Long term care carrier battles with reinsurer

Dispute sheds light on role of reinsurance in industry's financial health

Sep 1, 2008 @ 12:01 am

By Darla Mercado

A $100 million-plus contractual dispute between a Pennsylvania insurance company and its Bermuda-based reinsurer highlights the crucial — yet lightly regulated and often opaque — role of reinsurance companies in the financial stability of insurers. The dispute involves long term care insurer Penn Treaty American Corp. of Allentown, Pa., which claims that the Dublin, Ireland-based Imagine International Reinsurance Ltd. unit of Hamilton, Bermuda-based Imagine Group Holdings Ltd. breached its contract last month by reneging on a promise to provide additional letters of credit to back long term care policies issued before 2002. Imagine said it is responsible only for the $112 million it has paid Penn Treaty, while the insurer says it is due $140 million, Cameron Waite, executive vice president of strategic operations, said in a conference call last week. Imagine charges that Penn Treaty failed to push through a required rate hike, thereby nullifying the contract. A second contract between the two companies, covering policies written after 2005, is not affected. Penn Treaty also said that its policyholders remain protected and unaffected by the dispute. Last week, the companies said they would enter arbitration to settle their claims, but their disagreement sheds light on the limited reach of regulators among reinsurers. It also exposes the risks borne by a carrier and its policyholders if a reinsurer backs away from its obligations. "For reinsurers to step away or fail to post collateral can have a detrimental effect on carriers' balance sheets and hurt their risk-based capital, which ultimately will bring in the regulators," said James R. Potts, a partner with Stradley Ronon Stevens & Young LLP in Philadelphia. While contracts between insurers and their customers are the focus of state insurance regulators, contracts between insurers and reinsurers are considered commercial transactions outside the jurisdiction of regulators. Special reinsurance companies, or the reinsurance units of large insurance companies, are in the business of insuring other insurance companies. The business permits risk concentrated at one carrier to be spread over a wider financial base, providing greater stability to all parties.

When reinsurance disputes arise, the ceding insurer, or the company that gave up the risk, can sue the reinsurer in a court of law to enforce its obligations, said Steven M. Goldman, New Jersey's insurance commissioner and chairman of the Kansas City, Mo.-based National Association of Insurance Commissioners' reinsurance task force.

"Provided that there's no risk to the ceding company or reinsurer with respect to solvency, it plays out like any court case," he said.

In extreme cases, such as when an insurance company's future is threatened if a reinsurer steps away, regulators can act as mediators to facilitate a resolution, but they have no ability to demand that reinsurers pay up, Mr. Goldman said.

In some cases, reinsurance can make up a substantial portion of an insurer's assets. In fact, as long as a reinsurer is able to cover its portion of an insurer's losses, the carrier has to report only the uncovered portion as a liability on its balance sheet.

But since losses paid for by a reinsurer are considered a reduction of liabilities, the failure of a reinsurer to post its collateral results in those liabilities' showing up on the insurer's balance sheet.

Ultimately, a carrier can get hurt if its solvency depends on a reinsurer's coverage, said Joseph M. Belth, professor emeritus of insurance in the Kelley School of Business at Indiana University in Bloomington.

Depending on the financial health of the reinsurer, state insurance departments may disagree over whether they consider reinsurance an asset, he added.

In the worst-case scenario, excessive dependence on reinsurers can push carriers into regulatory trouble, as was in the case of Legion Insurance Co. of Philadelphia.

The health-and-accident carrier reinsured so much of its business that it became dependent on the reinsurers' timely claims payments for liquidity. Regulators became so concerned about the insurer's financial health that Legion wound up being liquidated by the commonwealth of Pennsylvania in 2005.

Because of the potential for future problems, ratings agencies don't look favorably on carriers' doing battle with a reinsurer. News of the Penn Treaty-Imagine dispute led New York-based Standard and Poor's last week to revise its outlook for Penn Treaty Network America Insurance Co., a Penn Treaty subsidiary, to "negative," from "stable."

Relationships with reinsurers play an indirect role in ratings determinations, noted Joel Levine, a senior vice president at Moody's Investors Service of New York.

"We generally aren't fussed about it in the normal course of business, but it can affect a company from the standpoint of the capital position," he said. For carriers whose capital is affected by its reinsurer's failure to meet its obligations or for those that don't divide risk among many reinsurers, a negative rating may be waiting in the wings, Mr. Levine said.

Agencies also pay attention to reinsurance when they look at a carrier with risky business lines such as variable annuities.

"There, many companies have issued products with guaranteed living benefits, so the extent to which you have reinsurance with a good reinsurer can help reduce the risk profile of the company," Mr. Levine said.

But if a carrier with these products got into a contractual dispute with a reinsurer and lost coverage, the company could have a hard time replacing it, he added.

There are some measures in place, however, to encourage contractual compliance. Many states, for instance, require non-U.S. reinsurers to post 100% collateral against their liabilities and agree to be subject to U.S. legal jurisdiction, Mr. Goldman said.

Currently, the NAIC's reinsurance task force is drafting a regulatory framework to address state supervision of reinsurers. But for now, regulators are placing the responsibility on the carriers to make sure their relationships with reinsurers don't jeopardize their financial health.

"The principal issue for regulators is to ensure the companies that write risks have the financial wherewithal to pay claims," Mr. Goldman said.

E-mail Darla Mercado at dmercado@investmentnews.com.

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