IN THE CIRCUIT COURT OF COLE COUNTY, MISSOURI IN RE TRANSIT CASUALTY COMPANY IN RECEIVERSHIP CAUSE NO. CV185-1206CC
REPORT AND RECOMMENDATIONS AS TO ORDER OF SECURITY
This report is submitted pursuant to Transit's Motion to Enforce Pre-Answer Security Requirement filed December 1, 1997, the Special Master's Order of Security dated April 17, 1998 and the referral of that Order back to the Special Master by Judge Patricia Joyce on June 2, 1998.
The Special Master, after hearing argument of counsel and having considered suggestions and briefs submitted by the parties makes this report and recommendations to the Court.
Pending before the Special Master is Transit's Motion to Enforce Pre-Answer Security Requirement filed December 1, 1997. Transit seeks security for its case reserves under Article IX of the Reinsurance Agreements and pre-answer security "in an amount...sufficient to secure the payment of any final judgment which may be rendered..." as provided in § 375.789, RSMo 1994. Similarly, § 375.281 requires pre-answer security for "any insurance company...or other insurer not incorporated or authorized under the laws of [Missouri]..." Transit seeks $15,835,300.00 in contractual reserve security and pre-answer security.
The contract provision applies to a "Reinsurer [that] is not authorized by the states as having jurisdiction over the Reinsured's loss reserves..." The statutes apply to "any unauthorized insurance company..." or "...insurer...not authorized." Thus, the issue presented to the Special Master is whether Defendants are "authorized" reinsurers or insurance companies. Transit argues that Lloyd's 109 are not "authorized" reinsurers or insurance companies because they (1) do not have a "certificate of authority" or a license to transact business in Missouri; and (2) they are not transacting "lawful reinsurance" in Missouri and therefore do not qualify for any exceptions to the pre-answer security statutes. To qualify for the exceptions, Lloyd's 109 must comply with the requirements of § 375.246.1(4). Transit also contends that the determination of the status of Defendants as "authorized" reinsurers or insurance companies should be made by the Receivership Court that has supervised Transit's liquidation since 1985. That determination should not be made by the Missouri Department of Insurance ("Department"), which has conducted only a cursory investigation of (1) Lloyd's 109 status for the purposes of credit for reinsurance or (2) the financial condition of the Lloyd's marketplace and the new reinsurance entity called Equitas.
Defendants argue that the term "authorized reinsurer," as used by those persons who drafted the Reinsurance Agreements, means that a domestic ceding insurance company, such as Transit, may take credit on its financial statements for liabilities ceded to the reinsurer. Defendants argue that the Department, by regulation, accepts all Lloyd's syndicates for reinsurance credit purposes and, therefore, recognizes Defendants as "authorized." Lloyd's 109 also contend that the department, not the Receivership Court, determines who is "authorized."
Defendants Lloyd's 109 further argues that should Pre-Answer security be ordered that the same need not be in "cash", but may also be posted in the form of a Letter of Credit.
The Special Master makes the following Findings of Fact and Conclusions of Law.
FINDINGS OF FACT
1. The Special Master finds that there is insufficient documentation on file with the Department or otherwise produced by Lloyd's 109 in this action to support a conclusion that Defendants are in compliance with § 375.246.1(4), as alleged by Defendants' counsel. (See Defendants' Exhibit 13, February 28, 1997 letter of John Mulhern.) Therefore, neither the Department nor the Receivership Court (which has specific supervisory authority over Transit), could properly permit Transit to take credit for reinsurance ceded to Lloyd's 109. The facts supporting this finding include, but are not limited to, the following:
a. No credible evidence exists to support a finding that the Lloyd's "trust" required under § 375.246.1(4)(a) has, as the statute requires, a "trusteed account representing the group's [Lloyd's] liabilities attributable to business written in the United States" or "a trusteed surplus of which one hundred million dollars shall be held jointly for the benefit of United States ceding insurers. . ." To the contrary, the evidence is clear that the current "trusteed surplus" is not held only for "business written in the United States" but includes any "liabilit[ies]. . .express[ed] in U.S. dollars." (Plaintiff's Exhibit 18A, ¶1.3)
b. No credible evidence exists showing that the trusteed surplus is held "jointly for the benefit of United States ceding insurers." In fact, Defendants' attorneys admit that the Lloyd's underwriting members (or "Names") "write insurance on their own accounts on a strictly several, not joint, basis." (Defendants' Exhibit 13, Mulhern letter; see also Plaintiff's Exhibit 18A, ¶5.1.)
