" title="Peter H. Bickford Legal & Dispute Resolution Services"> Peter H. Bickford Legal & Dispute Resolution Services

New York’s Governor Spitzer issued a press release on Monday (December 3) followed by a widely reported press conference announcing an agreement in principle “that will protect nearly 11,000 accident victims and other individuals receiving annual payments from structured settlements and pensions.” The release goes on to praise the Superintendent of Insurance and the head of the Liquidation Bureau for aggressively pursuing an agreement with the life and property/casualty companies and the guarantee funds that “resolved a significant deficit from a defunct insurance company.” (The press release can be found on the Insurance Department’s web site at http://ins.state.ny.us/press/2007/)

Before jumping on the bandwagon of kudos to the Governor, the Superintendent of Insurance and the Liquidation Bureau, however, there are a number of factual issues that one might want to consider.

The “defunct” company in question is Executive Life Insurance Company of New York (“ELNY”), which was placed into rehabilitation in 1991. According to the 1992 court approved Plan of Rehabilitation, ELNY was placed in rehabilitation because of the New York Insurance Department’s concerns that the adverse publicity regarding the seizure of its parent company, Executive Life Insurance Company of California, could result in an excessive number of cash surrenders. It was NOT placed in rehabilitation because it was insolvent! In fact, ELNY has never been determined to be insolvent. Consider also the following:

• At year-end 1994 (the first year the Liquidation Bureau was required to publish financials for the estates under its control), ELNY had almost 24,000 annuity contracts in force and reported assets of $1.65 billion.
• At year-end 2006, there were only 11,300 policies in force and reported assets of $1.37 billion – a 53% decline in outstanding policies and only a 17% decline in assets.
• In that 13 year period 1994 through 2006, ELNY continuously met all outstanding policy obligations to the tune of almost $2 billion.
• Throughout that same period, ELNY had the same major life insurer as administrator, the same nationally known actuarial firm as its actuarial consultant, and the same prominent financial firm as investment advisor.
• Over 90% of the outstanding obligations are fixed obligations under structured settlement agreements. There are no potential “long tail” obligations to cause a sudden and precipitous inflation of ultimate liabilities.

Notwithstanding these facts, the current administration has apparently “sold” the industry and the life guarantee funds on the premise that “ELNY would have a $2 billion deficit,” that continued payments to policyholders is at risk, and that an industry bail out is necessary and appropriate (Announcing a $2 billion deficit at this time is also curious in view of the fact that the Liquidation Bureau has engaged an audit of ELNY that is not expected to be completed until the middle or end of January 2008).

If there is in fact a $2 billion shortfall the big question is: How did it happen? It cannot be blamed on the former management of ELNY because the company was solvent when it was placed in rehabilitation. It has been under the Liquidation Bureau’s watch with the same prestigious advisors for over 16 years – through both Democratic and Republican administrations — paying all obligations on a timely basis, and has received a number of investment suitors that have all been rejected by the Bureau.

Now we are being told that there is a $2 billion shortfall that can only be resolved on the backs of the industry. If true, someone needs to explain how that happened and hold those responsible accountable. Given the prosecutorial background of the Governor, his Superintendent of Insurance and the head of the Liquidation Bureau, can we assume that as bright a light will be aimed at the causes of this development as is being shined on the bailout agreement?

(In the interest of full disclosure, I have represented various investor groups over the past ten years interested in restoring ELNY to the marketplace. I do not represent any such group at this time, however, although I am aware of continued investor interest based primarily on the belief that any significant deficit defies fact and logic.)

One of my pet peeves about the New York Liquidation Bureau over the years has been its inability (or refusal) to acknowledge in practice the difference between liquidation and rehabilitation under Article 74 of the Insurance Law. Unfortunately the Bureau’s Mission Statement as posted on its web site perpetuates the problem (www.nylb.org/mission.htm).

The Mission Statement avers that the Liquidation Bureau acts for the Superintendent of Insurance to “. . . return rehabilitated companies to the marketplace or distribute the proceeds of the company in a timely manner to creditors.” Under §7403 the rehabilitator’s statutory function is to “conduct the business” of the company in rehabilitation, and to take steps “toward the removal of the causes and conditions” that made the rehabilitation necessary. There is no statutory authority for the rehabilitator to “distribute the proceeds of the company in a timely manner to creditors.” That can only be done in liquidation, which is a separate proceeding with different statutory rules.

