Reliance: Anatomy of a Failure

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RelianceAnatomy of a Failure

• Robert Klein
• Dept. of Risk Management Insurance
• Georgia State University

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Reliance Facts Issues

• Large, prominent financial conglomerate with
  significant property-casualty operations (top
  10).
• Aggressive acquisition expansion strategy.
• Ambitious, controversial CEO Saul Steinberg.
• Troubles became apparent in 1999.
• Attempts at restructuring failed.
• Placed in receivership May 2001.
• Questions about regulatory performance.
• Disputes/lawsuits over receivership.
• Watershed insolvency significant implications.

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Contributing Factors

• Aggressive growth strategy in soft markets
• Cut-rate pricing
• Lax underwriting
• Under-reserving
• Fronted for WC group Unicover
• High debt load
• High expenses
• Others?

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A.M. Best Evaluations

• 1998
• Based on Reliances earnings momentum, improved
  asset quality capital strength, reduced
  financial leverage debt service obligations,
  Rs rating outlook is positive.
• Partially offsetting these strengths are Rs
  high underwriting, investment, financial
  leverage high expense ratios large equity
  non-investment grade bond holdings.
• 2000
• The rating assignment (B under review) follows a
  review of the groups financial condition, its
  strategic shift from active operations to an
  asset sale/run-off mode for many of its units
  an its unsuccessful acquisition by Leucadia
  National.
• will not be able to refinance its bank
  facility public debt maturing in 2000
• increased uncertainty related to its loss
  reserve adequacy reduced liquidity margin
  stemming from negative cash flows

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A Rapid Descent A.M. Best Ratings
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Leverage and Capital Adequacy
Decline into the Abyss Surplus (B)
?
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Change in NPW ()
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Net Premiums Written/Surplus
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Other Leverage Measures
Acceptable Range lt 5-7
Acceptable Range lt 4-6
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Profitability and Performance
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Operating Cash Flow
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Reserves
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Assets
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Agents Balances/Surplus
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Reliance IRIS Ratios
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Measurement Issues

• Reported surplus is as accurate as reported
  assets and liabilities.
• Underpricing under-reserving most problematic
  for property-casualty insurers.
• Capital and leverage need to be assessed against
  risks that firm faces.
• Reliance BCAR was 77.8 in 1998 and 122.6 in 1999.
• Decline can be rapid.

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Observations

• Events can rapidly overtake remedial action.
• Regulators and rating agencies proceed cautiously
  with lagging information.
• Desire not to undermine efforts to restructure or
  sell company.
• Size and importance of insurer can make
  regulators and raters even more cautious.
• More pro-active, risk-based oversight requires
  new mindset for U.S. regulators.

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Ratio Limitations

• There is no ratio measure that provides
  real-time indication of underpricing, poor
  underwriting, and under-reserving.
• Performance measures lag these practices,
  especially for long-tail lines.
• Early detection requires alternative approaches
  including street knowledge.
• Regulators raters reluctant to use subjective
  indicators to issue warnings.

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Questions

• What were the causes of or contributors to
  Reliance's insolvency?
• What were the roles and responsibilities of
  various "monitors" , e.g., regulators, rating
  agencies, accounting firms, and others and were
  there failures in their performance?
• To extent can we rely on "the market", i.e.,
  buyers of insurance, to impose sufficient
  discipline on insurers like Reliance to properly
  manage their financial risk?
• What does the Reliance story tell us about the
  effectiveness of the monitoring and regulatory
  system and does it reveal problems with that
  system that may or may not have been fixed since
  the Reliance insolvency?