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Article Author:

Organizing Reinsurance in Receiverships and Troubled Companies

Protecting Your Largest Asset by Getting a Handle on It: A Brief Checklist

It’s a dark and stormy night!! (Really)

The Department of Insurance is in the midst of an examination of The ABC Troubled Company (“Troubled Company”). Among other issues, Troubled Company is having problems collecting reinsurance. Troubled Company’s largest reinsurer has quit paying claims following an audit, claiming that Troubled Company misrepresented the business and financial solvency of the company. Other reinsurers are asking questions about billings and suggesting they will not pay until “support” is provided.

The company has a new reinsurance accounting system but only the last couple of months of activity is in the system. Consequently, Troubled Company is behind in billing reinsurers. Several of the treaties and accounting records are missing; others are difficult to read and could use a fresh review.

A significant amount of the business written by Troubled Company was written by agents and most of the claims are handled by third party administrators. Additionally, Troubled Company’s reinsurance manager and several staff have recently left the company. The Insurance Commissioner is considering what action to take and asks you to review Troubled Company’s reinsurance program and provide her with recommendations. Because she knows the reinsurance recoverables are a large asset, she has asked you, a reinsurance expert, to help sort this out.

After meeting with the Insurance Commissioner, you head off to Troubled Company with a good idea of some of the things you expect to find when you get there. You are not worried; you have seen it before and have a plan to get your arms around the problem. The ultimate goals of your plan are to identify all of the reinsurance treaties and salient documents and to collect the reinsurance balances and/or commute with Troubled Company’s reinsurers.

Are you Left High and Dry by the Former Management?

Does Troubled Company’s scenario sound familiar? Although reinsurance recoverables are commonly an insurance company’s largest asset, many companies do not have their reinsurance programs adequately in order. Management often thinks that the reinsurance contracts run themselves and if a reinsurance intermediary is involved that the intermediary is taking care of everything. Too frequently, it is not until the auditors, state examiners or reinsurers pay a visit to the company that the problems with the reinsurance programs come to light. No matter how much they strive to administer their programs, the company staff is often too involved in their day-to-day operations to organize the reinsurance treaties and other salient documents necessary to understand the reinsurance program. Additionally, management may not have had a “hands on“ approach to the reinsurance area. This can lead to the inability to collect reinsurance and may become a key factor in the failure of the company.

Given the scenario presented by the Insurance Commissioner, you can expect to find problems with the reinsurance program when you get to Troubled Company. Common problems include:

1. poorly organized files
2. missing treaty documents and information
3. undocumented transactions
4. problems with recoverables and reporting
5. misunderstandings of how the reinsurance contracts operate

As you are reviewing Troubled Company’s reinsurance program to respond to the Commissioner, you will likely find that you are trying to put together pieces of the program from incomplete records. Additionally, the people who have the best understanding of the reinsurance program may not be at the company, either because of personnel turnover or because the program was managed more by the reinsurance intermediaries rather than the company’s own staff.

At the end of the day, what will you need to do to organize, collect and possibly commute the reinsurance that is present? At a minimum, you will need to obtain and most importantly quickly understand the key ingredients of the reinsurance area:

1. types, forms and characteristics of the reinsurance treaties and facultative certificates
2. claims
3. actuarial
4. premium process
5.  cash position

You will need to get prepared for the likely reinsurance audits that will be taking place. You will have to identify problems and potential issues and quantify and triage them. As a receiver you will need to identify what are the strengths and weaknesses of the company’s position. As you delve further into the project, do not be surprised if documentation is complex and missing.

As time may be of the essence – especially to obtain the needed cash balance with supporting documentation for sending to the reinsurers, and/or analyzing what is needed to pay the cedents on assumed business – obtaining additional experienced/knowledgeable personnel may be needed. Reinsurance is a complex area. When a company becomes “troubled” or a receivership becomes imminent, there is often a loss of knowledgeable personnel and you cannot expect the remaining personnel to instantly become “experts.“

The-Not for the faint of heart-Checklist: (not all inclusive)

The following is a brief checklist to assist you in working in a troubled company or receivership’s reinsurance area. However general this checklist may be, it is not meant to be treated as a typical checklist whereby one merely obtains the documents or material and checks it off. It is specifically designed for those brave souls who really want to ascertain what the reinsurance area in the company is about. In other words, you will have to obtain, research, outline, understand and act on what is found. We hope this is a helpful tool for it is derived from both our experiences, which without going into detail is a heck of a lot!

1. Find the Contracts and Related Documents; Do You Know Where The Treaties Are?

The first thing to do is gather the reinsurance files. There are lots of places to look to determine what reinsurance is or was in place at the company. You may need to look in many places and talk to several people to find all the documents because the reinsurance treaties, certificates, addenda, correspondence and related documents are likely not maintained in one place. Try not to use jargon when asking company personnel for files because they may not be familiar with reinsurance or reinsurance terms. For instance, ask them for correspondence files related to the reinsurance contracts rather than asking for reinsurance placement files.

