When Zombies Walk the Night
Asbestos Claims and Insurance Claims Run-Off
THE RHA REVIEW
Volume 15, No. 2, First Quarter 2009
By Robert N. Hughes, CPCU, ARM
Zom-bie 2 a ; a person held to resemble the so-called walking dead. (Webster's New Collegiate Dictionary)
Body snatcher, a person who exhumes dead bodies to sell them. (Wikipedia, The Free Online Encyclopedia)
It’s a typical Bram Stoker story line … everything is lovely in the resort. The weather is beautiful. Lovers stroll the beach and God is in His heaven. Then the sun goes down and the horror begins. Ghouls invade the graveyards. Zombies, the walking dead, maim and kill with abandon. The zombies have the functions of living beings but have no reason to behave and are without human responsibilities. All this, of course, makes for good fun in the movies or in books, but we all know it isn’t real. Well, at least not as I have described it it isn’t, but few people realize that persons and entities very similar to zombies and body snatchers exist in parts of the world of insurance that are not generally known of and are certainly never seen by the ordinary person.
Let us start with the “everything is lovely” scenario and work forward. Fifty or sixty years ago the world of insurance was one of “ultimate good faith” and straightforward dealings. Insurers generally believed they owed a fiduciary duty to their policyholders and behaved accordingly. Claims were investigated and paid promptly. Misunderstandings about coverage were usually resolved in a fair and equitable manner. Policyholders almost never sued their insurers. Insurers made reasonable profits. They were pleased to be in the business and wished to remain in the business. As a result, they acted in good faith and were highly conscious of their public image. Everyone, companies and insureds alike, was generally happy.
Then in the 1970s the first of the black plagues of insurance struck. Asbestos, previously thought of as the miracle substance, was identified as a quiet but inexorable killer. Soon thereafter another blow was struck - unrelated to asbestos but equally detrimental to the insurance world - when our astute Congress passed the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), otherwise known as the Superfund. Ultimately, the workers’ compensation and third-party liability claims arising out of asbestos and pollution resulted in what, in my opinion, was the largely undeclared bankruptcy of the entire insurance industry. Almost no U.S. company was spared, and Lloyd’s of London tiptoed near financial collapse until Equitas saved it by reinsuring all the pre-1993 claims. The companies that did survive did so through mergers and by completely remaking their corporate personalities. Old-time insurance people were “out.” “In” were the money people who concentrated on cutting costs and hanging on to cash as long as possible. Large claims were regularly controverted, and lawyers took over the claims departments.
Now let’s think a moment about what normally happens when insurers get into serious financial straits without becoming actually insolvent. The first thing they usually do is to suspend underwriting and enter into what is known as “run off” mode. That is to say, they don’t sell any new business but remain an operating company in order to finish paying (or “running off”) all the outstanding claims. As one can imagine with lifetime medical workers’ compensation claims and “long tail” liability claims, this can take years.
Some companies don’t have that luxury, however. They are broke and must liquidate. Often this decision is made for them by regulators. In such cases, the company is put under the supervision of a receiver, and its affairs are managed until all the claims are paid. (In London such plans are known as “schemes of arrangement” and operate very similarly to U.S. companies in receivership.) These are not the companies I wish to discuss here, however. They are dead, and generally they stay that way. Their assets are distributed as equitably as possible to the policyholders, and anything that is left over goes to the creditors. Transit Casualty is a well-known example of this sort of insurer “dead body.”
What about “run-off” companies, however? Well, I’m happy to say that some of them have behaved very well, particularly in London. Their managers, feeling they still have a responsibility to the policyholders, have concentrated on equity and fairness and have generally done an excellent job of paying their claims.
Ah, but that brings us to the fall of night when the “beasties prowl.” What about the run-off companies that couldn’t care less about the policyholder? What about the “zombies” of the insurance world that have cash and outstanding claims reserves but have no further reason for being? Many of these companies have been acquired by investors who see an opportunity to make money in two ways. First, they hope to increase investment income on their reserves. Second, they hope to eventually pay out less in claims payments than the amounts for which they were reserved at the time of acquisition. Let’s take a look at both of these methods.
The only income a run-off company has is the investment income on its reserves. This income can be enhanced in only two ways. First, you can simply try to make a higher return on your invested capital than did the previous owners of the company. Frankly, the potential gains in this area are small because most insurance-company financial managers have been pretty good at their job. Second, however, you can try to keep your cash longer than was expected in the calculation of the acquisition cost of the company. In other words, in calculating the price of an insurance-company acquisition, one must determine how long it will take to pay out the claims, what the rate of pay-out will be and what rate of return can be expected on the invested reserves. Once the acquisition occurs, however, the new owners may attempt to restructure the dynamics of the price by simply keeping the cash longer than was expected.
These companies are the “zombies,” and their owners are the “body snatchers.” They have no connection with the policyholders. They don’t feel they owe them any fiduciary duty. They generally feel no responsibility for retaining records that will assist policyholders in perfecting their claims. They are solely in the business of managing the cash reserves of the company, keeping the money as long as possible and making as much interest as they can while they have it. They purchase legal defense on a wholesale basis and instruct their attorneys to make life as miserable as possible for policyholders who are attempting to perfect their claims against them.
Fortunately, most individuals and companies will not encounter these zombies or body snatchers because they don’t have old claims they are trying to collect from them. On the other hand, however, almost every large commercial entity, medical facility or religious institution will encounter one or more of these “beasties” sooner or later. All they can do, in my opinion, is to hire good lawyers, hope the courts will hold these companies to an appropriate standard of “good faith” and keep their crucifixes handy.