The latest news on the Unicover debacle.

When Moody's last commented on the Unicover situation in December of 1999, we asked whether the principal parties could find a way to turn a mountain back into a molehill. At that time, we believed that the combination of potential losses and the unsavoury tinge of Unicover involvement would most likely drive the majority of the participants toward a resolution. We felt that a resolution would limit the total business booked under Unicover, mitigate the gains to the primary ceding companies, and moderate the losses for Unicover's many layers of reinsurers. Those predictions have at least partially come to pass.

The bulk of the Unicover developments in 2000 can be summarised as follows:

  • the Unicover facilities did ‘shut down' prior to their contractual termination. Generally, no new ‘Unicover business' was written after 31 December 1999. This decline in premium writings did help to limit the total losses in the convoluted reinsurance pipeline;

  • the current amount of pre-tax Unicover-related charges aggregated for many of the primary participants still exceeds $1.1bn, however. The majority of the charges were announced in early 2000 and pertained to calendar year 1999, although continuing arbitration raises the spectre that further charges and legal and administrative expenses, at a minimum, may yet be looming. At least one company took an additional charge later in 2000, and some companies still have not provided for any potential losses that might arise from their Unicover involvement;

  • most of the rating reviews and negative outlooks that were precipitated as a result of Unicover involvement have been confirmed or moved back to stable, respectively. Two notable exceptions include primary companies that have encountered severe financial difficulties. Unicover charges were a contributing factor to the companies' problems;

  • two of the Unicover facilities (the Reliance and Lincoln National facilities) have been settled and, as far as we know, finalised. Generally, the settlements served to mitigate the gain to primary companies while forcing the reinsurers (including the pool facilitators) to fund a portion of their losses (typically based upon the present value of their anticipated future obligations);

  • the participants in the other major pool – the Unicover pool – are involved in the arbitration process to settle contract and coverage disputes with their reinsurers. Many of these participants have taken charges in an effort to account for their anticipated exposure. Further, various court cases and arbitration proceedings are ongoing further down the reinsurance chain. In Moody's view, the adequacy of the charges taken thus far will probably remain uncertain until a comprehensive final settlement is reached.

    Arbitration proceeds
    Various involved parties are currently arbitrating the status of the Unicover pool. Arbitration hearings have been set for early 2002 and a final decision will be rendered sometime thereafter, possibly later that year. Various other legal disputes and arbitration proceedings are underway among retrocessionaires further down the reinsurance pipeline. Some participants may elect to carry on to the end of the arbitration process, but Moody's believes companies may be motivated to pursue individual settlements along the way.

    Factors that might motivate individual settlements include:

  • a desire to avoid the opportunity cost of management time spent addressing past mistakes;

  • cash incentives to settle will intensify as claims start to flow through the system (this will increase the pressure on the primary insurers, or the pool participants, to settle and collect from their retrocessionaires);

  • litigation and administrative costs that will continue to mount and drive parties toward a settlement; and

  • pressure from stakeholders to end arbitration could mount – particularly for newly demutualised insurers.

    As is the case with all legal actions, it is impossible to predict the timing or ultimate result of the present arbitration. Considerable uncertainty will remain regarding the final results of these legal actions until a final decision or settlement is reached.

    On 19 November 1999, Moody's Investors Service attributed a string of recent rating actions to looming underwriting losses and credit risks stemming from some companies' involvement in the Unicover pool and other workers' compensation programs brokered by Unicover Managers, Inc (collectively, the Unicover facilities). Unicover exposure was, in some of these cases, one of a number of credit concerns facing the company for which a rating action, or change in rating outlook, was taken. At that time, Moody's cited outlook changes for three companies and reviews for potential downgrade for four companies.

    The table on the next page provides an update on each of the seven companies for whom Moody's took a rating action or changed our outlook. In that same press release, we cited four additional companies whose exposure was evaluated, but for which a rating action did not result. Those companies are included in the table on this page.

    Moody's recognises that the companies listed in the table overleaf are only a subset (albeit a substantial subset as measured by exposure) of the companies that were involved in some fashion with the Unicover facilities. We also rate several additional carriers with Unicover exposures that we believe to be more modest. In some cases, Unicover losses may have reached large insurance organisations through relatively small and not very well known subsidiaries. In all likelihood, however, the companies listed below account for the bulk of the exposure.

