Re/insurers are counting the cost of their exposure to Enron's collapse
In Hans Christian Andersen's fairy tale The Emperor's New Clothes, two scoundrels convinced an emperor that they could weave cloth that was invisible to anyone who was “unfit for his office or unpardonably stupid.” Of course, since no one – including the emperor – wanted to appear stupid, everyone agreed they saw a stunning new suit made from the magical material, and the tailors were rewarded with several bags of gold. Thus the emperor pranced about naked until finally, a boy pointed out that the emperor really had no clothes on; this saved the kingdom from more loss of gold to the swindlers, and saved the monarch further erosion of his subjects' trust.
In the real-life tale of Enron, however, the scoundrels appeared to have conspired with the emperor, spinning such convincing stories of the creation of an innovative and dynamic energy market that the financial mavens and watchdogs, spellbound, willingly showered gold and approval on the company. In a little more than 15 years, Enron transformed itself from an unexciting, regulated natural gas company into a world-class energy trader, with 21,000 employees producing billions in profits.
Few, if any, analysts, auditors, regulators, underwriters or investors wanted to appear “unpardonably stupid” and question the financial strength of the shimmering enterprise, and the stock shot up to $85 a share. Prestigious organisations far and wide honoured Enron as an outstanding company. Its CEO hobnobbed with the president of the US. Millions of dollars went into political campaigns.
Finally under pressure, Enron's gossamer fabric ripped in December revealing a company that had veiled its lack of for years. The stock fell to pennies, and the energy, banking and insurance industries were left with the tattered remnants of a bankrupt Enron, which with debts of $18bn could make it the biggest bankruptcy in US financial history.
While only preliminary estimates are available of how much Enron's failure will cost the life and P/C re/insurance industry, banks and investors, the total could reach $6.3bn or more. According to Fitch rating agency, P/C re/insurers, alone could have losses of at least $2bn against directors' and officers' policies, surety bonds and financial guarantees. Some life companies and re/insurers also have Enron stock and bonds in their investment portfolios which will lose most of their value.
Lack of analytical data
As of mid-December, the world's largest reinsurers have either not had ample time to review their policy and investment portfolios or do not have meaningful losses regarding the failure of Enron. None of the big four reinsurers – Munich Re, Swiss Re, General Re or Employers Re – have announced they have any significant losses from either assuming risk from primary insurers, partnering with Enron-brokered derivatives or in their investments.
Primary insurers have quickly revealed their involvement in the collapse of Enron. Chubb Corp says it could have a maximum net pre-tax exposure with outstanding surety bonds of about $220m. Surety bonds are monetary guarantees that pay the bondholders if the issuing company defaults, and are often used to improve a firm's credit rating. Chubb hasn't revealed any other exposure to Enron, such as directors' and officers' liability, which indicates reinsurance and reserves may cover any of these losses should they occur.
The St Paul Cos, one of the largest underwriters of surety bonds in the US, says its principal insurance exposure, net after tax, is $64m in face value from surety bonds, including gas supply bonds, financial guarantees and standard construction bonds. The company could pay out $19m in treaty reinsurance and directors' and officers' liability insurance. In addition, it has reported that it has about $23m par value of Enron corporate senior unsecured debt.
CNA Surety Corp estimates that its net exposure, reduced by the anticipated payments from reinsurance treaties, for outstanding surety bonds issued to Enron companies is approximately $8m pre-tax and $5m after tax.
XL Capital Ltd after an early review of financial guaranty, weather risk trading and investment exposures to Enron believes it has only minimal exposures in these areas. The company continues, however, to monitor other possible losses from its property and casualty insurance and reinsurance businesses.
ACE Ltd, after reviewing its directors' and officers' liability, financial guaranty, weather risk trading and other lines, says it has no substantial Enron exposures.