c. No credible evidence exists showing that Lloyd's has filed with the Department (or the New York Department of Insurance) "an annual certification of the solvency of each underwriter by the group's domiciliary regulator and its independent public accountants. . ," as required by the last sentence of § 375.246.1(40(a). (Tr. at 506, 577.) The evidence supplied by Lloyd's in this regard only identified "Names" who are Defendants in this action. (Tr. at 581, 584-585.) Moreover, there is no certification of the solvency of each underwriter by either the New York Department of Insurance or any independent accountant. Instead, the certification offered is made by Lloyd's Chairman as to current Names only. (Tr. at 511, 557, 560.) The Special Master takes judicial notice of the list of Names who are members of Lloyd's Syndicate 553 supplied by Lloyd's in discovery and made a part of this record.
d. No credible evidence exists showing that the trusts were "established in a form approved by the director of insurance" for Missouri, as required by § 375.246.1(4)(c). In fact, the Department's witness conceded that the trusts had not been approved. (Tr. at 560.) The trusts also do not provide that "contested claims shall be binding and enforceable upon the final order of any court of competent jurisdiction in the United States," as required by this same subsection. The key trust document filed by Lloyd's – the Lloyd's American Trust Deed ("LATD") – governs all payouts of funds in question in this action, gives significant control over the assets of the trusts to the "Agents" and "Council" of Lloyd's, and gives very limited responsibility over the trusts to the "American Trustee," Citibank. (Plaintiff's Exhibit 18A, ¶ ¶ 3.2, 4.1, 4.2(c), 12.1; ¶4.3)
e. No credible evidence exists showing that the "trust shall vest legal title to its assets in the trustees of the trust for its United States policyholders and ceding insurers" or that the trust "remain[s] in effect for as long as the assuming insurer shall have outstanding obligations due under the reinsurance agreements subject to trust," as required by § 375.246.1(4)(c). The only credible evidence presented on these issues showed that the new "Equitas Trust Fund" referred to in the LATD and the Equitas Reinsurance Agreements could, if "proportionate cover" were invoked, cause the trust to become "inadequate" by its own terms and all assets would go to the New York Superintendent of Insurance. (Tr. at 536; Plaintiff's Exhibit 25 at ¶ 12.)
f. The witness for the Department testified that Lloyd's had not complied with some of the statutory requirements of § 375.246 and that she did not know if the Department had evidence of compliance with the other terms. (Tr. at 548; 557-562.) The Special Master finds compelling the testimony that the Department has requested information from Lloyd's concerning whether the specific syndicates sued in Case Nos. CV595-2CC and CV596-4CC had complied with the requirements of § 375.246. (Tr. at 506.) The Department's witness testified that Lloyd's had not supplied the requested information. (Id.)
Accordingly, the Defendants have not complied with the requirements of § 375.246.1(4) and Transit, as a domestic ceding insurer, may not take credit for reinsurance placed with the Defendants.
2. Defendants argue that since the Department and others recognize them as "authorized," Article IX of the contracts and the pre-answer security statutes found at §§ 375.789 and 375.281 are not triggered. Defendants argue that Missouri regulation 20 CSR 200-2.200 specifically approves "Lloyd's, London" for the purpose of financial statement credit and, therefore, the syndicate underwriting members that Transit has sued are "authorized." The Special Master finds that the regulation purportedly allows Missouri ceding insurers to take credit for reinsurance placed with "Lloyd's, London" as a general "marketplace" of underwriters, provided the "underwriters [are] admitted to do business in some state of the United States." (Tr. at 468-469.) The Special Master finds that Defendants may not rely on the Department's regulation 20 CSR 200-2.200 as support for its contention that the underwriting members of Lloyd's 109 are "authorized." First, there is no evidence that this regulation was promulgated in accordance with Missouri statutes, including § 375.013. Second, the Department's witness could only testify that the Department's regulation existed, nothing more. However, the witness admitted that the financial statement upon which credits are taken must also be "in conformity with...our statutes and regulations." (Tr. at 482, emphasis added; Tr. at 592.) Third, even assuming that the regulation is valid, the members of Lloyd's 109 have provided insufficient evidence that it has complied with the regulation. They have offered the Affidavit of the Kentucky Director of Insurance in support of its contention that the underwriters sued in this action are admitted to do business in another state. (Defendants' Exhibit D3.) The Affidavit, however, is unclear in defining the term "Underwriters at Lloyd's" as used in that Affidavit. The Special Master cannot determine whether it refers to the underwriters who are members of the specific syndicates sued in this action. The Department's regulation is likewise unclear. In any case, the regulation is contrary to § 375.246.1(4), which is specifically applicable to Lloyd's 109. As set out in the Conclusions of Law, a regulation cannot supercede a statute's specific requirements. Thus, regulation 20 CSR 2002.200 does not displace, limit or control the requirements set forth in § 375.246.
