Are you exposing yourself?
How do Multinational Organisations manage large risks?
Introduction
The last few months have highlighted the fact that large scale catastrophes do still, and will continue to occur, often without warning. The consequences for those involved can be devastating both personally and commercially. The losses can take any form: from ash clouds to oil slicks, the collapse of complex financial instruments to the injuries caused by tiny asbestos fibres, alongside the more traditional catastrophe losses, such as hurricanes and earthquakes. When catastrophe losses occur multinationals often find themselves exposed to the damage in one way or another due to the large scale and global nature of their operations. No organisation can guarantee immunity from the unexpected but it is important that such organisations have provisions in place to minimise the impact to their business, should the worst happen. Appropriate corporate insurance structures can mean the difference between survival and insolvency and this article highlights how to avoid some of the pitfalls that can cause even a well thought out plan to fail in the face of the unexpected.
Discussion
It is hard to ignore BP's recent problems in the Gulf of Mexico following the explosion on board the Deepwater Horizon Oil Rig. Whilst headlines have focussed on the environmental impact, the politics within the upper echelons of BP, and even diplomatic relations between the UK and US, the drama has also drawn attention to the operation of captive insurance companies.
BP, like many large organisations, maintains its own captive insurer through which it self-insures. In BP's case this is through Guernsey based Jupiter Insurance. Jupiter maintains a US$700m per occurrence limit and at the end of 2008 held shareholder funds of US$4.8bn.
There are many advantages to setting up your own captive; payments to it are tax deductable, income generated by it can be tax free if, as in BP's case, it is registered offshore. In the present climate captives also provide an additional benefit in that they can provide cover which might be unavailable or prohibitively expensive in the commercial market. The insurance industry is mindful (and still feeling the effects) of increases in the number of US class actions and payouts in recent years e.g. Worldcom (US$6.2bn), Enron (US$7.2bn), Tyco (US$3.2bn). With numbers like these floating around, insurance against large losses can be hard to obtain, or at the very least be seen as an expensive option.
The difficulty in BP's case is that Jupiter was not reinsured. This means that the full loss (US$6bn and climbing) falls, one way or another, on BP. Whilst Jupiter can itself absorb a substantial chunk of the damage, ultimately the scale of the losses being faced by BP will force it to inject more money into Jupiter to recapitalise it if BP chooses not to pay out directly. This has led to BP searching for alternative means by which to recover its loss. Whilst there may be legitimate contribution claims from others involved in the spill (although BP owned the well, other companies operated the rig and manufactured, supplied and fitted the infamous blowout preventer) these claims remain to be established.
separate Lloyd's Syndicates (around half of the market), plus a string of other international insurers have formally rejected the claim alleging that Transocean's insuring obligations only extended to providing cover for damage to the rig and not for pollution.
It looks certain that BP will face substantial irrecoverable losses and this raises the question of what it could have done differently. One option would have been for its captive to obtain reinsurance but as discussed this can be hard to place at all on this scale, at least at an affordable rate. Over the last few years interest in Capital Markets has come and gone. In the case of very large risks, they offer the potential of a back-stop to prevent losses reaching the sorts of figures which may more commonly be found on the balance sheet of a small country.
The easiest way to access this market is through a catastrophe bond (or cat bond). Whilst not a new concept the first significant cat bond was issued in 2005 by Goldman Sachs on behalf of OCIL, a Bermudan based casualty insurer. The trouble was that even though the bond made it to the market it was a flop. The triggers were too easily reached and Tranche C of the deal was declared in default by Standard & Poors earlier this year. The fundamental problem is that companies are looking to insure against long-tail liabilities such as oil spills, product liability claims or asbestosis and investors are seeking short term certainty. One way around this may be to redefine the triggers for specific events, rather than basing them on losses. This could be, for example, an oil spill exceeding 10 million barrels. That would be easier to measure and make the probability easier to calculate in the same way that it is presently calculated for natural catastrophes. Traditionally the difficulty of defining triggers has meant that cat bonds have been limited to statistically definable events such as hurricanes, however, they have been used more widely and there is no reason why they cannot, provided the underlying risk can be modelled in some way.
