A) Loss Portfolio Transfers -- Insurers sometimes increase their surplus to policyholders – or in the case of Lloyd's Trusteed Surplus Statement – through loss portfolio transfers. Such transactions increase surplus if their cost (premium) is less than the incurred loss and loss adjustment expense reserves that are transferred.

The New York Insurance Department promulgated Regulation 108 to deal with loss portfolio transfers. The Regulation established certain requirements for disclosure, accounting treatment and maintenance of reserves. The regulation was intended to reduce the risk that such transactions could harm policyholders. For example, if higher than reasonable interest rate assumptions are used or longer payout assumptions are assumed, artificial increases to surplus may result. Also, if the cedent's financial condition may be adversely affected.

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B) Applicability – As the reinsurance cession commonly called the (the RITC) by Lloyd's to Equitas involved claims that were already incurred. Because the consideration paid by Lloyd's was discounted based upon anticipated investment income, such reinsurance constitutes a loss portfolio transfer under New York regulation.

Transit asserts that assuming, arguendo, New York law has been applied to approve the Equitas transactions, the Lloyd's/Equitas transaction was a loss portfolio transaction that does not comply with the provisions of Regulation 108. There are two respects in which the transaction violates the regulation:

1) Under Regulation 108, the loss portfolio transfer agreement cannot contain terms permitting the transferee (Equitas) to exercise influence over the claims settlement practices and procedure of the transferor (Lloyd's). According to the RITC agreement, the transferor (each syndicate) is to give Equitas exclusive and irrevocable authority to settle claims.

2) Regulation 108 requires that recoveries due the transferor be available without delay for payment of losses and claim obligations incurred under the agreement in a manner not inconsistent with orderly payment of incurred policy obligations by the transferor. However, the RITC contains a provision for the implementation of a proportional cover plan. Should it become necessary to invoke proportional cover, the transferor would certainly recover less than the full amount due.

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The RITC does not comply with the requirements of Regulation 108, the consideration paid by Lloyd's must be recorded as a deposit and reported as a nonadmitted asset in exhibit 1 of the annual and interim statements, with no deduction made from loss and loss adjustment expense reserves. Such treatment should bar Lloyd's from taking balance sheet credit for the Equitas reinsurance, and therefore negate the reported surplus increase.

Even assuming that the reinsurance contract complies in all respects with §112.5 of Regulation 108, the Regulation's requirements for reporting on annual statements and other filings should bar Lloyd's from reporting an increase in earned surplus. Specifically, the regulation requires the ceding insurer to report the loss portfolio transfer as an offset liability, and to record, without recognition of the loss portfolio transfer, its loss and expense reserves on a gross basis. Furthermore, the ceding company (Lloyd's) must, by write-in item segregate surplus resulting from any loss portfolio transfer as a special surplus fund, designated as a "loss portfolio transfer account." The surplus gain from any loss portfolio transfer may not be considered earned surplus until such time the actual liabilities transferred have been recovered or terminated.

In sum, the RITC does not comply with the Regulation 108. Thus, the consideration is a nonadmitted asset and no deduction may be made from the loss and loss adjustment expense reserves. Second, even if the RITC conformed to the requirements of Regulation 108, the surplus gain should not be considered earned surplus until such time as the actual liabilities transferred have been recovered or terminated.

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Respectfully submitted,

McCARTHY, LEONARD, KAEMMERER,

OWEN, LAMKIN & McGOVERN, L.C.

BY: (signed James C. Owen)

James C. Owen, #29604

Katherine S. Walsh, #37255

Chesterfield, MO 63017

(314) 532-7100

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