Some suggested steps for locating the reinsurance contracts and related documents are:

• Interview key people regarding the reinsurance program and contracts to help determine the reinsurance that is or was in place at the company. For example:
  • Talk to company reinsurance personnel about the reinsurance program.
  • Contact the reinsurance intermediaries.
  • Talk to senior management because not all of the reinsurance contracts may be in writing or in neat notebooks or computer files.
  • Talk to the company lawyers because they may have been involved in drafting the contracts or other key documents.
  • Talk to the claims personnel because they often provide notice of the claims to the reinsurers.
  • Talk to the actuaries about their understanding of the reinsurance program.
• Review company filings, audits and reports to assist in understanding the reinsurance in place. For example:
  • Review the company’s Annual Statement including the Notes.
  • Obtain Schedule F and Schedule F workpapers and review for reinsurance ceded and assumed.
  • Review the company’s balance sheet for reinsurance recoverables, funds deposited, funds held and provision for reinsurance.
  • Review the Insurance Department financial examination reports and market conduct reports.
  • Review the external audit reports and/or internal control reviews by the company’s outside auditors.
  • Review the company’s internal audit reports, if any exist.
  • Review reinsurance layoff sheets.
• Review the company’s reinsurance files and related documents to assist in understanding the reinsurance that is or was in place. For example:
  • Gather the reinsurance files; this may include contracts, addenda, endorsements, correspondence, invoices, billings, notices, accounting records, claims files and intermediary records.
  • Review correspondence/treaty placement information with reinsurers and intermediaries.
  • Inventory all treaties (ceded and assumed) and addenda and endorsement.
  • Read the reinsurance contracts and prepare synopses of each. Possibly use Exhibit C and D from the NAIC Financial Examiner’s Handbook @ 2009¹ to assist you in the preparation of reinsurance and reinsurance contract review templates.

2. Review and Understand the Contracts

Once the files have been collected, it is important to review and understand the reinsurance contracts and how the company dealt with them. An understanding of the contracts and the company’s course of dealing with them will help identify potential issues and lessen the chances of later surprises. Do not be shocked if your understanding of how the contracts should operate or be accounted for is different from the way the company did it. Also be prepared to find that certain contract terms may be ambiguous or subject to different interpretations by the company and the reinsurer. Also there may be things that the company did in the normal course of dealing with the contracts that are not included in the contract terms. Preparing diagrams or pictorial representations of the reinsurance contracts and the lines of business reinsured can help determine if there are any gaps in the reinsurance and whether there are missing contracts and related documents. Failure to identify reinsured policies can result in non collection of reinsurance recoverables.

Suggested steps for reviewing the contracts:

• Write up a narrative illustrating your understanding of the entire program.
• Have a peer review the narrative to make sure it makes sense – there can be differing interpretations of reinsurance terms.
• Prepare pictorial representations of the reinsurance structure – this will help to determine if there are/were any gaps in reinsurance.
• Review each contract to identify any features that may significantly affect the collectability of reinsurance – for instance, look for cut-throughs or unauthorized reinsurance or fronting arrangements.
• Determine whether there are any loss portfolio transfers, assumption agreements or other financial reinsurance arrangements.
• Do not forget to ask about intercompany reinsurance arrangements.

Items to include in the narrative of each reinsurance contract:

• Determine the lines of business reinsured by the contracts.
• Review the company retention and reinsurance limit.
• List the reinsurers and their participations.
• Ascertain whether the contracts have been executed by the reinsurers.
• Review the contract exclusions.
• Determine if the contracts include arbitration and insolvency clauses.
• Review the contract termination procedures.
• Ascertain whether there are any commutation clauses, sunset clauses and the dates for reporting per the clauses.
• Determine whether the company has made any reports in accordance with the sunset and commutation provisions.
• Determine whether the contract is losses occurring or risks attaching.
• Determine whether there are any special settlement procedures.
• Determine whether there are any notice requirements to reinsurers and whether the company has prepared the notices. For example, review the notices of large losses that are generally prepared by claims personnel. Failure to provide required notice to reinsurers may result in the inability to collect reinsurance.
• Determine if there is any MGA involvement.
• Determine if there are any clauses related to commissions, either ceding or contingent.
• Ascertain how the premium is calculated and if the contract is experience rated.
• Determine whether there are minimum premium or deposit premium requirements

3. Get a Handle on the Cash

A key area of concern at any troubled company is cash. In reviewing the reinsurance program, it is essential to understand the reinsurance cash flow, the reinsurance collateral requirements and the reinsurance recoverable collection procedures. Generally, you need to know what balances are owed, who has the cash or collateral and how to get it. Some steps to achieve this goal are:

• Find the collateral held – cash, trust funds, funds held and determine who is holding the funds.
•  Review the collateral agreements and determine the responsibilities and obligations of the company and what the requirements to use collateral are.
• Reconcile cash with bank statements – determine the cash in hand.
• Ascertain if the intermediary is holding funds.
• Locate original letters of credit and determine if they are evergreen.
• Determine if the collateral is sufficient.
• Understand the collection procedures – perform a walkthrough.
• Determine if there are any cash call provisions in the reinsurance contracts.
• Determine whether the company reconciles with the reinsurance intermediaries and how frequently.
• Determine whether the intermediary is allowed to offset amounts owed to the reinsurers with balances owed to the company.
• Determine if there are any amounts in dispute.

