New England Biz Law Update
Insurance companies today face unprecedented scrutiny in the wake of the burgeoning investigation of American International Group (AIG), General Reinsurance Corp. (Gen Re), and other insurers.
With state and federal regulators – to say nothing of the Department of Justice – beginning to dissect certain transactions, including especially reinsurance transactions, it is essential for insurance companies to examine their portfolios for potential problems. The key for in-house counsel is to recognize any such problems, and disclose them if necessary, before state examiners or federal agents come to the door.
The investigation of AIG and Gen Re began with a suspect transaction involving finite reinsurance. That investigation since has grown to encompass a range of insurance and accounting irregularities, as well as a restatement of AIG’s financial results.
The AIG board has ousted its storied chairman, while other senior executives have resigned or been fired after invoking their constitutional right against self-incrimination. State regulators have filed a civil complaint against AIG and former management. A grand jury has been convened, and some Gen Re executives already have pleaded guilty to criminal charges and agreed to cooperate with the DOJ.
More generally, the FBI has announced a new priority: A probe of insurance industry practices, including the uses made of reinsurance. Whatever may become of this FBI probe, state insurance regulators have stepped up their own oversight activities – a trend likely to persist for some time.
As reports of the AIG/Gen Re transaction suggest, finite reinsurance may bolster a company’s financial results without necessarily transferring risks covered by original insurance. A wide body of statutes, regulations, and court decisions conceives of reinsurance as entailing the transfer of underwriting, or indemnity, risk.
New York’s so-called Regulation 102, for example, prohibits taking reserve credit for reinsurance if it does not “transfer to the assuming insurer all of the significant risks inherent in the insurance policies or contracts reinsured.” Finite reinsurance arrangements with insufficient risk transfer do not necessarily qualify unless the governing jurisdiction supplies an appropriate safe harbor.
State insurance regulators have taken varying stances on such arrangements.
As one commentator put it, surplus relief via reinsurance “has negative connotations to insurance regulators, especially when a given agreement produces significant surplus aid for the ceding insurer, while providing little or no indemnification of policy benefits by the reinsurer.” (J.R. Scott, Life Reinsurance, in R.W. Strain, Reinsurance Contract Wording at 568-69 (1998)).
Regulators who in the past might have accepted, acquiesced in, or failed to focus on arrangements diverging from full-fledged reinsurance may now scrutinize them more closely.
One sensitive point for state regulators may involve the reporting of transactions as reinsurance on Schedule F or S to a company’s annual statement. By law, such statements must be subscribed and sworn to by company executives, typically the president and secretary as well as one or more financial officers and the corporate actuary. These officers attest that the annual statement, including annexed schedules, represents a “full and true statement of all the assets and liabilities and of the condition and affairs of the said insurer.”
Most recently, the New York Superintendent of Insurance has declared that for finite reinsurance arrangements, a company’s chief executive officer must attest to facts evidencing the transfer of risk. (State insurance law requirements are, of course, in addition to those imposed on public companies by the Sarbanes-Oxley Act.)
Against this backdrop, in-house counsel need to assess the risks that their company and its executives now face. Whenever uncertainty exists about the exact nature of the reinsurance business engaged in by a company – assumed as well as ceded – in-house counsel should determine in advance what regulators may find. To that end, an audit of the company’s reinsurance arrangements can serve as a useful tool, providing company attorneys with an orderly, reliable means of spotting and assessing potential issues. Such an audit can ensure that companies are geared up to respond to periodic examinations by state regulators, as well as any federal investigation which might ensue.
In-house counsel further can assure senior executives that they are properly discharging their responsibility in attesting to the condition and affairs of the company.
A general audit “protocol,” which can be tailored to suit the needs of particular companies, is as follows:
• Define the audit scope by class of business, issue(s), and level of inquiry.
• Establish a timetable for completion of work, including an assessment of the imminence of regulatory action.
• Focus on early identification of items warranting special attention.
• Assemble multidisciplinary team.
• Attend to protecting privileged, confidential, and proprietary information.
• Map the legal environment, including key legal issues that have emerged in the governing jurisdiction(s).
• Identify, assemble, and digest relevant background documents and information.
• Interview key people.
• Arrange and conduct detailed document/file review.
• Conduct any necessary follow-up interviews.
• Report findings and recommendations orally and/or in writing.
• Follow-up on recommendations as needed.
Should an audit uncover transactions which may be subject to challenge in the current regulatory environment, in-house counsel can then address any necessary or desirable preemptive action, including voluntary disclosure.
Whether questionable transactions should be disclosed is among the thorniest issues facing both in-house and outside counsel. Voluntary disclosure can sometimes forestall an intrusive investigation, yet might also precipitate a broad follow-up examination, the restatement of financial results, and, in the case of a public company, derivative suits.
