Insurance Litigation and Counseling, Reinsurance, and Appellate and Supreme Court Practices. Mr. Greenwald received his J.D. with honors from the University of Michigan Law School.

This article originally appeared in the Fall 2004 issue of Insurance Counselor, a publication of Jenner & Block LLP.

riskVue | The webzine for risk management professionals
May 2005