DECLARATION OF ROBERT L. WESTIN
I, Robert L. Westin, declare:
1. I am President and co-owner of Victus, Inc., a management consulting company specializing in entities engaged in insurance and insurance related activities. I have a Bachelor of Science degree in Business Administration (BSBA) with an insurance major awarded by the University of Denver. I am a Chartered Property and Casualty Underwriter (CPCU). If called as a witness, I could and would testify to the following facts based upon my personal knowledge, unless stated to be on information and belief.
2. I have been actively involved in the insurance industry for over forty years and have substantial experience as an employee of insurance carriers and brokerage firms as well as a consultant working with carriers and brokers. I have previously served as President of the attorney-in-fact for an inter-insurance exchange then known as Physicians and Surgeons Insurance Exchange of California, Senior Vice President of Administration for a publicly owned national insurance brokerage then known as Penn General Agencies, Inc., and General Manager of the Los Angeles Branch of the Home Insurance Company of New York.
3. I have published over 70 professional articles in various trade journals and am the author of "Management By Objectives for Insurance Agents and Brokers" published by Insurance Marketing Services of Santa Monica, California. I am past President of the Independent Agents and Brokers Association of Los Angeles, a past director of the Los Angeles Chapter of CPCU, a past Chairman of the insurance committee for the Amateur Athletic Union (AAU), and served as a member of the Rebuild LA insurance committee.
4. I am familiar with, and have both an academic and working knowledge of Lloyd's of London, its structure, function and inter-workings. Between 1969 and 1978 I was licensed as a California Surplus Lines Broker and served as the named transactor for Penn General Agencies of California. I was "tribunalized" by Lloyd's for personal lines property coverages (personal property floaters, fine arts, jewelry, furs, etc.) and race horse mortality. As a senior executive of Penn General Agencies, Inc.(PGA), I was involved in the oversight of the management of a small Lloyd's approved London brokerage, in which PGA held a minority interest. I personally visited the London office on at least four occasions to discuss the management of the brokerage, arrange my underwriting authority and transact business on the floor of Lloyd's.
5. As President of Physicians & Surgeons Insurance Exchange during the period 1978 through 1981, I personally negotiated the Exchange's medical malpractice reinsurance with underwriters at Lloyd's. I met in London with the underwriters on at least eight different occasions.
6. I have served as a consultant to four surplus lines brokers. I assisted a Maryland broker by evaluating the merits of an acquisition of his brokerage proposed by a London broker approved by Lloyd's. I analyzed the London broker's operation and financial statements. I assisted two California brokers by valuing their businesses for merger purposes. One had an exceptionally favorable reputation as a "personal lines" wholesaler in Southern California. This broker had Lloyd's line slip authority and participated in the underwriters' profits. Procedurally, the brokerage conducted its Lloyd's business in virtually the same manner as Lloyd's Managing Agents. I analyzed the historical profit calculations and forecast future expectations for the purpose of estimating the agency's value.
7. I have served as an expert consultant and/or witness in several cases of litigation involving Lloyd's policies, the placing brokers' responsibilities, interpretation of policy coverages, terms and conditions, and payment of claims.
SCOPE OF WORK
8. I have been retained to review certain documents for the purpose of formulating and expressing an expert opinion as to whether a freeze of Lloyd's Central Fund United States (CFUS) held by Citibank, N.A. in New York and a stay on the draw-down of the deposits and letters of credit (LOC) held by Lloyd's (funds on deposit) for approximately 2,000 American investors, or Names, would disrupt or halt the payment of insurance claims to thousands of policyholders and third party claimants residing in the States of Utah, Colorado, Tennessee and California and throughout the United States and also render insolvent numerous insurance companies doing business in the forenamed states and others throughout the United States.
The concern for the welfare of policyholders, third party claimants and insurance company insolvency was prompted by assertions made by California Insurance Commissioner Quackenbush in his Motion to Intervene in the matter of the People of the State of California v. Lloyd's et al United States District Court, Central District of California, Case No. 96-1357 TJH (Ctx) (the California action) that the relief sought by 300 California Names would "enormously disrupt and soon entirely halt the payment of insurance claims to tens of thousands of policyholders and third party claimants in California" and "also...render insolvent numerous insurance companies doing business in California."
9. I reviewed the following described pertinent documents along with others of interest. California Insurance Commissioner Quackenbush's Notice of Motion and Motion to Intervene; Citibank, N.A.'s Memorandum of Points and Authorities in Opposition to Plaintiff's Motion to Remand to the Los Angeles County Superior Court; Declaration of Peter F. Von Kaufmann in Support of Citibank N.A.'s Memorandum of Points and Authorities in Opposition to Plaintiff's Motion to Remand; Lloyd's of London White Paper dated March 23, 1996; Lloyd's of London Annual report and accounts 1994; LeBoeuf, Lamb, Greene & MacRae's letter dated July 28, 1995 to Paul Altruda, New York Insurance Department and attachments which include the Stipulation Agreement between the Superintendent of Insurance of the State of New York and J. David Rowland, Chairman of Lloyd's dated May 24, 1995 and a copy of the Report of Examination of Lloyd's London as of December 31, 1993; a copy of a March 20, 1996, memorandum from Barry Carmody, President of the Association of California Insurance Companies (ACIC) to the ACIC Board of Directors; a copy of a memorandum dated March 19, 1996 from William Palmer, General Counsel for ACIC to ACIC's Board of Directors; transcript of State Senator Johnston's hearing held on January 11, 1996; Lloyd's Names' Committee Interim Report November, 1995 (aka the Ridley Report); Epstein Grower & Michael Freeman November 14, 1995 Memorandum; Lloyd's Business plan progress report, April 1995; the Chatset Guide to Syndicate Run-Offs 1995, November 1995; Fireman's Fund Insurance Company, Annual Statement 1995; Lloyd's Names Association's Working Party Submission to the United Kingdom Treasury Select Committee on Self Regulation At Lloyd's dated January 1995; April 1996 edition of Lloyd's Names Associations Working Party Newsletter 22; Lloyd's Names Association's Working Party Discussion Paper Lloyd's: The Alternative to Reconstruction and Renewal; Lloyd's Reconstruction and Renewal Guide to your Indicative Finality Statement; Mini-Brief re Rescission prepared by counsel for Names; David Rowland's May 10, 1996 letter to Members; Lloyd's Reconstruction and Renewal Toward the Settlement, May 1996.
