Insurance Claims And Issues

Florida Office of Insurance Regulation Putins Allstate Insurance.

    For nearly a year, Allstate Insurance Company and its subsidiaries resisted investigations by the Florida Insurance Commissioner into its Reinsurance arrangements, its unauthorized Catastrophe Models that consistently predicted greater damage -- and thus the 'need' for greater Premiums -- than was predicted by the Catastrophe Models that have long been used in the industry and in Florida, and Allstate's relationships with raters and trade associations.  As readers of this web log know, many posts here have followed the developments during that time, until Allstate exhausted its appeals and Courts overruled its objections to the Insurance Commissioner's investigations.  Now, what the Florida Insurance Commissioner calls "'drastic actions'" have been agreed to by Allstate.  Tom Zucco, "Deal Cuts Allstate's Rates" (St. Petersburg Times Online, Friday, August 15, 2008).

    The capitulation to which Allstate has been forced to consent is as overwhelming in its own way, as the recent invasion of Georgia by the Russian Army.  Allstate's "agreeement" was released on Friday, August 15, 2008, the traditional day of the week to release bad news to the public and press.  The agreement includes these terms:

Allstate will pay a $5,000,0000.00 fine to the Florida Insurance Regulatory Trust Fund under its agreement with the Florida Office of Insurance Regulation, which is the Florida Insurance Commissioner's Office;

Allstate will write 100,000 new Insurance Policies in Florida over the next three years, breaking down into 50,000 new "basic" Homeowner's Insurance Policies and 50,000 new Condominium, Renters and other residential Property Insurance Policies;

Allstate will lower Premiums on its existing "Florida policies" by 5.6 %, it is reported in the linked article, although what kind of Insurance Policies they are is not reported;

Allstate will not seek a Premium Rate Increase for at least a year, although again, the linked article does not identify for what kind of Insurance Policies;

Allstate will continue to 'cooperate' with the Florida O.I.R. investigations; and

Allstate waives its rights to challenge this agreement in Court.

    Allstate is reportedly the Number 2 Automobile Insurance Company in Florida, writing an average of some $564,000.00 in new Premiums a month in that line of business.  It is also reportedly the Number 4 Property Insurance Company in Florida.

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Collateralized Debt Obligations, Credit Default Swaps, And Credit Insurance, Continuation ....

.... Part 3:  What Is The Prognosis?

     Merrill Lynch's recipe for settlements of CDO indemnity obligations may be "a template for Wall Street, Bank of America Corp. analysts said."  John Glover, "Merrill CDO Deal May Be Model, Bank of America Says (Update 1)" (Bloomberg.com, Friday, August 1, 2008).  

    Another description from a different analyst is that Merrill may have set a "benchmark".  John Glover, "Merrill Gives Up Gains, Is 'On Hook' For CDO Losses (Update 2)"  (Bloomberg.com, Wed., July 30, 2008).

    Yet a third description of this conduct is that Merrill Lynch has ushered in "a sea change in the way banks are approaching their holdings of troubled investments."  Jenny Anderson, "An Investment Firm That Prospered From Past Crises Turns to Mortgages" Business Day Section, p. C1, col. 3 (New York Times Nat'l Ed., Wed., July 30, 2008).

    Here is what Merrill arranged.  It held Collateralized Debt Obligations.  It sold them to Lone Star Funds.  The sale price was in the neighborhood of 22 cents for 100 cents or 22 cents on the dollar.  Merrill loaned Lone Star 75% of the 22 cents-for-100 cents purchase price.  Glover, "Merrill Gives Up Gains, is 'On Hook' for CDO Losses (Update 2)", supra.

    To fully understand the potential significance of this transaction, it is reported that some accounting information will help.  "Investment banks [like Merrill Lynch] can book a gain if an insurer is willing to pay more to terminate its liability on a default swap contract than the amount at which the bank has it on its books, Bank of America said."  Glover, "Merrill CDO Deal May Be Model, Bank of America Says (Update 1)," supra.  [Emphasis added.]  Unknown, unnamed "analysts" say:  "'Monetization of these gains, we feel, would follow.'"  Id.

     I think this means that right now, no-one can honestly say what these paper accounting "gains" are worth.  They do know enough to know, apparently, that an insurer shedding liability on "a default swap contract" is a postiive gain.  Insurance regulators will otherwise "probably" take over the Insurance Companies "and pay the holders of municipal bonds they guaranteed before the banks," according to "the analysts".  Id.

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Collateralized Debt Obligations, Credit Default Swaps, And Credit Insurance, Continuation ....

.... Part 2:  Devalue, Destroy, or Divest.