3. The Special Master finds that Defendants are not "authorized" as that term is used in Missouri's statutes. The evidence disclosed that none of the Lloyd's 109 "Names" were on the list of "authorized insurers" in Missouri. (Plaintiff's Exhibits 6 and 7.) Missouri statutes refer to "authorized" insurers as insurance companies that are "licensed" in Missouri, i.e. have a "certificate of authority." See, e.g. § 375.786.3. No Lloyd's syndicate is licensed in Missouri. (Tr. at 497.) The only evidence submitted by Defendants to support the contention that they are "authorized" was an instruction sheet from the Annual Instructions for Property and Casualty Insurance published by the National Association of Insurance Commissioners ("NAIC"). This instruction provides that reinsurance agreements with "Lloyd's" incepting before July 30, 1995 should be reported on an aggregated basis under "authorized other non-U.S. insurers." (Defendants' Exhibit 6.) However, whether Lloyd's 109 is "authorized" in Missouri is an issue controlled by statute, not by an NAIC publication.
4. The Special Master finds that all credible evidence, including the testimony of the Department's witness and Lloyd's counsel's correspondence to the Department, discloses that each Lloyd's "Name" is a separate insurer who is severally, not jointly, liable for his or her own liabilities. (Defendants' Exhibit 13: Tr. at 495.) Thus, no rationale exists for treating Lloyd's as a "marketplace," rather than as individual insurers, for purposes of determining credits for reinsurance. All other reinsurers are evaluated on an individual basis.
5. The Special Master finds that the Department has not regulated Transit's credit for reinsurance since 1985 when the Receivership Court placed it in liquidation. (Tr. at 490-491, 505.) Therefore, it is irrelevant that the Department, with or without regard for the requirements of § 375.246.1(4), permits domestic insurers to take credit for reinsurance placed with Lloyd's. The Department cannot confer authorized status on any Lloyd's syndicate if it has not complied with Missouri statutes, including §§ 375.246.1(4) and 375.786.3. If Defendants' argument were accepted, the underwriting members of Lloyd's 109 could conceivably have no assets in a trusteed account, could fail to comply with all of the requirements of § 375.246 and other Missouri statutes, yet they would still be "authorized."
6. The Special Master finds unwarranted by the facts or the law the Department's reliance on the actions of the New York Superintendent of Insurance in determining Missouri's policy on "credit for reinsurance" ceded to Lloyd's syndicates. The terms of § 375.246.1(4) control. Moreover, the Department has no factual or legal basis for accepting a "different requirement" for the Lloyd's "marketplace" than is required by § 375.246 and other Missouri statutes solely because no other state has taken action to deny Lloyd's 109 or any other syndicate credit for reinsurance. (Tr. at 466, 577.) This is especially true, since the Department has taken no action to determine if Lloyd's 109 has complied with Missouri statutes. (Tr. at 505-506.)
7. The Special Master finds that the Department has conducted only a very limited investigation of Lloyd's financial status, including the transaction involving Lloyd's and Equitas. (Tr. at 510-514.) The Department's witness made it clear that the Department has "limited resources" and that it had not independently investigated Lloyd's, despite the fact that "we are concerned about Lloyd's of London and their financial status." (Tr. at 512.) The Department has not "verified or substantiated" the amount of security in trust in New York or required compliance with § 375.246. (Tr. at 466, 510-512 and 537.) The Department has only determined that, in the aggregate for all Missouri ceding companies, reinsurance placed with Lloyd's (as a marketplace)_only represents 1.7 percent of the surplus of those companies and, therefore, no company is threatened by the financial collapse of Lloyd's. (Tr. at 512.) The Special Master finds that Transit, as an insolvent company, has no surplus, so the security issue implicates other public policies. The Special Master further finds that Defendants' liabilities to Transit in Case Nos. CV595-2CC AND CV596-4CC involve over $40 million in ultimate liabilities, $26 million of which is paid losses and loss reserves (not including IBNR). (Plaintiff's Exhibit 22A to 22D.) Moreover, those liabilities are owed "severally" by specific Names; they are not the liabilities of the Lloyd's marketplace as a whole. (Defendant's Exhibit 13; Tr. at 495.)