SUMMARY OF OPINION
10. According to the American Names Association (ANA), approximately 20 Names who reside in Utah, 30 Names who reside in Colorado, 30 Names who reside in Tennessee, and 300 Names who reside in California plus 1,620 Names who reside in other states (a total of 2,000) have resigned their membership in Lloyd's and still have funds on deposit with Lloyd's. Based upon my analysis of the information gathered from the documents reviewed and my analysis of the facts set forth in succeeding paragraphs, it is my opinion that: 1) a lien on CFUS and on 2,000 resigned American members' funds on deposit, including letters of credit, with Lloyd's (hereafter "restrictions") will have absolutely no effect upon the payment of claims to, or on behalf of, anyone insured or reinsured by a Lloyd's policy anywhere in the world; 2) the restrictions will not cause the insolvency of any insurance company admitted to do business in any state; and 3) the rescission of the resigned American members' Lloyd's memberships will have a minimal effect, if any, upon the financial efficacy of the Lloyd's market and will not materially effect Lloyd's plans to reorganize or trigger its collapse as a market place.
11. The restrictions sought by Utah, Colorado, Tennessee, California and 32 other state Securities Regulators arise out of complaints made by Lloyd's members, most of whom became Lloyd's members (Lloyd's refer's to its members as "Names") in years subsequent to 1980, that they were fraudulently induced by Lloyd's Member Agents and Lloyd's Managing Agents to become Lloyd's members. Some members were engaged in the insurance brokerage business at the time they became members. Most, however, were engaged in other enterprises and were unfamiliar with the insurance mechanism. Names shared two common motives for joining Lloyd's. The first was the potential for financial gain. The second was the prestige of being able to say "I, am a member of Lloyd's."
The complainants in the California action, and other states, allege they were lured by representations made by Lloyd's Member and Managing Agents that throughout the history of Lloyd's (founded 1688), profits had been the norm and losses the rare exception for Lloyd's Names. They were attracted by assurances of above average rates of return on their investments because they could use letters of credit, instead of cash, to secure their financial commitments. They were led to believe that the probability of a call on their LOC and other funds on deposit was remote.
Settlements and court decisions of litigation initiated in the United Kingdom and discovery of documents and letters confirm that Lloyd's Member Agents and Managing Agents (many of whom served on The Council of Lloyd's) intentionally failed to disclose the fact that, by becoming Members, the Names would be exposed to a share of the liability for the payment of mounting latent liability claims (90% related to pollution and asbestos claims emanating from the U.S.) which had been incurred in years prior to 1980 and dating back as far as 1960. During, or about, 1985, American insurance companies estimated that latent liability claims would total $623 billion. The amount of claims currently stands at approximately $92 billion.
12. During the past several years, Lloyd's business practices have been severely scrutinized by approximately 65 offensive Action Groups organized by Names. As the result litigation was initiated by approximately 40% of all Names against an assortment of defendants including Managing and Members' Agents. Through November, 1995, some of the litigants have either been awarded damages by triers of fact or received out-of-court settlements exceeding $1.03 billion. As a result of the complaints, Lloyd's implemented a plan to restructure its functional organization and improve the quality of services provided.
13. The litigation initiated in the various states is the result of recently disclosed large losses and Lloyd's imminently pending implementation of a proposed Reconstruction and Renewal Plan (R&R Plan) designed to purge its existing financial problems. The litigation was hastened by Lloyd's threatened draw-down of Names' LOC, and more recent threats by U.S. insurance regulators to seize all Names' assets. Although Lloyd's has reported substantial profits for the years ended 1993, 1994 and 1995, the R&R Plan is designed to resolve long standing problems brought about by fraud, wrongful closure of syndicate years, under reserving, and administrative ineptitude, and to prevent the collapse of Lloyd's as a market place. The R&R Plan is designed to give Lloyd's a fresh start by funding the outstanding liabilities of all Names dating back to 1992 and prior years and releasing all parties responsible for the wrongful conduct described above. It will allow Lloyd's to draw down on Names' letters of credit and other funds on deposit, to use Central Funds, to apply credits for recoveries on errors and omissions and stop loss insurance, and to obtain "new money" from Names to capitalize the formation of a new entity named Equitas. According to the R&R Plan, Equitas will function as the vehicle to provide "finality" for an estimated total of $6 billion of claims incurred in 1992 and prior years (most of which is for losses incurred but not reported [IBNR]) plus an estimated total of $2.85 billion in administrative costs. Equitas proposes to mutualize the Names' assets and convert them into interest bearing assets on its balance sheet.