    Ambac Financial Group Inc., a Bond Insurance Company that ventured into the dangerous land of Collateralized Debt Obligations and hoisted packages of subprime mortgages in exchange for real money, agreed with Citigroup Inc. that Ambac would get out from under a guarantee of CDOs.  Christine Richard & Jody Shenn, "Ambac to Pay $850 Million in Citigroup CDO Settlement (Update 7)" (Bloomberg.com, Friday, August 1, 2008).   Here is how the Ambac-Citigroup deal has been reported.  Recall that a very broad definition of Collateralized Debt Obligations is that they "package pools of securities," including subprime mortgages, "and slice them into pieces of varying risk."  Id.

    Not long ago, Ambac guaranteed a Collateralized Debt Obligation of $1,400,000,000.00 or $1.4 Billion.  After the subprime collapse and the credit crunch began, Ambac wrote down the value of the CDO by $1,000,000,000.00 or $1 Billion.  (Could this have been accurately reported instead as written down the value of the CDO to $1 Billion?  See below.)

    Next, Ambac paid $850,000,000.00 or $850 Million to Citigroup to get out from under Ambac's guarantee of the CDO.  By an accounting charade, Ambac reported that it gained $150,000,000.00 or $150 Million on the transaction.  See Christine Richard, "Ambac Posts Record Net Income on Accounting; New Business Falls" (Bloomberg.com, Wed., August 6, 2008).

    This accounting sleight of hand works on Wall Street.  After Ambac reported its settlement agreement with Citigroup, the shares of Ambac rose 50% to $3.79 a share.  The share price of its rival Bond Insurance Company MBIA also rose, by 29% to $7.67 a share.  Associated Press Report, "Stocks & Bonds/A Rough Week With a Sedate Conclusion," Business Day Section, p. B7, col. 2 (New York Times Nat'l Ed., Saturday, August 2, 2008).

    This is suddenly the preferred way of shedding exposure by shedding previously given guarantees of Collateralized Debt Obligations.  "Somehow, $4.4 billion just evaporated at Merrill Lynch."  Louise Story, "A Sale of Troubled Mortgage Assets Raises More Questions Than It Settles," Business Day Section, p.C1, col. 1 (New York Times Nat'l Ed., Wed., July 30, 2008), published Online as "A Deal at Merrill Puts Spotlight on Others".  Once again, CDOs are described in this newspaper report as "toxic mortgage investments".  Not long ago, Merrill Lynch assigned a value of $11,100,000,000.00 or $11.1 Billion to the "toxic" CDOs on its books.  At this time, it is selling those CDOs for the lesser value of $6,700,000,000.00 or $6.7 Billion.  That is not all.

    Merrill Lynch is loaning the buyer, Lone Star Funds, most of the purchase price.  It wrote down the value, and put it back on the balance sheet as a loan.  This arrangement is reportedly all about the corporate balance sheet.

    As reported in the newspapers and other media, Merrill Lynch's arrangement removes the iffy valuation of CDO ownership from its books.  It is replacing ownership of a likely low value asset on its books, with a loan.   However, as noted in the linked newspaper article, the risk of the CDOs remains.  That said, however, something else may have been gained besides a balance sheet balancing better.

    If CDOs are the new Credit Insurance, then not owning nor guaranteeing the payment of CDOs may mean that the party that sold them, even if it devalued them, no longer runs the additional risk of issuing an Insurance Policy without the authority of any State to do so.  That exposure means potential penalties.  It is generally unknown how to accurately calculate that unwanted exposure.  Dumping the CDOs may dump that additional "toxic" exposure, too.

    Merrill Lynch is not only moving its CDOs to Lone Star Funds, however.  It also reportedly settled recently with a Reinsurance Company, XL Capital Assurance, "which had insured some of the firm's C.D.O.'s."  Merrill is writing down those CDOs' value in the 3Q 2008.  Merrill Lynch's settlement agreeement with XL Capital will cost Merrill a reported $500 Million, while other settlements with "other reinsurance companies" will add another $800 Million in Merrill's obligations.  Louise Story, "Write-Down Is Planned At Merrill" p. C1, col. 5, Business Day Section (New York Times Nat'l Ed., Tuesday, July 29, 2008).

    What is not necessarily understood in all these stories, and what the linked article does not mention, is that reinsurance is insurance purchased by an Insurance Company.  If a Reinsurance Policy was issued to "insure some of Merrill's C.D.O.'s," that means that the Reinsurance Company and Merrill both implicitly viewed the CDOs as insurance for which Reinsurance was a good idea in their judgment.

    CDOs, the New -- and unauthorized and, so far, unregulated -- Credit Insurance.  The next post in the Continuation of this subject, Part 3, will address the Prognosis.

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Collateralized Debt Obligations, Credit Default Swaps, And Credit Insurance, Continuation ....

.... Part 1 -- What Are These Things?

