The final foundering of Trenwick shows how the future of reinsurers is not just in their own hands, but also those of the regulators, investors and ratings agencies. By Sarah Goddard.
Over the last few months, it has increasingly been a question of not if, but when Trenwick would finally breathe its last. At the sake of further flogging an overused phrase, the demise of Trenwick appears to be a textbook example of 'the perfect storm', with growth in soft markets, plummeting asset values and a jittery investment community all playing their part.
Doubts over sustainability
But question marks over Trenwick's sustainability are not necessarily new. Despite the recent gush of headlines asking 'Trenwick: is it the end?', uncertainty had been surrounding the business for a number of years. In Trenwick's 2001 report and accounts, Chairman, President and Chief Executive Officer James F Billett Jr, commented: "Last year at a speech in Bermuda addressing the huge devaluation of our currency, I paraphrased Mark Twain by saying, 'Reports of our death had been greatly exaggerated.'" During the course of 2001, Trenwick's share price fell 59%, which while perhaps not terminal, does not exactly reek of rude health. Like many of its peer group, Trenwick took a big hit from September 11, with losses topping the $140m level, but the year also saw a $110m reserve strengthening exercise, and these problems - alongside the high levels of bank debt it was carrying - meant Trenwick was not a contender in the capital-raising frenzy post-WTC.
Even so, Trenwick's management team was confident at the time that the business could strengthen its position in the hardening market and through the international spread of its various subsidiaries. These companies had been acquired by Trenwick as part of its 'big push' of the late 1990s. Trenwick's expansion plans included establishing a European presence, and in 1998 Trenwick Group, the holding company for Trenwick America Reinsurance Corp, bought Sorema UK, the London market business of the French reinsurer which was subsequently purchased by SCOR from Groupama. In 1999, Trenwick acquired Chartwell Re Corp, which not only brought on board North American reinsurance operations, but also opened up Trenwick's exposure to the Lloyd's market through Chartwell's managing agency operations, previously known as Castle and Archer. At the time the acquisition was announced, Chartwell Managing Agents Ltd was running the business of eight Lloyd's syndicates. Several of these syndicates had proved problematic in the past, leaving certain years of account open beyond their normal closing date because of uncertainties in their exposures. Subsequent to the purchase, five syndicates were merged into one, Trenwick set up a new syndicate with Swiss Re for blue water hull risks, two syndicates were purchased by another managing agency, Greenwich, and the combined syndicate, 839, started writing a marine binder for another Trenwick subsidiary, Specialist Risks Underwriters Ltd.
While all this activity was happening in Europe, Trenwick was hardly twiddling its thumbs on the other side of the Atlantic. As well as Lloyd's operations, the Chartwell Re acquisition resulted in the formation of Canterbury Financial Group, a Stamford, CT-based insurance holding company, to add to the Trenwick stable. Through its subsidiary companies, Canterbury wrote property and casualty programs in the US, on both an admitted and non-admitted basis, and The Insurance Corp of New York (INSCORP), Dakota Specialty Insurance Co and Chartwell Reinsurance Co became Canterbury subsidiaries. At the time of Canterbury's formation, INSCORP had total assets of $440.8m and a statutory surplus of $141.1m, Dakota had assets of $29.5m and statutory surplus of $27.4m, and Chartwell Re had assets of $599.1m and a statutory surplus of $268.3m. At the time, they were all rated A (Excellent) by AM Best and A+ 'financial strength' rating by Standard & Poor's.
2000: Bermuda move
The fourth quarter of 1999 proved exceptionally busy for Trenwick, with the further addition of Bermudian catastrophe specialist LaSalle Re Ltd to its ever-burgeoning roster of acquisitions. Trenwick also decided to move its headquarters to Bermuda, which Mr Billett described in early 2000 as a move which would "afford Trenwick additional financial flexibility and opportunities to develop new business products." Concurrent with this, Trenwick was actively repurchasing stock, "at prices which represented substantial discounts to book value," said Mr Billett. All these moves, he said, had repositioned Trenwick as "a large, diversified underwriting organisation that can grow and take advantage of future business opportunities on multiple fronts in the worldwide insurance and reinsurance markets."
Nevertheless, despite all this growth, Trenwick managed to post a consolidated net loss for the year to end 1999 of $11m, compared to a profit of $34.8m for the previous year. This loss, Trenwick stated, was due to $8.5m in catastrophe losses, restructuring costs due to the Chartwell acquisition and $18.7m in reserve adjustments. The consolidated assets following the Chartwell and LaSalle Re acquisitions were estimated at around $4bn, with more than $850m in shareholder equity and $1.1bn in total capitalisation.