14. The California action previously sought to impose a $500 million lien on CFUS and to prevent Lloyd's from drawing down on California Names' LOC and other funds on deposit with Lloyd's until the merits of their allegations have been determined and their litigation resolved. The restrictions sought by California and other states' Securities Regulators, will not affect Lloyd's ability to use premium trust funds held in the U.S., Canada or the U.K. to pay claims. Nor will the restrictions prohibit Lloyd's from using the Central Funds held in the U.K. to assure the solvency of any Name or to capitalize Equitas. Therefore, it follows that due to the profitability of the last three years and the immediate availability of other funds held in trust to pay claims, no policyholder, reinsured, or third party beneficiary will be damaged by the proposed interim restrictions.
15. In addition to preventing a draw-down on members' existing funds on deposit, the resigned Names seek the rescission of their Lloyd's memberships. It is my opinion that if the rescission effort of the 2,000 resigned American Names is successful, their withdrawal will not have a material impact upon Lloyd's overall premium capacity or implementation of its proposed R&R Plan.
The following table shows the distribution of American Names by state and by status. The column captioned "ACTIVE" includes those who have not withdrawn from membership in Lloyd's. The column captioned "NONACT" includes those who have withdrawn from membership and whose accounts are in run-off. This listing indicates there are 767 active and 1,989 inactive Names for a total of 2,756. This total accounts for approximately 8.1% of all Lloyd's Names.
Of the totals indicated, there are approximately 20 Utah Names, 30 Colorado Names, 30 Tennessee Names, 300 California Names, and approximately 1,620 Names in other states (collectively comprising less 5% of all Lloyd's Names) seeking rescission of their Lloyd's memberships.
Because a precise financial accounting cannot be obtained, due in part to Lloyd's failure to keep accurate records of the accounts of individual Names' and in part due to Lloyd's obligation to keep the records of Names confidential, it is only possible to estimate the amounts of money involved.
U.S. NAMES' DEPOSITS
16. The American Names Association (ANA) estimates that, on the average, each Name deposited funds with Lloyd's (principally in the form of LOC) in the amount of $158,000. In addition to voluntary payments made by Names, Lloyd's has already drawn down an average of approximately $63,000 per Name. The average remaining balance of funds on deposit is estimated by ANA to be $95,000 per Name.
17. In 1994, Lloyd's had the capacity to write $16.4 billion in premiums. Its actual writings totaled $14.3 billion leaving $2.1 billion of capacity that was not used. Because nearly all of the 2,000 American Names had resigned their Lloyd's memberships prior to 1994, it is obvious their withdrawal had no effect upon Lloyd's overall capacity or its ability to function as a market.
FUNDING OF EQUITAS
18. The R&R Plan contemplates, among other things, accelerated draw-downs of the Names' funds on deposit plus additional contributions from the Names. The immediate draw-downs and contributions are not needed to obtain cash to pay settled policyholder claims but rather to "fund" Equitas. Based upon the Ridley Report dated November, 1995, the total amount needed to capitalize Equitas was $8.85 billion. Lloyd's then estimated that it would be able to apply credits of approximately $5.1 billion for recoveries from settlements and sources other than the Names. Based upon a balance of $3.7 billion to be funded by draw-downs of Names' funds and "new money" contributions, the amount sought from each of the 34,100 Names was expected to average approximately $110,000. Due to the difference in the Names' means, allocation of credits for settlements, and other factors, the Plan will require some Names to pay more than others. According to Lloyd's White Paper, in addition to the draw-down of funds on deposit, no Name would be expected to contribute more than $150,000. The cap has been recently reduced for some categories of Names to $75,000.
According to Lloyd's Reconstruction and Renewal Towards the Settlement report dated May 1996, the amount required to capitalize Equitas has been "markedly" lowered. The "additional premium" due from Names has been reduced from the original estimate of $2.85 billion to $1.5 billion. This reduction resulted from Lloyd's discovery that the claims for some lines of business had been over reserved and that reinsurance protection was more substantial than expected. In addition, Lloyd's has obtained increases in settlement offers made by brokers, Managing Agents, auditors and others which increases the total settlements to $4.65 billion from $4.2 billion. Based upon the following table taken from the Ridley Report, the amount the Names are expected to pay has been lowered by $1.8 billion, or an average of approximately $52,750 for each of the 34,100 Names. Based upon Lloyd's current estimates, on the average, each Name will be expected to contribute $57,200 in funds drawn from deposits and LOC held by Lloyd's and additional cash payments.
Names' receivables 8.85 7.50
Less Settlement Fund (4.2) (4.65)
Triple profit release (1.2) (1.20)
Payments to Names in surplus .30 .30
Leaving: Finality bill 3.75 1.95
Draw-downs of Names Funds (2.25) (1.95)
Payments from Names in deficit (new money) ( .90) 0.0
Names' residual receivable .60 0.0
19. Assuming an average draw-down and new money contribution of $57,200 Lloyd's is expecting to collect from American Names seeking rescission, a total of $1.144 million from 20 Utah Names, $1.716 million from 30 Colorado Names, $1.716 million from 30 Tennessee Names, $17.16 million from the 300 California Names, plus an additional $92.664 million from the other 1,620 American Names, for a combined total of $114.4 million.
20. It is estimated that each American Name has an average of $95,000 remaining on deposit with Lloyd's. Therefore, based upon an average draw-down on LOC of $57,200, no additional cash contributions are indicated. The actual amount will be determined on a Name by Name basis and may be greater or less than the average.