8. The Special Master further finds erroneous Defendants' contentions that Lloyd's "trusteed surplus" is $100 million in excess of its U.S. liabilities as required by § 375.246. The only reason that the trusteed surplus currently exceeds that figure is because most of the Lloyd's Names entered into a new, second reinsurance arrangement to cover most of the syndicates' pre-1992 reinsurance liabilities to Transit and other insurers. (Tr. at 514, 529-532.) This new reinsurer is known as "Equitas." This second reinsurance or "retrocession" to Equitas of Lloyd's reinsurance liabilities to Transit turned a deficiency of over $6 billion into a surplus of $860 million. This change occurred during a three-month period from June 1996 to September 1996, despite the influx of only $2 billion in new dollars into the Equitas fund. (Plaintiff's Exhibit 16; Defendants' Exhibit 13.) The uncontroverted evidence shows that neither Transit nor the Department has control over "Equitas" because no Missouri ceding insurer has privity of contract with Equitas in its capacity as a reinsurer of Lloyd's. (Tr. at 522.) Equitas is not an "approved reinsurer" in Missouri even under Defendants' offered definition. (Tr. at 514.) Further, the Department's witness reviewed the two trusteed surplus statements for the three month period described. She concluded that the swing of over $7 billion in the surplus was due to a shift of $5.5 billion out of the trusteed surplus. (Tr. at 529-532.) That money was paid as a reinsurance premium to Equitas in exchange for its assumption of over $12 billion in Lloyd's liabilities. (Tr. at 555.) This transaction created the $7 billion "swing" is surplus – from a $6 billion deficient to an approximately $1 billion surplus. (Id.) The Special Master finds that the swing in surplus is not recognized as valid under either Missouri or New York law. New York's Regulation 108 and Missouri's equivalent do not recognize such "portfolio transfers" or "retroactive reinsurance" until the actual liabilities assumed by the new reinsurer exceed the premium paid for that reinsurance. In other words, if the reinsurer assumes $12 billion in liabilities for $5.5 billion in premium paid to it, the surplus may not change more than $5.5 billion until the new reinsurer (e.g. Equitas) begins paying reinsurance claims in excess of $5.5 billion. In short, under New York and Missouri law the Special Master finds that the deficiency in Lloyd's trusteed surplus is still approximately $6 billion until the time that Equitas begins to pay claims in excess of that amount. (Tr. at 556.)
9. The Special Master further finds that the report of the independent auditors of Equitas – Coopers & Lybrand – as well as the 1997 analysis of Standard & Poors, make clear that the Equitas reinsurance is not the type of security required by the Missouri statute governing "trusteed surplus." The credible evidence shows that the new, post-1995 Lloyd's – which is currently regulated as individual syndicates with separate funding – receives high ratings by these independent sources. (Plaintiff's Exhibits 20 at 5; Tr. at 579-581.) However, the financial audit of the old, pre-1995 Lloyd's (reinsured by Equitas) – which covers most of the liabilities at issue here – was highly qualified by Coopers & Lybrand in its most recent report. That report includes specific allegations that the auditors did not receive the "quality and completeness" of data. (Plaintiff's Exhibit 25 at 23, ¶¶ 9-11.) Accordingly, it concluded that all of the surplus of Equitas could be diminished. (Plaintiff's Exhibit 25 at 23, ¶12; Tr. at 534-535, 580-582.) Standard & Poor's analysis further states that "there is a strong possibility that the Equitas surplus will be eroded and that it could become insolvent at some point in the future." (Plaintiff's Exhibit 20 at 42; Tr. at 541.)
10. The Special Master finds that in reference to Lloyd's Syndicate 109 et al Transit has loss reserves in the amount of $13,744,486.00 and Transit has paid losses in the amount of $2,090,826.00. (Plaintiff's exhibits 22-E) (Tr. at 135.)
CONCLUSIONS OF LAW
1. Recent case law requiring pre-answer security from Lloyd's rebuts the argument made here that the syndicates sued by Transit are not required to post security. See generally Ostrager & Vyskocil, Modern Reinsurance Law and Practice, § 13.02[b] (1996). See also Curiale v. Andra Ins. Co., Ltd., 88 N.Y. 2d 268 (1996): Aetna v. Lloyd's of London, No. 118676/95, slip op. (Sup.Ct.N.Y., May 15, 1996); Argonaut Ins. Co. v. Certain Underwrie the Department permits Missouri ceding companies to take credit on their financial statements for losses ceded to Defendants. Thus, Defendants present essentially the same argument here as they did in resisting the security required by Article IX of the contracts. For the same reasons, the Special Master again rejects the argument as unsupported by the facts or the law.