If the New York Liquidation Bureau wants the insurance community to believe it has a new attitude about its role in rehabilitations, it might want to consider revising its Mission Statement to reflect the law.

For a more extensive review of the receivership process, particularly in New York, see my article, “Who Protects us from the Reciever?” at https://www.pbnylaw.com/articles/whoprotectsusfromthereciever-11-04.pdf.

On November 5th the New York Superintendent of Insurance, Eric Dinallo, issued a press release and a draft regulation that Mr. Dinallo states “would make the New York Insurance Department the first in the nation to establish principles-based regulation.” The press release states that the aim of principles-based regulation is to “reduce unnecessary regulatory and administrative burdens . . .”, and sets forth the principles for both the regulated and the regulators (the proposed regulation just sets forth the principles for the regulated — I guess they figure a regulator cannot issue a regulation regulating itself). To see copies of the press release and proposed regulation go to http://ins.state.ny.us and look under the heading “New Item”.

In essence, the proposal sets for rules to live by, both for the regulated companies and for the regulators. The rules themselves are mostly common sense rules that, it could be argued, are what is supposed to be the case in any event – such as Principle #1 for the companies: “A licensee shall lawfully conduct its business with integrity, due skill, and diligence.” Commentators have already taken shots at the principles, basically arguing that they could even lead to more regulation or litigation as regulators start to “define” the elements of the principles more narrowly than under current rules. One only need look at the body of law and disagreement over that simple document of principles called the U.S. Constitution to understand the possibilities.

On the other hand, any attempt to reduce or simplify the regulatory process should be welcomed by the industry, and it should diligently pursue this initiative with the Superintendent to try and make it work. For the most part those of us that have dealt with regulators for decades are understandably skeptical, particularly when it comes to regulatory initiatives. However, I believe the Superintendent should be given a chance to put some meaningful substance to the bones of the principles.

There is one principle that should be added to the Regulators list. The Regulators should be required to acknowledge that licensees are for-profit entities and that their owners are entitles to a fair return on their investment. Mr. Dinallo has frequently stated in public forums that he is anxious to bring new investment into the industry. A starting point for investors would be to know that if they do so successfully, they can and will be rewarded. If the regulators cannot make this principle commitment, why should investors make a principal commitment?

Vincent J. Dowling, Jr., (Dowling & Partners, http://www.dowling.com/) an outspoken analyst of the insurance industry, was the keynote speaker at the annual meeting of ARIAS-US* last week. Speaking before an opening session crowd of over 650 arbitrators, company (cedant and reinsurer) representatives, lawyers and industry consultants, Mr. Dowling made a number of thought provoking statements that started the proceedings off to a rollicking start. One of his more interesting observations for the arbitrators present was that reinsurance recoverables as a percentage of policyholder surplus in the US is down from 50% in 2001 to 30% today (perhaps helping to explain the anecdotal perception among the arbitrators present that the number of arbitrations has ebbed the last couple of years). While he regaled the audience with criticisms of the arbitration process, his most provocative comments were aimed at the investment community, concluding that the property/casualty insurance and reinsurance business is and will continue to be a “lousy” business “for the invest-able future.”
For instance, Mr. Dowling stated that:

* Underwriters’ reported financial statements are always wrong.

* Rating Agencies are the de-facto regulators of the industry.

* Investing in the insurance/reinsurance business is like a roach motel – easy to get in but impossible to get out.

* Bermuda is the “Better Mousetrap” for investors because of the regulatory climate and the ability to actually make an adequate return on capital.

* If you want to invest in the insurance business, control the customer – become an intermediary not an underwriter.

* New capital has managed to come in to the industry on short tail business, but has not yet figured out how to come in with enough capital for long tail business.

* We are in a soft market cycle and can expect another round of company insolvencies in the foreseeable future.

All of these statements were supported by lots of charts and schedules, all of which I am sure VJ would be delighted to share with anyone who asks.

* ARIAS-US (http://www.arias-us.org/) is an organization that “promotes improvement of the insurance and reinsurance arbitration process for the international and domestic markets.” I am an ARIAS certified arbitrator and umpire.