21. Of the $4.65 billion (reduced from an original estimate of $6 billion) of claims liabilities to be assumed by Equitas, it is estimated that at least $3.7 billion is based upon reserves for claims incurred but not reported (IBNR) and inflation. Although Lloyd's anticipates that the settlement of current and future liabilities assumed by Equitas will not be fully paid for at least 20 years, it wants the Names' funds to appear as interest bearing assets on Equitas' balance sheet now. The formation of Equitas will not be impeded should there be an initial shortfall in the collection of all or part of the $114.4 million in contributions expected from American Names seeking rescission. Nor would it be impeded if the average draw-down and new money expected from the American Names significantly exceed the average for all Names.
LLOYD'S TOTAL RESOURCES
22. Based upon Lloyd's report of 1994 global results, Members' resources total $41.5 billion. After provisions for current and future liabilities totaling $31.6 billion, Lloyd's has net resources of $9.9 billion. If, in fact, $7.5 billion is needed to fund Equitas now and no contributions are obtained from the American Names seeking rescission, Lloyd's would only have to collect less than an additional $7,800 from each of the 14,700 active Names who stand to benefit the most from the formation of Equitas. Alternatively, Lloyd's can capitalize Equitas for $7.3856 billion ($7.5 billion less $114.4 million shortfall due to non-payment by 2,000 American Names) now and create an Equitas trust to fund any ultimate deficiency through assessments levied on future premiums written by Lloyd's and upon Managing Agents' underwriting commissions and profits.
It is my opinion the restrictions sought by Utah's and other states' security regulators will not impair Lloyd's ability to meet ongoing cash claims settlement obligations to, or for the benefit of, any of Lloyd's policyholders or reinsureds anywhere in the world during the pendency of the matter at hand.
23. Commissioner Quackenbush's and other state insurance commissioners' doomsday projections of insurer insolvencies are predicated upon the method prescribed by the National Association of Insurance Commissioners (NAIC) to calculate each carrier's statutory policyholders' surplus. Policyholders' surplus serves as a benchmark to quantify an insurer's ability to respond to unexpected financial losses. It also serves as the basis for determining the insurer's written premium capacity and the amount of risk it can retain for any single exposure.
In simplistic terms, insurance companies admitted to do business in California and other states are permitted to recognize reinsurance recoveries due from authorized non-admitted reinsurers as assets for the purpose of computing surplus. However, they must post offsetting liabilities for recoveries due from non-authorized non-admitted reinsurers. According to William Palmer's March 19, 1996, memorandum to the directors of ACIC (the Palmer memo), reinsurance recoverables from Lloyd's for all California companies in the National Association of Insurance Commissioners (NAIC) data base are approximately $5.2 billion, or roughly 3% of the California carriers' total surplus. It is expected that similar percentages will apply in other states.
24. The outcome of the Insurance Commissioners' predictions of carrier insolvencies is solely within their control. The only way Lloyd's can lose its status as an "authorized" non-admitted reinsurer in any state is for a state Commissioner, or the NAIC, to rescind it. As a matter of practice, if the Commissioner believes a domiciled company is insolvent, he can place the company into conservatorship. If the conservator believes the carrier's business can be run off in an orderly fashion, its in force policies can be allowed to expire in due course with non-renewal notices sent in advance. Otherwise, the conservator will typically send in-term cancellation notices 30 days in advance of the effective date of cancellation selected.
25. In the cases of non-domiciled admitted and non-admitted companies, including Lloyd's, each Commissioner's action is generally limited to revoking the certificate of authority of admitted carriers and issuing cease and desist orders to non-admitted carriers, both of which prevent them from issuing new policies and renewing existing policies.
26. Although Commissioners should be concerned about Lloyd's internal strife, Lloyd's has presumably satisfied the requirements for authorized status prescribed by the NAIC by maintaining deposits of specified funds with the Citibank, N.A. in New York. In fact, as a result of an audit conducted by the New York Insurance Department in 1994, on May 24, 1995, Edward J. Muhl, Superintendent of Insurance of the State of New York and David Rowland, Chairman of Lloyd's, executed a Stipulation Agreement which, among other things, acknowledged Lloyd's intent "to cause underwriting members to cede their assets and liabilities arising under policies allocated to their 1992 and prior years of account ("Old Years") to Equitas...and in the event Equitas is ultimately unable to satisfy all claims, such claims shall continue to be enforceable against the underwriting members who subscribed the original Old Years policies issued to American Policyholders..." and to transfer assets held in LATF relating to the Old Years "to a newly-created trust fund, the grantor of which will be Equitas..."
Lloyd's agreed that on or before May 31, 1995 it would place $500 million in trust in New York "to be held unconditionally for the benefit of American Policyholders..." and to "maintain the Joint Assets each in an amount of not less than $100 million applicable to all existing and future liabilities." ("Joint Assets" means funds jointly and severally available to United States surplus lines and reinsured American Policyholders known as the Lloyd's American Surplus or Excess Lines Insurance Joint Asset Trust Fund and the Lloyd's American Credit for Reinsurance Joint Asset Trust Fund, established by Lloyd's in September, 1993.)
Lloyd's further agreed that "[O]n or after August 1, 1995, only underwriting members of Lloyd's of London subscribing risks through syndicates that establish and maintain amounts within the trust funds established in accordance with...this agreement ("Sponsoring Syndicates"), and only with respect to policies subscribed through such Sponsoring Syndicates, shall be accredited reinsurers or eligible excess or surplus line insurers, as the case may be." Lloyd's agreed to establish a trust fund for liabilities arising under policies issued to insurers making insurance statutory annual statement filings in the U.S. ("Situs Reinsurance") and another for liabilities arising under policies issued to U.S. policyholders pursuant to the surplus or excess lines laws of the several United States ("Situs Surplus Lines Insurance"), where premium and loss payments are to be made in U.S. currency. Lloyd's agreed "[T]he amount of assets required to be held in each trust fund shall not be less than the liabilities incurred by the underwriting members of Lloyd's of London as participants of the Sponsoring Syndicate arising under policies covering Situs Reinsurance and Situs Surplus Lines Insurance."
