Remember the Clash anthem of the mid `80s, "Should I stay or should I go"? Many risk managers and in-house counsel now face a similar question with regard to their companies' historic Lloyd's of London insurance coverage written before Jan. 1, 1993, and now reinsured through Equitas: Should I keep this coverage or should I cash it out? The issue is complex, and the answer may vary among policyholders. However, given the recent explosion of asbestos claims and some recent pronouncements by Equitas, asking the question--and searching for the right answer--is imperative.
Lloyd's, Unanticipated Losses and the Formation of Equitas
As most readers know, Lloyd's of London is not an insurance company; rather, it is an insurance market. Historically, the Lloyd's market was organized with private individuals--called "Names"--pledging their own personal assets to underwrite insurance risks. For literally hundreds of years, Lloyd's held the reputation as one of the safest places in the world to insure high-profile--and high-risk--risks. During the last half of the 20th century, Lloyd's was one of the most significant sources for comprehensive liability insurance. Thus, for many large manufacturing concerns, Lloyd's was the excess insurance market of choice. As a result, Lloyd's wrote a large number of policies during the period of widespread asbestos use in the United States (i.e., pre-1970s).
Many of the risks covered under these policies were so-called "long-tail" risks, the true impact of which were not felt until years--and sometimes decades--after the policies were written. Beginning in the early 1990s, it became apparent that losses on these and other liability risks were creating a financial crisis at Lloyd's. From 1990 to 1994, the Lloyd's market lost $8 billion.1
Faced with massive losses from these liability insurance policies, in 1996 the Council of Lloyd's of London developed a Reconstruction and Renewal Plan to restore the London market's integrity and provide some affordable finality to the individual Names who had issued policies written before 1993.2 The plan created a company, known as Equitas,3 to bring the market back from the brink of bankruptcy by reinsuring the Names' policies and handling the runoff of the reinsured business.4 The mission of Equitas was to resolve liability exposures for asbestos, pollution and health hazard (APH) claims that either were never anticipated or were poorly priced during the underwriting process.5 As one commentator has observed, "[t]he goal was to achieve economies of scale and to provide negotiating leverage by consolidating the claims handling process."6 To be entitled to the reinsurance, the Names were required to enter into the Equitas Reinsurance and Runoff Contract, which provided that Equitas would have the exclusive authority to handle, litigate, defend and settle any claim against the names under pre-1993 policies.7
Constituted as a separate legal entity from Lloyd's, Equitas was capitalized with almost $19 billion, comprised of reinsurance premiums from Names, transfers of trust funds and an intermarket settlement.8 Equitas assumed liabilities in respect of Lloyd's syndicates for the period before 1993.9 Quantification of these liabilities was undertaken by an actuarial study, known as the Reserving Project, over a three-year period.10 Equitas became operational Sept. 4, 1996.
The consolidation of pre-1993 claims into an independent reinsurance vehicle had several perceived advantages: (1) centralization of claims management and reinsurance functions among a variety of syndicates; (2) realization of cost savings due to economies of scale; (3) identification of dedicated long-tail claims reserves for pre-1993 policies; and (4) enhancement of investment returns from constitution of long-term organization (syndicates were organized as annual ventures). The system also had several perceived disadvantages, however, including: (1) lack of additional source of revenue; (2) potential inadequacies of reserves for new, unanticipated classes of claims; (3) the prospect that investment income might not meet projections; and (4) possible cost overruns from administrative expenses.11
U.S. Policyholders' Recourse Against Lloyd's Names, Equitas
Although Equitas was promoted to the Names as a means of bringing finality to their liabilities, there is little legal justification for the assertion that the Names have been released of their obligations to policyholders. Indeed, U.S. counsel for Equitas has recognized that "[n]either Lloyd's nor Equitas could affect the liability of Lloyd's name[s] to policyholders, nor did they."12 But this direct liability of the Names to policyholders may well prove more illusory than real, since the task of identifying, locating, suing and serving thousands of individual Names is daunting--if not impossible.13 Moreover, Equitas itself has vigorously resisted being sued in U.S. courts, arguing both that it is not subject to personal jurisdiction and that policyholders lack the necessary privity of contract to bring suit directly.14 Thus, Lloyd's and Equitas can fairly be charged with trying to place policyholders in a classic catch-22: Suing the Names directly is infeasible and Equitas itself--the only entity against whom a practical remedy may exist--has resisted suits against it. Although policyholders have met with some recent success in their efforts to proceed directly against Equitas, the prospects of future success remain highly uncertain.15
Even as it has resisted being sued in the U.S., Equitas has embarked upon an aggressive, pro-active effort to resolve its book of claims. Since September 1996, Equitas has implemented a policy of settling APH claims in exchange for "finality"--and has paid billions of dollars to policyholders with this policy goal in mind. These policyholders, many of whom are major multinational corporations, presumably agreed to policy buy-outs because they had concluded that they received the right price given the comparative risks between such buyout now and the uncertain value of their policies down the road.