Fast forward less than four years, and the story has taken a pitiful turn. Trenwick's 10-Q filing of 20 August for the quarter ended 20 June 2003 makes sorry reading indeed, culminating in the statement: "Trenwick believes that it is unlikely that any of the holders of the shares of Trenwick or of its wholly-owned Bermuda subsidiary, LaSalle Re Holdings Ltd, will receive any return on their investment in the near term if at all." With Trenwick shares trading at $0.03 on that day, compared to $4.20 a year before and a 52-week high of $5.59 (11 September 2002), Trenwick's assertion seems pretty well-founded.
On the same day the 10-Q was lodged with the US Securities and Exchange Commission, Trenwick filed for Chapter 11 protection in the bankruptcy court in Delaware, and applied to the Supreme Court in Bermuda for winding up procedures to begin.
Mark Rouck, the Fitch Ratings analyst who covered Trenwick, put the group's demise down to "a convergence of several factors." Trenwick, he said, had been "cobbled together" through a series of acquisitions which included the group assuming bank and other debt. At the time Trenwick was expanding the business, the international re/insurance sector was languishing in the doldrums of the soft market, and, like a not inconsiderable number of its competitors, Trenwick was putting underpriced business on its books, while its back year reserves were proving inadequate. With the huge losses the LaSalle operation in particular sustained from WTC and the tough credit markets of last year which made it impossible for Trenwick to refinance, there were few options for the business. Trenwick sold its LaSalle Re renewal rights to its 'Class of 2001' compatriot Endurance through a 100% quota share arrangement, which freed up some capital to deal with the high levels of bank debt and gave Trenwick a 25% ceding commission and a 50% profit share if losses did not go above a 45% loss ratio. But the hunt for new capital proved fruitless. A brief venture with Chubb Re, through which Trenwick American Reinsurance Corp could write up to $400m of US reinsurance business on Chubb paper, set up in the fourth quarter of 2002 and due to continue throughout 2003, did not survive the first half of this year. At the same time, the Canterbury operations were put into run-off, as was the London market business called Trenwick International, and Trenwick America Re, and the management of Trenwick's Lloyd's operations were deep in talks with the Bermudian parent to buy out the only remaining operating unit in the group.
"Trenwick tried the best they could to continue to participate," said Mr Rouck. But despite the current, favourable hard market conditions, "they couldn't carry on any longer."
This was to no small extent due to regulatory pressures, particularly in the US. The 10-Q lays bare the stance taken by state regulators, in particular in Connecticut and New York, who were unconvinced about the viability of the business going forward. In the 10-Q, Trenwick notes: "Trenwick has entered into letter agreements with the insurance departments of the states of Connecticut and New York which restrict Trenwick America Re and INSCORP from taking certain actions such as paying dividends."
INSCORP had, in fact, entered into a letter of understanding with the New York regulator which stipulated a number of requirements:
Under the agreement, senior Trenwick management meets regularly with the NYID, as well as providing monthly financial statements. However, about $26m in loans made to Trenwick America by INSCORP in 2002 were in contravention of New York regulatory requirements, according to the NYID, and both organisations are potentially facing regulatory action as a result.
There is no arguing that Trenwick tried its best to restructure the burden of debt constantly pulling the business down, but with no success. When Trenwick took on LaSalle Re in September 2000, the group entered an amended $490m credit agreement with a number of banks, guaranteed by LaSalle Re. This comprised a $260m revolving credit facility and $230m letter of credit, the former of which was subsequently converted into a four-year term loan and repaid in June 2002. On Christmas Eve last year, the letter of credit, used to support Trenwick's Lloyd's operations, was reduced to its current level of $182.5m. Alongside the credit agreement, Trenwick guaranteed Trenwick America and Trenwick Holdings with the capital stock of LaSalle Re Holdings, using LaSalle Re as collateral for the banks, subject, of course, to certain conditions including the rating of Trenwick companies. On 18 October last year, rating agency AM Best downgraded Trenwick's operating subsidiaries to B+ or B, falling beneath the vital A- barrier and thus constituting a default event. Simultaneously, reserve increases for unpaid claims and claims expenses, as well as a deferred tax asset valuation allowance, meant that Trenwick fell beneath the minimum tangible net worth and risk-based capital levels in the credit agreement.
On 13 November, the banks and Trenwick reached a forbearance agreement, subsequently amended on December 24, including the amendment for the Lloyd's letter of credit. These so-called 'December amendments' included the extended letter of credit to keep the Lloyd's business operating, an agreement to pay 5% per year cash letter of credit fee, issue pay-in-kind notes bearing interest at LIBOR plus 2.5% per annum, issue warrants equal to 10% of Trenwick's fully diluted equity capital, and pay 15% of profits earned by Trenwick and its subsidiaries for the Lloyd's 2002 and 2003 years of account.