It is significant to note that the deposit requirements only relate to premiums written on policies issued to risks domiciled in the U.S. and transacted in U.S. dollars whereas previously, all transactions conducted anywhere in the world in U.S. dollars where held in the LATF. Further, the Stipulation Agreement does not apply to CFUS funds held in trust. Until such time as the premium deposits are depleted or not otherwise available for the protection of U.S. reinsureds and policyholders, there is no justification for further changes in the trust arrangement.
27. California serves as a benchmark to measure Lloyd's position in the U.S. market. There are approximately 630 property and casualty insurance companies admitted to do business in the State of California. In 1994, their combined earned premiums for all classes of insurance written totaled $32.81 billion. Approximately 60% of the premiums are written by 35 companies operating individually or as a part of a commonly owned group of companies. A sampling of the following companies and groups included in this count was conducted: Travelers Group, Aetna C&S, ITT Hartford Group, the Chubb Group, CNA Financial Corporation, and the Fireman's Fund Insurance Co. Each of the foregoing operate in most, if not all of the 50 states.
The following quote is taken from the Traveler's 1995 financial report to its shareholders.
"The largest reinsurer of Travelers Insurance asbestos risks is Lloyd's of London (Lloyds). Lloyds is currently undergoing restructuring to seek to obtain additional capital and to segregate claims for years before 1986. The ultimate effect of this restructuring on reinsurance recoverable from Lloyds is not yet known. The Company does not believe that any uncollectible amounts of reinsurance recoverables would be material to its results of operations, financial condition or liquidity."
Significantly, no mention is even made of Lloyd's reinsurance in the financial reports, including 10K forms, of Aetna C&S, the ITT Hartford Group, the Chubb Group, or CNA Financial Corporation. The conclusion inferred is that they do not believe the amounts of reinsurance recoverable from Lloyd's (or not recoverable if Lloyd's fails) are significant enough to mention.
The Fireman's Fund is not publicly traded and, therefore, a stockholders' report is not available for public review. However, analysis of its Convention Statement prepared in conformance with statutory requirements (as opposed to generally accepted accounting principles [GAAP]) reveals the following.
Fireman's Fund's 1995
- written premiums in all states totaled $1.283 billion;
- written premiums in California totaled $552.3 million
(placing it in the top 10 ranked by premiums);
- policyholders' surplus at 12-31-95 was $1.988 billion;
- net reinsurance recoverable from Lloyd's totaled
- $73 million after deductions for payments past due.
In notes appended to the General Interrogatory section of its Convention Statement, the Fund provides an accounting of its loss and loss expense reserves for asbestos and environmental claims incurred. The combined reserves, gross of reinsurance total $1.1 billion and net of reinsurance, $864.5 million. The company's policyholder's surplus of $1.988 billion is over and above the net amount.
If Utah's or any other state's Commissioner rescinds Lloyd's status as an authorized reinsurer, Fireman's Fund's statutory surplus will be reduced by $73 million (3.65%) to $1.915 billion. The reduction cannot be reasonably interpreted as impairing the company's solvency.
28. Commissioner Quackenbush has not identified the 15 insurers which he predicts may become insolvent or the 41 others which may become technically insolvent if they are not allowed to take credit for reinsurance recoverables due from Lloyd's. Without knowing their identity and their market share, it is not possible to accurately predict the impact upon the insuring public in California or elsewhere. However, if 35 individual companies account for 60% of the property and casualty premiums written by carriers admitted to do business in California, and the balance is allocated to the remaining 595, on the average, each company's share of the premium pool is only $22 million. Assuming $1 of surplus will support $2 of net premium income, the estimated average surplus of each carrier is $11 million. Assuming reinsurance recoveries from Lloyd's are equal to 3% of surplus, as stated by William Palmer in his March 19, 1996, memorandum to the directors of ACIC, the average net worth of each of the 595 companies will only be reduced by $330,000 (3% of $11 million) or a total of $196,350,000 (595 x $330,000).
29. It is logical to assume that should any Commissioner place any admitted carrier in liquidation, he will call upon the his state's guarantee fund to mitigate the damages which may be incurred by policyholders and third-party claimants. The fund will be able to call upon the Lloyd's American Trust Funds held by Citibank ($12.6 billion at this time). Should there be any shortfall after all resources have been exhausted, the Guarantee Fund can then obtain the funds needed to cover the shortfall by assessing the remaining companies. Using California as an example, and assuming 56 companies are declared insolvent(per the "potential threat" described by Quackenbush), based upon the averages, $18.48 million (56 x $330,000) of Lloyd's reinsurance recovery is indicated. On a worst case scenario, and assuming no funds can be obtained from LATF, and the entire $18.48 million is at risk, the assessment of the remaining 539 companies will only average approximately $34,300 per company ($18.48 million ÷ 539).
30. California accounts for approximately 13.1% of all property and casualty premiums written in the U.S. Although no attempt was made to estimate the impact upon carriers operating in Utah, Colorado, Tennessee or other states, it is logical to assume the results would be similar to those estimated for California.
SURPLUS LINES POLICYHOLDERS
31. According to Palmer's memorandum, 19,320 Lloyd's policies were issued to California residents and businesses in 1995. The combined premiums written by Lloyd's totaled $227 million, or an indicated average premium of $11,749 per policy.