Nevertheless, many policyholders have opted not to resolve their claims against the Lloyd's syndicates under pre-1993 policies. Some likely believe that their claims picture is not mature enough--and, therefore, not certain enough--to value their coverage. Others had previously negotiated coverage-in-place arrangements with Lloyd's, often during the pre-1993 era when they were dealing directly with leading Lloyd's syndicates. Such companies presumably have concluded that these arrangements afford them ample protection and certainty.
There are recent indications, however, that times are changing, at least from Equitas' perspective. These signals should, at minimum, raise questions in the minds of policyholders about the wisdom of continuing to deal with Equitas by leaving old Lloyd's coverage in place. For example, last year Equitas announced it would demand more information to justify paying asbestos claims and that it would subject so-called "inventory settlements"--package deals whereby large numbers of asbestos claims have been settled on an established grid--to increased scrutiny.16 And, perhaps more ominously, Equitas also announced that it had "terminated one `coverage-in-place' agreement and filed a declaratory judgment action in which we asked the court to impose new, more favorable rules for allocating claims among policies and between insurers and the policyholder."17 Equitas has been candid about its motivation: "[t]hese `coverage-in-place' agreements were negotiated following a series of defeats for insurers in coverage litigation with asbestos defendants, and the terms of the agreements relating to trigger and `allocation' issues therefore tend to favor policyholders."18
In this newly aggressive climate, even policyholders who believe that they have favorable, firm coverage-in-place agreements might wish to consider the desirability of a policy buy-out that would sever any future relationships with Equitas. As discussed below, such a review may be even more prudent in light of the current financial posture of Equitas and its ongoing exposure to escalating pollution and asbestos claims and potential liabilities.
Equitas' Darkening Financial Picture
During its first several years, Equitas was able to report an improving financial picture, partially as the result of favorable investment and economic conditions, increasing its surplus by approximately $320 million. But that picture has begun to change, driven in large measure by Equitas' aggressive effort to resolve environmental pollution claims and by a second wave of U.S. asbestos litigation.
Over the past several years, Equitas has reached major environmental buy-outs with a large number of Lloyd's pre-1993 policyholders. It appears that Equitas has been paying between $1.5 billion and $2.0 billion per year in pollution claims. Last year, Equitas announced that it had settled 29 percent of the direct pollution claims pending as of April 1, 2000, and settled 44 percent of direct pollution claims with reserves in excess of £10M.19 Although not specifically disclosed, an analysis of disclosed financial results suggests that Equitas' pollution reserves are now under $5 billion. But Equitas' pro-active effort to settle environmental claims does not appear to have slowed the numbers of pollution claims being filed: New pollution claims against Equitas nearly doubled for the year ending March 31, 2001.20
At the same time that Equitas was embarking on its aggressive settlement program of pollution claims, its asbestos exposure picture began to darken. When Equitas was formed in 1996, asbestos liabilities for U.S. insurers were estimated to be about $40 billion.21 It is now apparent that this estimate was far too low. The facts are sobering:
- AM Best estimated in May 2001 that asbestos claims would ultimately cost the U.S. insurance industry, not including Lloyd's syndicates or other non-U.S. insurers, approximately $65 billion.22 Two recent commentators have estimated that total asbestos settlements will likely reach $200B.23
- Plaintiffs' lawyers currently file about 40,000 new asbestos cases a year.24
- More than 2,000 companies currently are defendants in asbestos lawsuits, as compared with 300 companies in the 1980s.25 Asbestos lawsuits have driven company after company into Chapter 11 bankruptcy. Indeed, since February 2000, 10 asbestos defendants have filed for Chapter 11 protection.26 These bankruptcy filings, themselves caused by the explosion in claims, in turn have accelerated claim filings and demands against nonbankrupt defendants.27