The Hartford Financial Services Group, Inc expects to record an after-tax loss of approximately $40m from sales and write-downs of Enron and related securities. It also said it had an estimated maximum exposure after taxes and net of reinsurance of about $12m from surety bonds and directors' and officers' insurance, and $8m from assumed reinsurance.
Axa has indicated that it holds bonds and assimilated products of Enron totaling about $177m.
Fortis's exposure to Enron amounts to $67m and relates to the investment portfolio of Fortis's insurance business in the US and the credit portfolio of Fortis Bank. The life insurance industry has about $1bn in exposure to Enron. John Hancock Financial Services Inc has the largest – about $320m, of which about a third is secured.
Other potential losses
Other large potential losses include $172m at Principal Financial Group; $62.6m in long-term bonds at MetLife Inc; $24m in unsecured direct debt holding at UnumProvident Corp; and $22.9m at Allmerica Financial Corp. Lincoln National Corp has $25m in exposure and $70m at two Enron subsidiaries that are still rated investment grade. ING Groep says it has an unsecured exposure of $195m to Enron – $130m in unsecured bank exposure and $65m in unsecured bonds.
Though specific losses have not been determined, AEGON confirms that its gross loan exposure to Enron and affiliated entities will be approximately $300m, which will be charged to default reserves.
Ambac Financial Group Inc has insured $37m of bonds for Portland General Electric, a Enron subsidiary, while MBIA Inc has about $40m of exposure to that company. Other bond insurers are also exposed, but haven't yet made estimates on any losses.
While the known losses to re/insurers can be broadly quantified, still to come are the possible payouts re/insurers may have to make resulting from several lawsuits that have been filed relating to Enron's failure.
Arthur Andersen, Enron's accounting firm, is seen as the best chance by employees and investors to recover some of the $80bn lost in the freefall of Enron's stock. A suit for $1bn has been filed against Andersen by members of Enron's retirement plan for losses they suffered. The suit alleges Andersen “knowingly participated in Enron's breaches of fiduciary duty” by covering up accounting manipulations by Enron that overstated its profits by $586m, and failed to include $2.6bn of debt over a three-year period.
A spokesperson for Milberg Weiss Bershad Hynes & Lerach, an active plaintiff class-action law firm, said, “Andersen is going to be up to its eyeballs here.” Payments, possibly in the millions, from suits against the accounting firm could be partially paid by errors and omissions insurance policies covering its accountants. And while the re/insurance industry certainly did not need the Enron claims on top of the at least $40bn from the WTC attacks, observers don't expect the losses to affect drastically the financial status of the industry.
Specific market impact
Loretta Worters, vice-president, Insurance Information Institute, said the Enron fall – out will have an impact on the insurance industry, but not so much on companies' bottom lines as on specific markets, such as surety and D&O. Actually, the demise of Enron will open certain markets, weather and credit insurance and derivatives to other insurance markets.
Ms Worters speculated D&O rates may increase, but it is unlikely to be an across-the-board increase, as premium rates are not broadly influenced by one particular incident. “Insurers may require their insureds to take higher deductibles and have co-insurance in place to obtain D&O coverage,” she said, “especially for companies that resemble Enron.”
Certainly, insurance underwriters in the future will not be so eager to issue surety bonds or write D&O coverage without examining very carefully how a company manages its business risk, Worters said. “Underwriters will be more concerned with the total financial disclosure of a company,” she said, “and be more sceptical of reports and audits from accounting firms that don't provide easy-to-understand explanations of intracompany transactions.”
Morgan Stanley's Alice Schroeder, in a research note, said the losses from Enron's collapse would be material, but not devastating for the industry. “This event is likely to exacerbate the (reinsurance) capacity shortfall in the market that already exists, making 2002 one of the more, if not the most, powerful pricing years in recent history,” she said.
Fitch noted in a statement that it is too early to assess individual company exposures to Enron, but coming in the wake of the events of September 11, Enron's problems will send reinsurance rates up dramatically.