In 1994, the California Surplus Lines Association reported approximately 170,000 insureds had purchased policies from non-admitted carriers and total premiums of $1.443 billion (about 3.7% of total California premiums). It is, therefore, estimated that Lloyd's share of the surplus market is approximately 11.4% of the policyholders and 15.7% of the premiums. It is expected that Lloyd's market share will be similar in other states.
Lloyd's policyholders are protected by the LATF deposits of $12.6 billion. Due to the amendment of the trust deeds required by the New York Insurance Department in May, 1995, these funds can be mutualized and used to pay the liabilities of all Names. Therefore, until these funds held in New York, and the Central Funds held in London, are both depleted, the valid claims of current and prior years' policyholders will be paid. There is no justification for the prediction that the restrictions sought to be imposed by the Security Regulators' enforcement actions present a material risk of Lloyd's non-payment of policyholders' and reinsureds' claims in the foreseeable future.
Further, it is my opinion that sufficient capacity exists in the domestic and non-admitted market to absorb the policies underwritten by Lloyd's should its status as an authorized non-admitted carrier be rescinded by any Commissioner or the NAIC.
HOW LLOYD'S OPERATES
32. The Lloyd's White Paper is the basic reference document being relied upon by the insurance regulators. Although the White Paper provides a textbook explanation of how Lloyd's is structured and functions, it fails to provide details which are significant to the issues at hand and needed by the uninitiated to acquire a balanced perspective of the underlying disputes.
33. To provide a clearer understanding of the significance of the American Names' allegations, and why the actions of the Securities Regulators is required to protect their assets, an explanation of how Lloyd's actually functions is necessary.
Lloyd's is not an insurance company. It is the "self" regulator, or controlling entity, of an insurance market that raises capital for the market from individuals who are admitted to "membership" in Lloyd's and who have pledged their personal assets to Lloyd's to support the underwriting of insurance. It has survived for 300 years on a foundation of goodwill built upon a reputation of trust. This reputation has been severely tarnished by recent revelations of material breaches of that trust by those actively engaged in the daily market place and those designated to regulate and govern the activities of the Lloyd's market, mainly the Council of Lloyd's.
34. There are two classes of Members; Working Members who are occupied principally in the business of insurance in the Lloyd's market and External Members who are not principally occupied, and indeed forbidden from participating, in the business of insurance at Lloyd's.
Lloyd's is governed by a Council of 18 Members; six Working Members, six External Members, and six Members nominated at large. In principal, the individual Names elect the Council. In fact, the majority of External Members' Managing Agents select the candidates and exercise the voting rights of the Names they represent as "agent."
35. Presently, Lloyd's has approximately 14,700 active Members. However, there are approximately 19,400 individual Names that have withdrawn from active membership but still remain in the Lloyd's pool due to their participation in unclosed syndicates. The entire net worth of approximately 34,100 Names is currently at risk on a several basis.
Prior to 1969, Lloyd's memberships were limited to citizens of the U.K. In 1969, membership was opened to U.S. citizens. Prior to 1994, only individuals could become Members. In 1994, membership was open to corporations. Between 1970 and 1995, 2,756 Americans who still have unclosed accounts became Members. During 1995, only 767 U.S. citizens were still participating Names. Virtually all of the 1,989 American Names who withdrew their memberships remain in Lloyd's pool: collectively, 5.8% of the total.
36. The Names provide the capital required to support the syndicates' underwriting of insurance. Lloyd's sets the amount of premium which may be underwritten for each Name's account in each year. The Name's overall premium limit (OPL) is based in part on the amount of means disclosed by the Name and on funds deposited at Lloyd's. The funds deposited may be in the form of cash, letters of credit, cash value of life insurance, bank guarantees and other liquid assets. Most American Names have posted letters of credit. In practice, the Names actually decide how much they want to invest in Lloyd's and, subject to a minimum of approximately $37,500, limit the amount they deposit with Lloyd's accordingly. A Name's actual OPL translates to approximately three times the amount of funds on deposit with Lloyd's.
Each Name's OPL is recalculated at the beginning of each year. If Names wish to withdraw from membership in Lloyd's they may do so. However, they, or their estates, remain liable for all open accounts (commonly referred to as open syndicate years) on the date of withdrawal. Their withdrawal cannot be finalized until all open syndicate years have been closed, generally through the purchase of retroactive reinsurance (Reinsurance to Close [RITC]).
In 1994, Lloyd's overall premium capacity was approximately $16.4 billion against which its gross premium income totaled approximately $14.3 billion. In contrast, the combined premium income of U.S. domiciled property and life insurance companies totaled approximately $775 billion. The worldwide market was estimated to total $1,552 billion. Lloyd's premium income accounted for only .092% of the world market compared to U.S.'s share of approximately 50%. Approximately 37% of Lloyd's premium income is written in the U.K., 32% in the U.S. (.59% of the total), 12% in Europe, and 19% throughout the rest of the world.
37. Under English law the individual Names are supposed to be sole traders and not liable for the risks underwritten on the assets of other Names. At the inception of Lloyd's, Names were actively engaged in the underwriting and acceptance of risks. They would sit in "boxes" on the "floor" of Lloyd's and affix their signatures to placement slips presented by brokers. As the volume of business grew, the Names appointed agents to man their boxes and perform the underwriting function. Lloyd's rules currently (as they have for many years) strictly prohibit Names from participating in the daily underwriting of insurance. Rather, Names rely entirely upon Managing Agents to perform the daily task of selecting and pricing risks.