- The Manville Trust received 58,600 new asbestos claims in 2000, which was an 81 percent increase over the 32,300 claims filed in 1999.28 This was "the greatest number of claims the Trust has received in one year with the sole exception of 1989, the first full year of Trust operations."29 The explosion of new asbestos claims forced the Trust to cut its payment level by one-half last summer.30 Moreover, as of approximately mid-year 2001, the Manville Trust received 88,848 claims, more than a 60 percent increase over the total received for the entire year of 2000.31 Other asbestos trusts likewise have been inundated with claims.32
- In the past two years, asbestos verdicts have skyrocketed, with one verdict reaching $52 million and at least 10 more verdicts of over $10 million.33
These developments have placed severe financial pressures on Equitas. Paul Jardine, communications director and chief actuary for equitas, has indicated that if the current level of asbestos claims continues unabated, many additional companies--including U.S. and European market insurers, as well as U.S. asbestos producers--could face financial collapse.34 A review of the March 31, 2001, Equitas accounts for fiscal 2000 leaves one with the strong feeling that Mr. Jardine had his own company firmly in mind despite his own denials. In that year Equitas increased its gross reserves for asbestos by approximately $2.7 billion, to $12.9 billion. During that same year, payments on asbestos claims rose dramatically to over $649 million, compared with just $177 million in fiscal 1999.35
Despite the increase in both environmental and asbestos claims payments for the fiscal year ended March 31, 2001, Equitas considerably lengthened its assumption concerning the time period over which it projects future claims payments. After present valuing, this adjustment created almost $1 billion in cushion for Equitas' surplus. Without this reassessment, most of that surplus would have been wiped out. Although there may be a cogent reason for this reassessment of the timing, it is hard to reconcile this presumed lengthening of the payment stream with the recent increase in payments for environmental and asbestos claims and the spiraling number of asbestos claims.
These facts may have severe ramifications for Equitas and, ultimately, policyholders. If pollution claims are paid on the same pace as in the past, it is difficult to see the current pollution reserves lasting longer than three to four years. Moreover, the recent explosion of asbestos claims call into question the adequacy of Equitas' asbestos reserves. Accelerated payment of pollution claims combined with inadequate asbestos reserves are a very bad mix for policyholders.
Some Preliminary Conclusions
In light of these facts, policyholders should ask themselves whether they should stand pat and keep their pre-1993 Lloyd's coverage--including any associated coverage-in-place agreements--in place or whether they should negotiate a policy buy-out. The answer to the question is complex and depends on more than simply an assessment of Equitas' solvency. A policyholder also needs to:
- Develop a complete picture of its own claim situation, including known and unknown claims. If an acceptable price for finality is to be achieved, a complete assessment needs to be performed. Accepted methodologies exist for dealing with mature, immature and unknown claims.
- Understand the likely tail on its claims portfolio--when the claims might mature and how long it may take to resolve the claims.
- Consider the policies that may be triggered and the availability of non-Equitas coverage to pay the claims, including an analysis of policy exhaustion and insolvency issues.
- Analyze the likely coverage issues facing it and develop appropriate assessments of its likelihood of prevailing on such issues.
- Explore the availability of other financial instruments for funding claims, including retroactive insurance and insurance captives. The availability of these alternatives will affect the attractiveness of any buy-out scenario.
Final Observation and Summary
Equitas has aggressively been cashing in its own insurance--the available reinsurance on the pre-1993 Lloyd's policies. It has followed a policy of aggregating its reinsurance claims and pursuing one-time payments for finality. The stated reason for this policy is that it reduces transaction costs, removes the risk of insolvency, and lets the time value of money work for Equitas and not for the reinsurer. Perhaps there is a message in this for policyholders. Faced with the fact that Equitas has limited--and perhaps rapidly diminishing--reserves, policyholders should seriously consider whether they should go. A careful analysis of the relative merits of policy buy-outs and coverage-in-place arrangements is both warranted and wise. If a policyholder chooses to do nothing and simply leave its current coverage in place, that decision should reflect a deliberate choice for the status quo--not simply a failure to act.