The lead article in today’s New York Law Journal reports that because of “newly discovered assets” of an insurance company that has been in liquidation since 1997, $18 million has been added to the strapped Public Motor Vehicle Security Fund (PMV Fund), which will allow the PMV Fund to pay approved claims that have been unpaid for many years because of a lack of funds, and to allow the Bureau to address the backlog of unprocessed claims.

The company is New York Merchant Bakers Insurance Company (“Merchant Bakers”). According to public records and other data obtained from the Insurance Department under the Freedom of Information Law, Merchant Bakers has not just been the largest drain on the PMV Fund; it has been the monster drain. For the five years from 2002 through 2006, the PMV Fund paid out over $131 million in claims, of which almost $95 million were paid to claimants of Merchant Bakers – more than 72% of the total. In fact, Merchant Bakers and one other company, Capital Mutual Insurance Company, which has been in liquidation since 2000, account for over 90% of the total payments from the PMV Fund.

I applaud the Liquidation Bureau for addressing long overdue claims against the PMV Fund. However, the impact of Merchant Bakers on the financially challenged PMV Fund over past decade underscores the need to separate the security fund function from the Liquidation Bureau. New York is the only state where the insurance security or guaranty funds are not separate entities from the receiver – usually with their own boards of directors or trustees including industry representation (after all, it is their money in these funds). In New York, however, the funds are basically bank accounts with the receiver as the authorized signatory (for a discussion of the liquidation process in the US, including the operation of guaranty funds see my article “Who Protects Us from the Receiver?” at www.pbnylaw.com/publications).

Perhaps if the PMV Fund had been a separate entity, it would have questioned the overly concentrated drain on the Fund by one or two companies, which could have led to solutions to the PMV Fund crisis. Perhaps, too, pressure from a separate entity could have helped the Liquidation Bureau “find” the $18 million in assets a lot sooner. The law Journal article does not explain where or how the $18 million was “newly discovered.” That could well be the real story here!

The New York Court of Appeals unanimously decided yesterday that in his capacity as liquidator of insurance companies the superintendent of insurance is not a state officer, and that the New York Liquidation Bureau acting as the liquidator’s agent is not a state agency. Furthermore, the Court determined that the assets of the estates under the control of the liquidator are private not state funds, nor are these assets funds held by a state officer or agency. Therefore, the State Comptroller has no authority to audit the Bureau or subpoena its personnel. A copy of the decision can be obtained from the Liquidation Bureau’s website at http://www.nylb.org/ or by sending a request to me at pbickford@pbnylaw.com.

Although the case seems to put to bed the Comptroller’s ability to force an audit of the Liquidation Bureau, there is an interesting footnote in the decision that reads as follows:

“This holding is not meant to imply that the Superintendent may not be subject to an independent audit. Although the Legislature does not have the authority under our holding in Blue Cross and Blue Shield to assign to the Comptroller the task of auditing the Bureau, it does have the authority to require the Bureau to retain independent auditors.”

This footnote seems to leave the door open for the Legislature to provide for forced, independent audits of the Liquidation Bureau, a move the Superintendent may have anticipated in the Liquidation Bureau’s press release on the decision where the Superintendent states:

“Although this case was about far more than transparency and outside oversight, transparency and accountability are nonetheless critical elements in successfully fulfilling the Bureau’s legal responsibilities.”

The Superintendent then goes on to talk about all the actions, including a “top to bottom” audit of the Bureau and each of the estates under its control. I will be commenting more fully on these “transparency” and “audit” issue in future postings. For my earlier comments on this case, made following the Appellate Division ruling, see my entry for March 22, 2007.

When New York Attorney General Eliot Spitzer (now Governor Spitzer) went after the major insurance brokerage firms for bid rigging a few years ago, he also attacked contingent commissions as part of the scheme to direct business, characterizing these payments as equivalent to kickbacks. In the subsequent settlements with the major brokers, the brokers agreed to forego contingent commissions in the future, casting a pall over the practice by the entire brokerage community, not just the majors.

