Reliance: Anatomy of a Failure

1. Reliance:Anatomy of a Failure Robert Klein Dept. of Risk Management & Insurance Georgia State University

2. Reliance: Facts & Issues • Large, prominent financial conglomerate with significant property-casualty operations (top 10). • Aggressive acquisition & expansion strategy. • Ambitious, controversial CEO – Saul Steinberg. • Troubles became “apparent” in 1999. • Attempts at restructuring failed. • Placed in receivership May 2001. • Questions about regulatory performance. • Disputes/lawsuits over receivership. • Watershed insolvency – significant implications.

3. Contributing Factors • Aggressive growth strategy in soft markets • Cut-rate pricing • Lax underwriting • Under-reserving • “Fronted” for WC group Unicover • High debt load • High expenses • Others?

4. A.M. Best Evaluations • 1998 • “Based on Reliance’s earnings momentum, improved asset quality & capital strength, reduced financial leverage & debt service obligations, R’s rating outlook is positive. • “Partially offsetting these strengths are R’s high underwriting, investment, & financial leverage …high expense ratios … large equity & non-investment grade bond holdings.” • 2000 • “The rating assignment (B under review) follows a review of the group’s financial condition, its strategic shift from active operations to an asset sale/run-off mode for many of its units … [an its unsuccessful acquisition by Leucadia National].” • “ … will not be able to refinance its bank facility & public debt maturing in 2000 …” • “… increased uncertainty related to its loss reserve adequacy & reduced liquidity margin stemming from negative cash flows … “

5. A Rapid Descent: A.M. Best Ratings

6. Leverage and Capital Adequacy Decline into the Abyss: Surplus ($B) ?

7. Change in NPW (%)

8. Net Premiums Written/Surplus

9. Other Leverage Measures Acceptable Range < 5-7% Acceptable Range < 4-6%

10. Profitability and Performance

11. Operating Cash Flow

12. Reserves

13. Assets

14. Agents’ Balances/Surplus

15. Reliance IRIS Ratios

16. Measurement Issues • Reported surplus is as accurate as reported assets and liabilities. • Underpricing & under-reserving most problematic for property-casualty insurers. • Capital and leverage need to be assessed against risks that firm faces. • Reliance BCAR was 77.8 in 1998 and 122.6 in 1999. • Decline can be rapid.

17. Observations • Events can rapidly overtake remedial action. • Regulators and rating agencies proceed cautiously with lagging information. • Desire not to undermine efforts to restructure or sell company. • Size and importance of insurer can make regulators and raters even more cautious. • More pro-active, risk-based oversight requires new mindset for U.S. regulators.

18. Ratio Limitations • There is no ratio measure that provides “real-time” indication of underpricing, poor underwriting, and under-reserving. • Performance measures lag these practices, especially for long-tail lines. • Early detection requires alternative approaches including “street knowledge.” • Regulators & raters reluctant to use “subjective” indicators to issue warnings.

19. Questions • What were the causes of or contributors to Reliance's insolvency? • What were the roles and responsibilities of various "monitors" , e.g., regulators, rating agencies, accounting firms, and others and were there failures in their performance? • To extent can we rely on "the market", i.e., buyers of insurance, to impose sufficient discipline on insurers like Reliance to properly manage their financial risk? • What does the Reliance story tell us about the effectiveness of the monitoring and regulatory system and does it reveal problems with that system that may or may not have been fixed since the Reliance insolvency?