9. Defendants also argue that they are exempt from the pre-answer security statutes by reason of §§ 375.786 and 375.301. These statutes provide exceptions for the "lawful transaction of reinsurance" and "reinsurance in accordance with laws of Missouri," respectively. The exceptions, however, do not apply to the reinsurance placed with Lloyd's 109. The so-called exceptions only apply to reinsurance that complies with the primary laws governing reinsurance set out at § 375.246. However, Transit's reinsurance with Lloyd's 109 does not comply with that statute and, therefore, it is not "lawful" or "in accordance with the laws of Missouri." Moreover, the exceptions exist only because the Missouri legislature intended that companies transacting "Lawful reinsurance" would have already posted security in the form of Letters of Credit, cash or a trust in compliance with § 375.246. If that security does not exist or if it is insufficient, the pre-answer security statutes apply. Finally, the defendants argue that § 375.789 does not apply to them because it is triggered only by actions served on the Secretary of State pursuant to § 375.788. The Special Master rejects this argument as inconsistent with the rule of statutory construction known as the "last antecedent rule." The service provision only applies to the Director's administrative proceedings. It does not limit the application of § 375.789 in this case.
10. The pre-answer security statutes, when read in pari materia with the primary statute governing "reinsurance" -- § 375.246 – indicate a legislative goal of protecting the policyholders of Missouri insurance companies against alien reinsurers who may become financially impaired or insolvent and leave Missouri policyholders without security to cover the payment of future losses. (Tr. at 517-518, 520-522.) When a company is not licensed in Missouri, it is not subject to Missouri regulation or seizure of assets. These unauthorized insurers or reinsurers must, if they want to avoid posting security, either acquire a "certificate of authority" (i.e. a license to do business in the state) or qualify under some other exception to this requirement. The underwriting members of Lloyd's 109 have done neither. Likewise, a Missouri ceding insurer, in order to transact lawful reinsurance, must use a reinsurer who is licensed in Missouri or one who has posted collateral or security for the losses ceded to it in the form of Letters of Credit or cash. See § 375.246; see also the testimony of the Department's witness at Tr. at 517-522. Defendants' interpretation of two statutes in isolation would perpetuate an illogical and unfair result contrary to the intent expressed in the statutory scheme.
11. Under §§ 375.789 and 375.281 and Article IX of the parties' reinsurance agreement Lloyd's Syndicate 109 et al, is required to post a clean, unconditional, irrevocable, Letter of Credit, Cash Advance or a Combination there of to secure Transit's loss reserves of $13,744,486.00 and paid losses of $2,090,826.00 for a total of $15,835,312.00 all of which may be part of any Final Judgment.
12. Transit adduced significant, credible evidence supporting the reasonableness of its paid losses, loss reserves, and the 9% pre-judgment interest it seeks. (Tr. at 125-143, 273-372.) It also presented prima facie evidence of the actions taken by Lloyd's 109 that would constitute "vexatious delay" and would support the total of $15.8 million of damages requested by Transit as part of "any final judgment" under §§ 375.789 and 375.281. (Tr. at 125-143.) In short, ample evidence exists to support this Order, assuming such evidence is even necessary under the pre-answer security statutes.
The Special Master respectfully recommends the Court adopt the following Order.
Based on the credible evidence submitted, the "Names" or underwriting members comprising the Defendants Lloyd's Syndicates 109, et al. can not be deemed "authorized" under Article IX of the parties' Reinsurance Agreements or the relevant Missouri statutes. Nor are they exempt from the pre-answer security statutes. Thus, they must post security.
Pursuant to the Liquidation Order, the Missouri insurance insolvency code (§§ 375.650, et seq.) and §§ 375.789 and 375.281, the underwriting members of Lloyd's 109 must, within 10 days of this Order, post "a clean, unconditional, irrevocable Letter of Credit, Cash Advance, or a combination thereof" in the sum of $13,744,486.00 as and for Transit's loss reserves. In addition to the security for the loss reserves, the underwriting members of Lloyd's 109 must post similar security in the sum of $2,090,826.00 as and for Transit's paid losses all of which may be part of "any final judgment", pursuant to §§ 375.789 and 375.281. The total security due of $15,835,312 is based on Transit's September 30, 1997 loss figures.
Transit may draw down on the security posted only upon further order of the Special Master or Circuit Court. If the underwriting members of Lloyd's 109 et al agree to post a Letter of Credit and the parties cannot agree on the wording of the Letter of Credit, the Special Master shall resolve any conflicts and approve the final wording.
Dated: __July 23, 1998____
James P. Dalton, Special Master
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