Now a recent Appellate Division case, Hersch v. DeWitt Stern Group, Inc. (2007 NY Slip Op 06567, App. Div. 1^st Dept., Sept. 6, 2007), has focused attention again on the propriety of contingent commissions. In the Hersch case, plaintiff had sued his broker for failing to obtain certain coverages, and several of the causes of action were based on breach of fiduciary duty for, inter alia, failing to disclose the existence of a contingent commission agreement. The Court found that the fiduciary duty causes of action should have been dismissed because contingent commissions are not illegal and, absent a special relationship, defendant had no duty to disclose the existence of the contingent commission agreement.

The Court based its finding that contingent commissions are not illegal on a 1985 Court of Appeals decision, Amusement Bus. Underwriters v. American Intl. Group (66 NY2d 878). The Court of Appeals in Amusement Bus. Underwriters, however, did not specifically hold that contingent commissions were legal. It was interpreting the terms of a contingent commission agreement, and the issue of the legality of the agreement does not appear to have been before the Court.

The Hersch Court’s finding that the broker had no duty to disclose the contingent commission agreement, also seems to fly in the face of a regulatory requirement for disclosure. Circular Letter 22 issued by the New York Insurance Department in 1998 imposes a regulatory requirement that all special or extra compensation arrangements between carriers and a broker must be disclosed to customers. The Hersch Court makes no mention of this requirement.

Given the significance of the issues it roils, the Hersch decision is remarkably short (three paragraphs). We will have to wait and see if the decision is appealed, but until the Court of Appeals rules otherwise, it appears that contingent commissions can once again be discussed openly in polite circles – at least in New York’s First Department.

In a recently published article, “Is Arbitration a Trap for The Unwary Insurance Agency?”, February 2007, I warn that arbitration does not provide a level playing field to insurance agencies in disputes with carriers, and urge the brokerage and agency community to expand the pool of qualified and available arbitrators knowledgeable on agency issues.

The impetus for the article was an arbitration between an agency with a small but profitable and fully reinsured program and the insurer of the program. The issues before the arbitrators included the circumstances of the termination and the treatment of the agency following termination. The arbitration resulted in an award by a majority of the three arbitrators denying the agency’s claims, but without any explanation. The dissenting arbitrator, however, issued an unusual written dissent stating that the majority had failed to apply custom and practice in its decision, and misapplied the law. As I note in the article, this dissent should be required reading for all insurance agencies and program managers concerned with resolving disputes with their carriers. Because of its importance, a copy of the award and dissent in The Garn Group v. Arch Insurance Company dated December 7, 2006 can be accessed in pdf format through this link.

A recent Appellate Division decision has again raised the question of what exactly is the New York Liquidation Bureau — a state agency, subject to all the oversight imposed on any other state agency, a private employees of the Superintendent of Insurance in his fiduciary role as receiver of insolvent insurers, or some other kind of hybrid?

As early as 1988 the lower courts of New York had held that the Liquidation Bureau was not a state agency and therefore not subject to the Freedom of Information Act. See Consolidated Edison Company of New York, Inc. v. The Insurance Department of the State of New York, 532 NY Supp.2d, 140 Misc.2d 969 (Sup.Ct., NY County, 1988). Thus when the State Comptroller sought to audit the activities of the Liquidation Bureau and issue subpoenas to Liquidation Bureau personnel, the lower court quashed the subpoenas under the Con Ed line of cases. The Appellate Division, First Department, however, has overturned this decision and reinstated the subpoenas concluding in a 3 to 2 decision that the Superintendent of Insurance is a State Officer, and the Liquidation Bureau is therefore carrying out the functions of a State Officer. Hence it is a State Agency subject to audit by the Comptroller. Serio v. Hevesi, 2007 NY Slip Op 01820 (App. Div., 1st Dept., March 6, 2007). The decision can be obtained from the New York Unified Court System web site at www.nycourts.gov/decisions, or by contacting me at pbickford@pbnylaw.com.

The core of the majority opinion is that as a State Officer, the handling of any funds under the Superintendent’s control are subject to audit by the Comptroller. The dissent disagrees, however, stating that the funds of insolvent insurers are private funds “owned” by the creditors and policyholders of the estates, and are not State funds. In this capacity, the Superintendent is a fiduciary subject to the oversight of the Courts, not the Comptroller. The reach of the majority decision, however, could extend far beyond this one issue, and it is quite likely that the decision will be appealed to the Court of Appeals. Stay tuned!