Mark C. Hargis is a partner in the Chicago office of Andersen, where he specializes in assisting policyholders in evaluating and negotiating insurance recoveries . Michael P. Foradas is a partner with Kirkland & Ellis in Chicago and represents policyholders as trial counsel in insurance coverage matters. The view expressed are those of the authors and not of their respective firms.
(1) David Johnson, "Renowned Insurers Lloyd's and Equitas Face New Financial and Legal Challenges," Insurance Coverage Litigation Reporter, Feb. 9, 2001, at 1.
(2) Ellen Robbins and Robert O'Keefe, "The Battle Over Equitas: Can Equitas Be Sued in the United States?" Insurance Coverage Litigation Reporter, March 23, 2001, at 1.
(3) Equitas stated that Equitas was established "to achieve long-term security for all stakeholders by demonstrating world-class capability for innovation and effective management of claims, recoveries, investment assets and operating processes" and "reducing uncertainty relating to insurance assets and liabilities by the creative use of actuarial and financial techiauers." Paul Jardine, communications director and chief actuary, Equitas Limited, "Equitas: Managing Long-Tail Risks," May 12, 2000, presentation.
(4) Lisa Buckingham, "Names Will Hold Out for Clean Break," Daily Mail, Jan. 27, 2002.
(5) Donald Watson, "The Cycle Turns for US Reinsurers," National Underwriter Property & Casualty-Risk & Benefits Management, July 16, 2001, at 1.
(6) "Note: Regulatory Crisis at Lloyd's of London: Reform From Within," 18 Fordham Int'l L.J. 1924, 1952-1953 (1995).
(7) Robbins and O'Keefe, supra n.2, at 1.
(8) Statistics about Equitas:--over 250,000 reinsurance policies written by 3,000 reinsurers--over 400 million pages of paper documents--simultaneous acquisition of more than 90 independent businesses--745 open syndicates reinsured--Jardine, supra n3. (9) Johnson, supra n.1, at 1.
(10) Jardine, supra n.3.
(12) Martin & Baach and Joseph Ruby, "The Battle Over Equitas: A Reply," 11 No. 28 Andrews Ins. Cov. Lit. Rep. 653 (2001).
(13) See Kalis, Reiter and Seyeblahl, "Policyholder's Guide to Insurance Coverage," 23.04 at 23-32, 33 (2000 supplement).
(14) Robbins and O'Keefe, supra n.2, at 2.
(15) Compare, e.g., Equitas Reinsurance Ltd. v. Browning-Ferris Indus. Inc., 2001 WL 422765 (Tex. App. Ct., Apr. 26, 2001) (holding that Equitas failed to demonstrate that trial court erred in finding it had personal jurisdiction) and GAF Corp. v. Hartford Acc. & Indem. Co., No. L-980-97)(N.J. Super. Ct., May 12, 2000) (denying motion to dismiss for lack of personal jurisdiction and failure to state a claim) with Long Island Lighting Co. v. Aetna Cas. & Sur. Co., No. 96 Civ. 9664 (MBM), 1997 U.S. Dist. LEXIS 13720 (S.D. N.Y. Sept. 11, 1997) ("Conventional wisdom is that policyholders have no direct rights of action as against the reinsurer Equitas, but must instead pursue the Names.") and Millenium Petrochem Inc. v. Jago, 50 F. Supp. 2d 654 (W.E. Ky. 1999) (holding that plaintiff did not demonstrate facts establishing jurisdiction since Equitas "did not assume the insurance contracts; rather, it assumed the responsibility for paying the liabilities arising under the insurance contracts" and therefore "cannot be deemed a successor-in-interest" to contract's jurisdiction consent clause). The Litigation scorecard in efforts to sue Equitas in the United States is summarized in Robbins & O'Keefe, supra n.2 and in Baach and Ruby, supra n.12. In fact, the authors of these two articles disagree about most things, including what the score is. Compare Robbins & O'Keefe, supra n.2 at 6 ("courts are sharply divided over whether Equitas is properly named in United States Coverage Litigation") with Baach and Ruby, supra n.12 ("among jurisdictions the split is 11 to four favoring Equitas").
(16) Press Release, Equitas, Financial Results for Year Ended 31 March 2001 (July 20, 2001) (on file with author).
