Legion & Villanova: Carriers Gone Bad’

The recent rehabilitation of the Legion and Villanova Insurance Companies of the Legion Insurance Group is sure to have raised some eyebrows across the insurance industry, but is it an indicator of what could be in store for companies in the future? Or are Legion and Villanova simply unique and isolated incidents, unfortunate in light of the events of the past year?

Ralph Cagnetta, a managing senior financial analyst at A.M. Best, attributed Legion’s rehabilitation status to a number of factors, including the significant growth Legion experienced in the late 1990’s, taking on added exposure and paying the additional premium to go along with it.

“What they ended up doing was leveraging their balance sheet to an extreme. They didn’t retain much, but they ended up feeding out to the insurance market,” Cagnetta said. “Legion ran into a situation where they weren’t able to collect on their insurance or recoverables, or the reinsurers were just low paying.”

Cagnetta also cited financial leverage at Legion’s parent company, Mutual Risk Management, as contributing to Legion’s troubles. “MRM had pretty high debt load and was not able to raise any additional cash to infuse into the Legion company,” he said. “This … offset pressures down at Legion, with what they were having with their reinsurance and reserve problems.”

“It is definitely a liquidity issue with this company,” said Melissa Fox, deputy press secretary at the Pennsylvania Insurance Department. She explained that the company had been on watch for approximately two years by the PDI. “They have gone through some multiple downgrades with A.M. Best. There was $494 million in liquid assets for Legion. Unfortunately for them $317 million of that was restricted by the reinsurance. Over half of the liquid assets were tied up in reinsurance. That really sped up the liquidity issue because the reinsurance essentially stopped coming through the door.”

Fox explained that Legion attempted to raise an additional $100 million in equity, filed with the SEC, and lined up an underwriter. The filing failed when an outside auditor reduced its tax-deferred assets, resulting in another downgrade from Best. The underwriter withdrew.

The PDI took Legion and Villanova into rehabilitation on April 1, with Pennsylvania Insurance Commissioner M. Diane Koken appointed as rehabilitator.

“The policyholders are the first priority in the rehabilitation process,” Fox said, adding that it is essential that their coverage is available to them and that they have access to any outstanding claims.

“We say that on average it takes about 90 days to determine a rehabilitation plan,” continued Fox. “As with any rehabilitation our goal is to marshal the assets and establish a financial picture of the company,” a procedure that allows the department to determine whether or not rehabilitation will be successful, or if the court would be petitioned for an order of liquidation.

Once the company is taken into possession, the PDI ensures that there is enough money, and consumer protections are employed to ensure that policyholders are safeguarded.

Fox added, “Some of the claims have been put on hold pending the development of the rehabilitation plan, in particular, auto insurance claims.”

So what further implications can this have on the insurance industry?

“Legion and Mutual Risk in general are program writers. They all have a terrific advantage when there’s a soft market, and there’s plenty of reinsurance capacity,” said Donald Watson, a managing director at Standard & Poor’s. “What’s happened for Mutual Risk, Legion and a number of other program writers is that reinsurance capacity has become scarce.”

Watson attributed the scarcity in part to the Sept. 11 tragedy, but also to a large amount of underpricing in the reinsurance market. “Beginning in 1998, the pricing environment became so soft generally speaking that very little of the program’s business was as profitable as it had been historically, and it started generating losses to the reinsurers. And when the reinsurers start paying losses, they start charging more for the coverage. And it ultimately can get so expensive that you effectively can’t reinsure the business, and then you’re stuck with the risk or you can’t accept it.”

MRM began to try to retain as much as 30 percent of the risk in 2002 due to the pressuring of reinsurers but, Watson said, “It was still a tough battle to get the reinsurers to sign on for the amount of capacity. And if the reinsurers don’t support you, you’ve got to take all of that risk on your own balance sheet. MRM didn’t have the capital that would allow them to do so.”

Describing some of the early warning indicators that identify a company heading for trouble, Watson said growth and reinsurance recoverables are two of the most significant signs. “In fact, MRM has had to take some reserve hits for some of the reinsurance recoverables that have proven to be uncollectable because reinsurers successfully challenged whether they were really on risk or not.”

Cagnetta asserted that monitoring financials in companies that show signs of financial instability is crucial. “We look at them on a quarterly basis to help identify changes or trends in a company’s operations, which may lead to concerns about the overall stability of the company.”

Growth, again, is a tell-tale factor. Cagnetta questions companies that show significant growth in a short time period. “Is the insurer able to handle the additional business? Are they charging the adequate rates for exposures assumed?

“A lot of the rapid growth, especially in the soft pricing environment, is a pretty big risk factor,” he added.

Analysts also look at the reserves and reserve adequacy. At Best, a proprietary loss reserve model is used to indicate if a company’s reserves are deficient utilizing different actuarial techniques.

“Then of course you have the obvious factors, a company that loses surplus, or negative cash flow, changes in senior management, they’re all indicators of problems at a company,” Cagnetta said. He also noted the role of stress in the corporate family, referencing the financial instability at MRM.

Watson added, “When you look at what’s happened with Legion, a big part of it has been that they did not have a history of writing risk with an intent to retain it, and as a result, underwriting quality was not at a level that would keep the reinsurers supporting the group at the level that would make it possible for them.”

Additionally, Legion lost financing from its premium finance company only eight months ago. The loss further antagonized Legion’s financial instability.

But to Watson, Legion’s troubles come as no surprise. “In following the aftermath of a catastrophe loss year like 2001, it’s not surprising to see a withdrawal of capacity from the market. You’re going to see some shrinkage.

“I think their [Legion’s] difficulties are predominately a function of market conditions and a lack of capital and underwriting expertise that they need in the current environment. Give them some time, and they can manage a risk portfolio on a smaller basis.”

As for the fate of MRM, Cagnetta said, “As far as I know they haven’t filed bankruptcy. But they’re in a very precarious situation.” According to Cagnetta, Bermuda regulatory agencies are looking at the offshore parent company, but he is uncertain as to whether any action has been taken.

To comment on this story, e-mail cbeisiegel@insurancejournal.com.