      Collateralized Debt Obligations and Credit Default Swaps belong to a group collectively labeled "toxic securities" in the media.  See "Merrill CDO Sale Not As Good As It Looks:  Analyst," a Reuters report published online at washingtonpost.com, Wed., July 30, 2008.  A more polite name that they go by is "structured finance revenue," meaning revenue from "structured products" like CDOs and other securities backed by mortgages on peoples' houses or commercial properties, "and credit derivatives."  Jonathan Stempel, Reuters report, "Moody's Profit Tumbles, To Be Sued By Connecticut" (washingtonpost.com, Wed., July 30, 2008).

     Perhaps a little more sharpness in definition will aid in understanding.  Perhaps not.  It is worth a try.  CDOs are securities.  They "repackage pools of bonds and loans and divide" the cash flow from these pools of bonds and loans "into notes of varying risk and returns that are sold to investors."  John Glover, "Merrill CDO Deal May Be Model, Bank of America Says (Update 1)" (Bloomberg.com Friday, August 1, 2008).

     CDOs "package pools of securities, including those backed by subprime mortgages, and slice them into pieces of varying risk."  Christine Richard & Jody Shenn, "Ambac to Pay $850 Million in Citigroup CDO Settlement (Update 7)" (Bloomberg.com, Friday, August 1, 2008).  More simply put, "CDOs repackage bonds, loans and credit-default swaps and use the income to pay investors."  John Glover, "Merrill Gives Up Gains, Is 'On Hook' For CDO Losses (Update 2)" (Bloomberg.com, Wed., July 30, 2008).  [Emphasis added.]  

     So, then, "Collateralized Debt Obligations" include "Credit Default Swaps," it appears.  CDSs have been defined by the same financial reporter as "contracts conceived to protect bondholders against default, [they] pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements."  John Glover July 30, 2008, supra.  CDSs, in addition, are defined by their use "to speculate on a company's ability to repay debt."  John Glover, August 1, 2008, supra.  See also Christine Richard & Jody Shenn, August 1, 2008, supra.

     If this is confusing, try wrapping your mind around what the media describes simply as "complex European products known as constant proportion debt obligations (CPDOs)".  Jonathan Stempel, July 30, 2008, supra. 

     There is no present need to venture into the world of CPDOs.  It is enough to recognize that reporters, through no fault of their own, do not appear to understand what Collateralized Debt Obligations and Credit Default Swaps are all about, how they function, what they actually do.  They function like Insurance.  Although it is the job of reporters to report to the public what these things are all about, it is not at all the fault of reporters that they do not understand financial vehicles backed by or involving packages of subprime mortgages.  People and particularly regulators were never supposed to understand that CDOs and CDSs are really Insurance.  They function just like Insurance, and they insure credit obligations every bit as much as regulated Credit Insurance.  They are called seemingly impenetrable names for a reason, which is that their makers do not wish them to be understood for what they are:  Insurance.

     The title of this post reflects that it is a Continuation.  In many posts in this space, see, e.g., the post here of July 10, 2008, the similarity between these seemingly mystical securities and Credit Insurance was found to be identical.  The disguise worn by these securities has so far deflected closer examination and prevented any kind of regulation.  The damage done by this deception is the subject of the next post in this series, Continuation Part 2, Devalue, Destory and Divest.

Please See The Disclaimer.

Securitization and the "New" Insurance, No Assurance.

     "Securitization" includes, in basic terms, bundling securities and selling them.  Previous posts in this space have addressed one of those "securitization" vehicles, collateralized debt obligations, which are not regulated as "Insurance," and their virtually identical resemblance to regulated Credit Insurance.

    Other features of "securitization" besides the avoidance of regulation, include that borrowers and lenders are not likely to know much about the other, even their identity in at least some cases.   "[T]oday the holder of the note securing the property is a faceless investor represented by a trustee, like the Bank of New York."

     Further, loan servicing companies stand in the middle between lender and borrower.  It is the job of a loan servicing company to obtain for the lender all the money from the borrower that can be obtained.  "And because the foreclosure process can generate lucrative fees, servicers have an incentive to drag out the process, experts say."

     In particular, plaintiffs attempting to foreclose on residential housing are at a loss in many cases to present the actual note given by the borrower as evidence that the plaintiff owns the "securitized" debt or otherwise has the right to foreclose on the security, i.e., the borrower's home, in the event of nonpayment of the loan.  This evidentiary disability is a growing disadvantage as more Judges require evidence of authority to foreclose.  A "consumer lawyer at Jacksonville Area Legal Aid in Florida" is quoted in this regard in Gretchen Morgenson, "How One Borrower Beat the Foreclosure Machine" p. 1, col. 2 "Sunday Business" Section (New York Times Nat'l Ed., Sunday, July 27, 2008).  The consumer lawyer points out that this is an issue of whether the plaintiff has standing to sue, and the answer to that question may well determine whether the same plaintiff has standing to settle.