38. To improve the efficiency of the underwriting process and assure a proper spread of risk, Lloyd's organized Names into groups known as syndicates. Subject to the terms of the agency agreement, individual Names had to delegate all authority to the Managing Agent to use all, or a part of, their OPL. Managing Agents are thereby empowered to commit the collective capacity of numerous Names to selected risks. Each syndicate is assigned an identification number.
There are approximately 170 syndicates managed by 60 Managing Agents. Each year, the average Name participates in 17 syndicates. Policies issued by Lloyd's identify the security backing the policies' obligations only by syndicate number rather than by Members' names. Individual syndicate members' names do not appear on any "slip" or policy. Policyholders are not given, and generally have no way of knowing, the actual names of the Members participating in the syndicates listed on their policies.
Although individual syndicates are perpetuated, the participating Names on each syndicate will change each year as Names withdraw and new Names are added. Those who participate in several syndicates may actually compound the amount of liability assumed on any one risk if that risk is insured by more than one syndicate.
39. It is my opinion that under Lloyd's applicable rules, the Names involved in this dispute are no more individual underwriters than shareholders of capital stock insurance companies or policyholders of mutual insurance companies and reciprocal inter-insurance exchanges. The only difference is the extent of assumed investment risk.
40. It is also my opinion that none of the 50 states' insurance regulators would presently license any insurance company capitalized in a similar fashion. Historically, U.S. domiciled property and casualty insurance companies admitted to do business in various states have been permitted to write premiums, net after deductions for ceded reinsurance, equal to two to three times policyholders' surplus; i.e. capital plus retained earnings.
41. The NAIC has adopted uniform accounting standards which restrict the types of assets which may be included in the calculation of policyholder's surplus for statutory purposes. Generally letters of credit posted by individuals as contributions to capital are not included as admitted assets. Nor are credits taken for reinsurance ceded to reinsurer's not approved by the NAIC.
The NAIC allows admitted insurers to take credit for reinsurance ceded to Lloyd's because of Lloyd's image of collective wealth. This image of wealth is secured by deposits held by Citibank in New York.
42. Lloyd's first transferred funds it held in trust for the payment of claims (the Lloyd's Trust Fund [LTF]) to the U.S. in 1939 to be held in trust as security for the payment of policyholders' claims throughout the course of WW II. In more recent history, although these deposits are held for world wide policy transactions conducted in U.S. dollars, the deposits have been mandated by U.S. insurance regulators and deposited in the Lloyd's American Trust Fund (LATF). Funds deposited in the LATF provide the security required for Lloyd's to be recognized as an authorized non-admitted insurer and reinsurer. Although the LATF provides security for the payment of claims, individual policyholders cannot gain direct access to the funds.
In principle, the funds held in trust were to be allocated to the individual Names based upon premiums collected. In fact, because hundreds of accounts had been established by Managing Agents for their syndicates, and because of the way Citibank N.A. mismanaged the trust, it became virtually impossible to identify the amounts deposited for any individual Name.
Because Citibank, N.A. in New York is the LATF trustee, the New York Department of Insurance is responsible for monitoring the funds. To assure they are adequate, the N.Y. Department periodically conducts an audit. The last audit was commenced in 1994, for the calendar year 1993. The audit revealed serious deficiencies in the accounting of funds and the amounts deposited. As a result, the trust deed and operating agreements were amended. The most significant change was amendment of the trust deed to allow the funds to be held jointly rather than severally (mutualized) after July 31, 1995.
43. In addition to the premium trust funds, each year Lloyd's assesses its Members a fee of 0.6% of allocated capacity which is deposited in a Central Fund. The Lloyd's corporation has sole ownership rights to deposits made to the Central Fund. The Council has the sole authority to use the funds to pay the claims of Names who are unable, or unwilling, to meet their financial commitments. In 1993, the assets held in Lloyd's Central Fund exceeded $1.35 billion of which $370.16 million was held in trust by Citibank in Lloyd's Central Fund U.S. (CFUS).
44. It is generally misunderstood that the amounts deposited to the LTF and the LATF on a regular basis are determined by the amounts of claims incurred. Rather, all routine deposits are based upon premium transactions conducted in U.S. dollars. The actual deposit of premiums collected generally are made months after they are collected from insureds.
Policies issued through Lloyd's to insureds domiciled in the U.S. must be processed by surplus line brokers (SLBs) licensed by the various states. The SLBs rely heavily upon retail insurance brokers as their source of business. As representatives of the insureds, placing brokers typically collect the required premiums from the insureds and remit them to the SLBs. Depending upon the SLBs' credit policy, the premiums may not be received by the SLBs for 30 or more days.
Depending upon the SLBs' arrangements with Managing Agents, the premiums may be held for an additional 30 days or more. If the SLBs have the "underwriters' pen" and authority to pay claims, they may in fact hold the premiums in trust for months and offset the amounts held by the amount of claims payments made.
The SLBs do not, as a matter of general practice, transmit premiums to the LATF. Rather, they remit the net premiums due, after deductions for commissions and, if applicable, claims payments directly to the Lloyd's brokers who arranged the placements with Managing Agents. The Lloyd's brokers may hold the premiums in trust for an additional 30 days or more before remitting the net premiums due on the amounts collected, after deductions for their commissions, to the Managing Agents. The Managing Agents then deposit the net premiums after deductions for commissions and fees due them under their agency agreements. By the time $1 of original written premium reaches the LATF, a minimum of 120 days will have lapsed and, after deductions for the payment of commissions, the ultimate amount deposited will have been reduced to 60¢ or less.