    The tables invite several observations:

  • the size of the overall charge, which is certainly underestimated by the $1.1bn sum of figures shown in the above table (owing to the carriers not included and still unresolved legal disputes) is solidly within the $1bn to $2bn estimates that circulated through the industry in 1999;

  • the effects of Unicover in isolation have not yet led to any rating downgrades. The size of the charges, while meaningful, were generally within tolerable limits for the companies whose outlook was moved back to stable. We believe that most of these companies have since taken concrete actions to improve their risk management practices. In some cases, such as Sun Life and Phoenix Home Life, the companies have exited the reinsurance business altogether. In other cases, the company was already out of the business but remained liable for business previously written; and

  • the two property/casualty companies on the list – Reliance and Fremont – both encountered substantial financial difficulties in 2000. Reliance defaulted on its debt and its principal insurer is operating under regulatory supervision. Fremont's property/casualty company also came under regulatory scrutiny in 2000. In both cases, involvement with Unicover was a contributing factor to their difficulties, although other matters such as loss reserve inadequacies and underpriced business were the principal problems.

    Limited carve-out market
    The pricing inadequacies inherent in the Unicover facilities helped to fuel and sustain a soft primary workers' compensation market in many parts of the country during the latter part of the 1990s. Essentially, the Unicover facilities channelled the flow of capital from reinsurers and retrocessionaires to primary companies, and particularly to employers who benefited greatly from low workers' compensation rates during that time. A quick analysis of the industry's aggregate workers' compensation results illustrates this point.

    Based on our review of the initial accident year 2000 results that are now becoming available, we believe that ceded loss ratios in 2000 will be much closer to the direct, or gross, loss ratios.

    After several years of steadily increasing, direct loss ratios may also begin to show meaningful signs of improvement in 2000. Calendar year results may show deterioration, however, if adverse loss development materialises.

    The resolution of the Unicover facilities is an important contributing factor to the (anticipated) decline in ceded loss ratios in 2000. As far as Moody's is aware, most of the parties which were involved in Unicover have either stopped, or severely curtailed, their involvement in low-layer workers' compensation carve-out business.

    It is possible that some life insurance companies will continue to take part in high, catastrophic layers of workers' compensation reinsurance protection. It is the low-layer reinsurance market, however, that caused the problems associated with Unicover.

    The workers' compensation market is generally improving across the nation. California, the largest and, until recently, most troubled market, has seen substantial rate increases ranging from 20% to 40% and more in the past year. Of course, this follows a period where most market participants were reporting combined ratios in the range of 140%.

    With loss severity increasing at a steady 10% to 15%, it is not yet clear whether 2000 will produce a positive result for the carriers writing in the California marketplace. Moody's is of the opinion that many of the carriers now stepping in to fill the void left by prominent failures and market withdrawals may face a year of losses before they see the benefits of the ongoing rate increases.

    The absence of inexpensive reinsurance has served to force pricing discipline on a marketplace that spent several years gorging at the reinsurance trough. The very prominent and public unwinding of the Unicover facilities helped to expedite the rate hardening process. We expect that although history will probably repeat itself at some point, the Unicover debacle was sufficiently large and painful that several years of discipline will pass before we move beyond the point of insurers' notoriously short memories.

    Core business
    Moody's insurance financial strength ratings speak to the ability of a company to honour its policyholder obligations. Importantly, the ratings cannot speak to the company's willingness to pay claims.

    It is common practice in the insurance and reinsurance industry to question, investigate and negotiate claim settlements rather than to simply pay claims as presented. Where coverage uncertainties exist, or where questions related to fraud or bad faith are evident, insurers rarely fail to deny coverage – at least initially. This time-honoured practice is clearly illustrated in the Unicover situation.

    The Unicover debacle serves as a cautionary tale for re/insurers looking to establish relationships with counterparties that are venturing outside of their core lines of business. Core lines of business are those to which an insurer or reinsurer has dedicated substantial fixed resources. A core business serves customers where the re/insurer intends to make a market for the medium to long term. These factors were clearly missing in the Unicover situation, and many parties which thought they were adequately reinsured are still expending substantial time and financial resources to collect their money.