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Policy Limits Concept Continues for Deposit Insurance ... or Not?

     Put another way, should the Federal Deposit Insurance Corporation face liability without limit?  Since the FDIC is funded by Taxpayer money, that question really becomes, should Taxpayers face liability without limit to protect everyone's savings deposits?  These and similar questions are explored by Tom Petruno in "Market Beat/Deposit Insurance Limits Make Sense--At Least in Principle" (Los Angeles Times Online, Saturday, July 26, 2008).

     Almost, it seems, to address an issue raised in another post in this space, namely, that the "authority" of recent actions taken by the FDIC did not seem entirely clear, it is reported in the linked newspaper column that since 1991, a Federal Statute has required the FDIC to address each bank failure "in the least costly manner to the agency's insurance fund".  Reportedly, the FDIC's preferred solution to bank failures is to "merge" a failing bank with a solvent bank, which is the solution adopted by the FDIC in the post here involving reports regarding, for example, First National Bank Holding Co. of Arizona and Mutual of Omaha Bank, respectively.  See id.

     Since September, 2007, the FDIC has taken control of eight banks, including the now well-known IndyMac which presented the FDIC with what is reported to be the second-largest bank failure in the history of the United States.  Id.

     However, if one theory behind limits on Deposit Insurance is as suggested in this newspaper column, to "force individuals to be disciplined about where they put their cash," then there is a problem.  Most people simply do not know how to judge which banks are solvent and which are in danger of imminent or future collapse -- until there is a bank failure or a threat of one.

     The linked newspaper column includes anecdotal evidence from Britian and Japan, where the governments reportedly issued a "blanket deposit guarantee for all bank customers" or "unlimited insurance coverage" up to the total amount of each deposit.  The exact workings of such plans either in Britain or in Japan are not discussed in the column.  Whether such plans would have any chance of working in the United States may well depend on future conditions.

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Increasing Risk, Increasing Insurance Role.

    Current market conditions strongly reflect significant risk.  In this situation, Insurance Coverage Issues and Claims are inevitable.  They are coming.  They are coming under all sorts of Insurance Policies.  These Insurance Coverage Issues and Claims will in turn trigger many accusations that Insurance Companies and others acting in Fiduciary settings did not act in Good Faith and Deal Fairly.  In a climate like this one, these Issues and Claims are inevitable.  See generally Peter G. Gosselin, "In This Economy, Failure is an Option" (Los Angeles Times Online Sunday, July 20, 2008).

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Where is the Help for Homeowners?

     This is the question asked in a Letter to the Editor of The Boston Globe by Ms. Sharon Smith of Portland, Maine, published on Sunday, July 20, 2008.  In the whirl that surrounds issues and events connected with Homeowner's Insurance and Market Performance and the like, it is necessary to stop and listen to the questions posed by people who presumably stand on the outside of those issues and events and ask:  "Why is the government NOT backing Americans who are losing their homes because of predatory lending and usury?"

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Lenders and Insurance: Tied Together.

    There are those that wonder what Insurance has to do with Banks and Foreclosures and the continuing bad Market Conditions.   Many banks and other lenders took back risky mortgages as collateral.  The mortgages are now increasingly in default, and even people who were formerly "good" credit risks are being foreclosed.  When lenders write down the value of their mortgage collateral, it is not really a mystery that the action is adverse even to themselves.  "The losses at Merrill [Lynch] were widely expected, in part because the bank has exposure to mortgage reinsurance companies like MBIA that have seen their credit ratings drop."  Louise Story, "Merrill Reports $4.9 Billion Loss on Write-Downs" (New York Times Online, dated Friday, July 18, 2008).  [Emphasis added.]

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CatClaims Spawned by 80 Percent More Tornadoes.

     Compared to the entire Second Quarter in 2007, so far in the Second Quarter of 2008 there have been 1,100 reported tornadoes in the United States, according to the National Weather Service.  This figure represents an 80% increase over 2Q 2007.

     Insurance Companies reporting that an increase in resulting CatClaims from these tornadoes will reduce earnings include Philadelphia Consolidated Holding Corporation of Bala Cynwyd, Pennsylvania, Cincinnati Financial Corporation, United Fire & Casualty Co., and EMC Insurance Group, Inc.  Cincinnati Financial in particular reports that it expects a record number of Catastrophe losses for the First and Second Quarters of 2008.  See Erik Holm, "Philadelphia Consolidated Falls on U.S. Storm Costs (Update 2)" (Bloomberg.com, Friday, June 20, 2008).

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