45. In general terms, claims are divided into two categories collectively referred to as "incurred losses": those reported to insurers, and those which have been incurred but not yet reported to insurers (IBNR). Insurers are able to predict the amount of their liabilities for claims reported with reasonable accuracy. Because the bulk of IBNR reserves are based upon premiums written under third party liability insurance contracts that have "long tail" exposures, the amount reserved is at best speculative. The amount of reserves established for latent liability claims which account for approximately 75% of Lloyd's outstanding claims serves to illustrate the wide fluctuations which regularly occur.
46. At the end of each calendar year, the Names' liability for claims incurred is calculated. Generally, two years after the end of each calendar year, the Names' liabilities are closed out through the purchase of RITC. For example, at the end of 1996, RITC will be purchased (ceded) to transfer the liability for unsettled and unreported claims which occurred on policies issued in 1994. Managing Agents facilitate the closure of their syndicates' liabilities by either purchasing RITC secured by the Names then participating in the same numbered syndicate, other syndicates they manage, or others within and outside the Lloyd's market. Although the Names remain primarily liable for claims which occur under policies secured by their assets, the purchase of RITC theoretically transfers their liability to the assuming reinsurer, absent fraud.
Through the RITC process, new Names coming into the market and participating in syndicates who issue RITC policies, accept the financial liabilities of ceding syndicates for claims incurred long before ever becoming Members. The failure of Lloyd's Managing Agents and others to fully disclose the liabilities accepted by new Names under RITC policies and violations of various securities laws are at the core of some of the Names' actions at hand and triggered most of the complaints filed by Names which have either already been settled by Lloyd's, decided by U.K. courts, or are still pending.
47. Names are able to protect their assets by purchasing Personal Stop-Loss (PSL) and Estate Protection Plan (EPP) insurance issued by certain syndicates who offer the coverage. Approximately one half of the Names have purchased one or both of these policies. If the losses incurred by a Name exceed a selected threshold, the PSL will first respond, and next the EPP. If the amounts covered by the PSL and EPP are insufficient, and the Name's solvency is impaired, Lloyd's may pay the remaining balance of unpaid claims by withdrawing funds from the Central Fund in the U.K. or CFUS.
48. The incestuous mechanism for spreading risk among Lloyd's syndicates often produces a spiraling result which effectively increases the number of dollars that will actually be exchanged to settle specific or catastrophic claims. For example, the estimated total insured loss may be $1.4 million. However when the liability of all participating syndicates through direct participation and through reinsurance is totaled, the amount of money which may actually exchange hands may exceed $3.5 million. This "spiral" effect compounds the difficulty of assessing the Names' actual liability at any point in time.
49. Equitas is being formed to wipe the slate clean and give the active Names a new foundation upon which the Lloyd's market can be perpetuated. Those who have the most to lose are the Names who have withdrawn their memberships and are expected to participate in the mutualization of outstanding liabilities prior to 1993 through Equitas. It is noted that should Equitas' have insufficient funds to meet its claims obligations, the Names will be expected to contribute additional funds. Therefore, Equitas will not finalize the Names' exposure to further calls for funds ten, 20 or more years into the future.
Those who stand to gain the most are the brokers authorized to place business with Lloyd's, the Member Agents and Managing Agents. Those Names who have profits in 1993, 1994, and 1995 will be able to preserve them because any losses that would otherwise be charged to them will be assumed by Equitas. Significantly, Lloyd's has not indicated a willingness to guarantee payment of Equitas' claims nor to release or indemnify Names for pre 1993 losses.
50. I have read the Mini-Brief re Rescission prepared by counsel for Names, a copy of which is attached as Attachment A to this declaration. I agree with the factual analysis set forth in the first three paragraphs as follows:
"Lloyd's contends that Names cannot obtain equitable relief in the form of rescission. Lloyd's makes this argument in its March 23, 1996 'White Paper'. The Lloyd's contention is unfounded as a matter of fact and frivolous as a matter of law.
Lloyd's argument rests on several false factual assumptions. First, Lloyd's asserts that policyholders and third-party claimants would suffer a 'devastating impact' if the investments of defrauded Names were undone. This is wrong. Rescission would have no effect on the claims of policyholders who purchased insurance from Lloyd's syndicates. Only the reinsurance policies that fraudulently shifted losses from one syndicate to another would be set aside. The result of such a remedy, of course, would be to place the ultimate policyholder in precisely the position for which he bargained: his claims are covered, if at all, by the syndicate that insured him to begin with. (Certainly third-party tort claimants who are strangers to these insurance arrangements have no right to demand more coverage than their tortfeasors contracted to buy.) Moreover rescission on behalf of defrauded Names would not affect the many reinsurance contracts that preceded the fraudulent RITC transactions, which began in the 1980's.
Second, Lloyd's argues that rescission would undermine the capital reserves of primary insurance carriers in the United States. This is a speculative assertion, for it assumes that Lloyd's itself will become insolvent if rescission is granted. Yet, as just pointed out, rescission would not affect the obligation of other syndicates which accepted non-fraudulent insurance and reinsurance contracts. Relief for the defrauded Names would only shift losses to other Names who legitimately and without deception agreed to accept those risks in prior syndicate years."
It is my opinion that the survival of the Lloyd's market does not depend upon the $114.4 million it seeks to collect from those American Names seeking rescission of their Lloyd's memberships. Nor is there any evidence that the restrictions sought to be imposed by Securities Regulators, including prohibiting draw-downs, or similar restrictions, will cause the collapse of the Lloyd's market or the insolvency of any company admitted to do business in any state in the U.S.
I declare under penalty of perjury under the laws of the State of California, that the foregoing is true and correct, and that this declaration is executed on this 3rd day of May, 1996, at Pasadena, California.
ROBERT L. WESTIN, CPCU
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