4. Review and Understand the Business Subject to the Contracts

Another important step in getting your arms around Troubled Company’s reinsurance program is to understand the company’s business and what business is subject to the reinsurance contracts. You will likely need to interview several people in different departments at the company and may need to interview outside consultants and other third parties. Personnel to interview and steps to gain an understanding of the business include:

• Interview operational/underwriting personnel about their involvement in the placement process.
• Interview IT personnel to ascertain how the reinsurance is/was set up on any system.
• Interview accounting personnel and ascertain how the accounting system handles reinsurance; perform a limited walkthrough of the system using one or two quarters of reinsurance data (see below).
• Interview claims personnel regarding claims issues and problem claims, underlying claims litigation, coverage issues and claims systems.
• Interview actuaries to understand reserves and reserving philosophy.
• Interview legal, both in house counsel and outside counsel regarding problem claims and claims litigation, problem books of business and disputes with reinsurers. Also ask about prior commutations (within the preference period) and whether there are continuing obligations of the company pursuant to the commutations.
• Review reinsurer audit reports if any exist and were given to the company.
• Review internal audit reports related to the business written and company operations.

5. Review and Understand the Reporting and Accounting for the Reinsurance

It is also essential to understand the premium and other reporting requirements of the contracts and how the company accounts and reports to the reinsurers and/or the intermediaries. Often when a company is in trouble, reinsurers quit paying or slow pay and may begin demanding support for billings where they did not do so before the company began having financial problems. One needs to understand how the reinsurance flows and evaluate the different systems used by the company. This will assist in determining whether the reinsurance transactions are recorded timely and are properly valued, classified and correctly recorded.

Suggested areas to review include:

• Gain an understanding of the policy/premium processing flow.
• Perform walkthroughs of the reinsurance functions – these are essential to understanding the reinsurance process and are key in a receivership or troubled company.
• Determine whether there are policy and premium registers or bordereaux.
• Review the accounting and reporting processes and procedures.
• Determine what computer systems, if any, the company uses for accounting and reporting; do not be surprised to find that reports and the accounting are maintained in spreadsheets.
• Ascertain how the losses subject to the treaty are identified.
• Determine whether loss bordereaux are prepared and/or claim reports prepared in connection with the billings to reinsurers.
• Determine how offsets are identified and if they are applied in the billings to reinsurers.
• Obtain support for the ceded business prior to sending out requests for payment to the reinsurers.
• Review collection procedures currently in use and make modifications if necessary.
• Get in touch with your intermediaries and other third parties.
• Establish your own relationship with the intermediaries.
• If assuming the reinsurance, contact the cedent and/or reinsurance intermediary to confirm terms/status.
• Perform periodic reconciliations with the intermediaries to ascertain that what was sent to them is correctly and timely passed to the reinsurer(s).

6. Monitor the Reinsurers’ Status on a Periodic Basis

Finally, because the reinsurance recoverable may be the company’s largest asset, it is important to know who the company’s reinsurers are and what their current financial condition is. While there is no guarantee that the reinsurers will remain solvent and willing and able to pay the company’s claims, you can improve your odds of collection by gaining a thorough understanding of the reinsurers and potential issues that may impact payment of claims or commutation.

Suggested steps for the review of the company’s reinsurers are:

• Identify all reinsurers and whether there have been corporate/name changes.
• Determine if there are any unauthorized reinsurers.
• Identify any fronting arrangements.
• Identify the intermediaries involved with each reinsurer.
• Determine the collateral requirements for unauthorized reinsurers.
• Review the financial condition of reinsurers.
• Determine whether there are any reinsurers that are slow in paying claims or not paying claims.

Conclusion

Now that the reinsurance area is better organized and your plan addresses the steps to collect the reinsurance recoverables, commute with the reinsurers, and work with any cedents from whom you have assumed business, you should be able to sleep better at night. Your company might be troubled but its reinsurance program should be better functioning. Now that you know and understand Troubled Company’s reinsurance program, you can begin to build an effective reinsurance administration program that will either serve the company if it is to continue in existence or prepare the receiver to deal with potential reinsurance problems before they arise.

This article was contributed to Blackman Kallick by Kathleen M. McCain, Principal, Kathleen McCain Consulting and Evan Bennett, Director of Blackman's Reinsurance Consulting. For more information contact Kathleen at kmmccain@earthlink.net, or 213-509-7636, or Evan at ebennett@BlackmanKallick.com or 312-980-3353, Jerry Hufton at jhufton@BlackmanKallick.com or 312-980-2961, Jeff Dertz at jdertz@BlackmanKallick.com or 312-980-3224, Doug Youngren at dyoungren@BlackmanKallick.com or 312-980-2944, or your Blackman Kallick representative.

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¹ NAIC © 1976-2009 National Association of Insurance Commissioners. All rights reserved.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.