Other provisions in the amendments included Trenwick being prevented from declaring or paying any dividends, selling any assets or property, reporting regularly to the banks and adjusting certain financial covenants downwards.
It is these December amendments which have proved Trenwick's final death knell. Among the conditions in them was the requirement that Trenwick collateralise 60% of the outstanding letters of credit with cash, equivalents or marketable securities by the beginning of August this year. The deadline came and went without the requirement being met, meaning under the amendments that from that point, all Trenwick underwriting business had to be approved by the banks in advance. In addition, Trenwick is now required to do its best to terminate the letters of credit by the end of this year.
In fact, the Lloyd's operation - soon to be renamed - is the only part of Trenwick still actively trading, and the management team there, led by Michael Watson, has teamed up with new private equity investor Englefield Capital LLP to buy out the business. Englefield's Adam Barron said the attraction of Trenwick's Lloyd's business includes its strong management team, in place since 2001, which, he said "has done a very good job of stabilising the business." By contrast, several members of the Trenwick Group senior management team, including James Billett, are no longer with the organisation. In addition, said Mr Barron, the Lloyd's operation has a "good second level of management and a good company underwriting franchise." By mid-October we should know whether these are sufficient for Englefield and the touchingly-named Magicsunny Ltd (a holding company owned by the MBO team and the private equity investors, but disappointingly expected to be renamed Talisman Holdings), to reach an agreement with Trenwick Group.
An agreement which has been recently made, however, is the sale of Trenwick International to LCL Acquisitions Ltd, part of the London-based Litigation Control Group, through Bestpark Ltd. According to the 10-Q, the consideration for this was £2m, and it relates solely to Trenwick's London market (ex-Sorema UK) rather than Lloyd's business. The UK regulator, the Financial Services Authority approved the change of ownership, and Philip Holden, director of the LCL Group, said in a statement: "I am confident that (the transaction) will be welcomed by TIL policyholders and also by the employees of Trenwick Management Services Ltd (TIL's service company) who will now be working as part of the LCL team in dealing with the orderly run-off of TIL."
For many months now, the issue of the collectibility of reinsurance has been exercising the industry, not least because of the exposures some organisations have to the now defunct Trenwick. In turn, Trenwick assessed that at the end of June 2003, it had reinsurance recoverables of around $1.8bn on its books. In the 10-Q, Trenwick somewhat ironically stated: "Our subsidiaries are subject to credit risk with respect to their reinsurers because the transfer of risk to a reinsurer does not relieve the insurers of their liability to the insureds. In addition, reinsurers may be unwilling to pay our insurance company subsidiaries even though they have the financial resources and are contractually obligated to do so. Unfavourable arbitration decisions or the failure of one or more of the reinsurers to honour their obligations or make timely payments would impact our subsidiaries' cash flow and could cause us to incur significant losses."
In an ever greater irony, a post-WTC dispute between Trenwick and a Swiss Re subsidiary, European Reinsurance Co of Zurich, could result in the latter taking control of Trenwick. When Trenwick bought LaSalle Re in September 2000, it also took over a $100m equity catastrophe put option from European Re. Post-WTC, when LaSalle Re faced more than $140m in cat losses, Trenwick called on the option, but European Re contested the claim. Eventually the two organisations restated the agreement in September 2002, so that European Re purchased 550,000 Series B shares in Trenwick, with a liquidation preference of $100 per share, for an aggregate purchase price of $40m. These are convertible into common shares after five years, or if there are "special conversion events", or if Trenwick did not maintain certain capital levels. It is almost unnecessary to state that the capital levels were breached, and European Re now is in a position where it can convert its Series B shares into Trenwick common shares with 60 days' notice. At the time of writing, the two organisations are disagreeing on just what percentage of common shares the conversion would involve, but even at the lowest figures, Trenwick stated in its 10-Q: "If European Re converts its Series B Preferred Shares, there would be substantial dilution to the holders of the common shares, and this conversion could result in European Re obtaining control of Trenwick."
According to documents, Trenwick has assets of $154.4m and £288.9m in debt, and in payment terms, it is banks before shareholders. Trenwick's filings to the Delaware bankruptcy court show the extent of certain banks' exposure to Trenwick. Bank One Trust Co has filed a $76.9m claim on 6.7% unsecured notes. Trenwick's failure to meet payments on these had triggered a default on the $185m unsecured letters of credit led by JP Morgan Chase & Co. MBIA Insurance Corp has a $56.4m unsecured claim against the notes. Other banks involved with Trenwick debt and financing include EquiServe Trust Co NA, Wachovia Bank and Fleet National Bank.
No doubt, the complement of players and the unravelling of the plot of the demise of Trenwick has a long way to go yet, but it appears that it was the perfect storm that blew over the good ship Trenwick.
By Sarah Goddard
Sarah Goddard is the editor of Global Reinsurance.