(17) Equitas, Report & Accounts for the Year Ended 31 March, 2001; Asbestos Liabilities: A Special Report at 27; see also Original Declaratory Judgment Complaint, Certain Underwriters at Lloyd's v. Babcock & Wilcox Co., No. 01-1143 (Bankr. E.D. La.)(seeking a declaration absolving underwriters "of any further obligations under the" coverage-in-place agreement and a declaration regarding the extent of coverage under policies that had been subject to the coverage-in-place agreement).
(18) Id. at 19.
(19) Press Release, supra n.16 at 2-3.
(20) Equitas, Report & Accounts, Financial Results for Year Ended 31 March, 2001, supra n.17 at 4, 7. In the prior year, there were 23 new claims brought against Equitas. This number was derived by taking the 509 open direct pollution claims and subtracting the 128 closed claims. The remaining 381 claims were then subtracted from the number of open claims existing at the end of the year, or 404, which left 23 new claims. In the fiscal year that ended March 2001, there were 41 new claims brought against Equitas. This number was derived by taking the 404 open direct pollution claims and subtracting the 116 closed claims. The remaining 288 claims were then subtracted from the number of open claims existing at the end of the year, or 329, which left 41 new claims.
(21) Michael Angelina and Jennifer Briggs, "Sizing Up Asbestos Exposure," 16 No. 4 Mealey's Lit. Rept. Insurance 37 (Nov. 27, 2001).
(22) Commentary on Equitas Financial Results, supra n.17 at 2 n.2, (citing AM Best).
(23) Angelina and Briggs, supra n. 21.
(24) Daniel A. Shaw, "To The Rescue," Corporate Council, September 2001, at 44.
(25) Brian Brown and Lori Julga, "Reinsurers May Be Spared Asbestos Claims, National Underwriter Property & Casualty-Risk & Benefits Management," Sept. 3, 2001, at 1.
(26) These companies include Babcock & Wilcox, Pittsburgh Corning, Owens Corning, Burns & Roe, Armstrong World Industries, G-I Holdings, W.R. Grace, USG, U.S. Mineral, and Federal-Mogul. Pittsburgh Corning's observations are typical: "High defense costs and administrative costs, coupled with sharply increasing demands, combined to threaten PCC's long-term financial health and left it with no alternative means for resolving the claims brought against it." "Pittsburgh Corning Filed for Bankruptcy Protection," Mealey's Litig. Rep.: Asbestos 6 (April 21, 2000).
(27) In the words of an official at insurance rating service A.M. Best, "When a bankruptcy occurs, plaintiffs are more likely to come forward quickly, because they worry there may not be money left to cover later claims." Wall St. J. A4 (May 7, 2001); see also Daily Bankr. Rev. 4, 11 (June 6, 2001) ("due to the declining number of solvent asbestos-tainted companies that lawsuits can target, attorneys are `rushing to get claims in" because as more companies file for bankruptcy protection, the fewer there are to sue") (quoting Omar Maja of Fitch bond rating agency).
(28) Lisa Howard, "London Limits Asbestos Claims," National Underwriter Property & Casualty-Risk & Benefits Management, May 14, 2001, at 1.
(29) Id., at 1.
(30) D. Austern March 26, 2001 Mem. to Attorneys (available at www.mantrust.org/legal/morator.htm); Mealey's Litig. Rep.: Asbestos (Aug. 3, 2001) at 13, 14.
(31) Table, "Number of Claims by Year Received and Industry" (D. Austern July 2, 2001 Mealey's materials).
(32) See, e.g., UNR Asbestos Trust Letter, Mealey's Litig. Rep. 21 (Dec. 1, 2000), at D-1 (In the fall of 2000, claims against UNR Trust had increased 33 percent from the prior year, and had escalated so quickly that Trust was forced to lower its payout from 12.9 percent to 7.8 percent).
(33) Megan Shank and Michael Rarmizy, "The Price of Asbestos," Corporate Council, September 2001.
(34) Lisa Howard, "Equitas Slams Lawyer `Greed' on Asbestos," National Underwriter Property & Casualty-Risk & Benefits Management, June 18, 2001, at 1.
(35) Equitas, Report & Accounts for the Year Ended 31 March 2001 (2001).
This article is republished with permission from law.com and the March 2002 edition of Insurance Coverage Law Bulletin. c 2002 NLP IP Company