In recent times there has been a small flurry of activity in this sector. In May of this year AIG introduced a cat bond through Lodestone Re providing them with £425m of protection against hurricanes and earthquakes. Whilst this was a particularly large offering there have also been increasing numbers of smaller offerings and there seems to be a developing market for such products. The poor returns currently being realised in equity markets compared to the double digit returns being seen on a number of cat bonds have undoubtedly helped to fuel interest. Aon Benfield is forecasting US$5bn (£3.2bn) of cat bond issuances this year alone.
But back to captives: if you operate across multiple jurisdictions and consider a captive as an attractive option there are some basic but important lessons which can and should be learnt from the mistakes of those that have come (and gone) before.
1. How affordable is the alternative of a commercial premium, if it is available?
How likely is it that the worst could happen and if it did could you survive? The problem is the unforeseen and the overlooked. Asbestosis was unheard of in the 1970's yet policies placed at that time almost led to the collapse of the whole Lloyd's market. Since 1982 over 90 companies have filed for bankruptcy in the US as a direct result of asbestos liabilities. A trust fund of up to US$140bn has been proposed in the US to compensate claimants who cannot recover because the companies responsible are unable to pay. Estimates of future costs related to asbestosis and related diseases in the UK alone range from £8bn to £20bn (half of this is predicted to fall to insurers). There can be no clearer example of the value to companies of insuring against these types of losses.
2. Should you reinsure?
Can you afford not to? One has to look no further than a chart of BP's share price and the takeover rumours across the financial press to see the scale of the impact that can affect even the biggest multinationals.
3. Would the policy cover losses occurring in different jurisdictions?
On 24 March 1989 the tanker Exxon Valdez ran aground in Prince William Sound Alaska, causing a major spillage of oil which led to heavy environmental damage and necessitated a huge clean-up operation. The clean up alone cost US$2.5bn and 20 years later with claims still being brought the total cost could be nearer US$7bn. The tanker's owners, Exxon Shipping Co, had protection and indemnity cover in respect of their liability for spillage of US$400m in excess of US$210m and recovered the full amount insured from their P&I club. The owners of the cargo of oil were the parent company of the shipowners, Exxon Corp. Exxon Corp made claims under a general corporate excess (GCE) insurance policy. These claims were challenged by a number of the insurers and reinsurers and formed the subject of the well known Equitas v R&Q and Commercial Union v NRG litigation.
The GCE policy was placed through brokers in the London Market and comprised a Lloyd's policy, a UK companies' policy and a policy led in the Scandinavian market, all in materially identical terms. Ultimately, whilst Exxon's insurance responded, the reinsurance only did so in part due to different governing law provisions under the various reinsurance contracts. This meant that significant losses had to be absorbed by some of the original insurers/reinsurers despite the fact that they believed that these had been ceded/retroceded.
This highlights the importance of ensuring that if you are seeking to reinsure a captive you need to check that any reinsurance is governed by the same law as the underlying policy or at least that it contains broad follow-the-settlements language to avoid a situation where losses which had intended to be ceded from the captive to the reinsurer actually remain with the captive.
4. Will you recover your settlement?
Whilst claims were settled by various insurers in relation to Exxon Valdez it was subsequently found (when the settlements were challenged by reinsurers) that not all of insurers' settlements were covered by the terms of the relevant insurance policies. Consequently, reinsurers were able to challenge the validity of the insurers' claims, i.e. did the claims properly fall within the terms of the reinsurances? It is therefore paramount that as an insured or as a captive, you have a clear understanding of the way in which your insurance arrangements operate. The aim always is to try to have back-to-back cover in place and to take full legal advice in advance of entering into any settlements.
Conclusion
Planning these types of insurance structures is not an exact science and there are no right or wrong answers. However, one area in which many companies fall down is in managing and handling potential claims when they do arise. Often insurance is not given significant consideration at an early enough stage and this can in some cases mean that losses which could otherwise be recovered under insurance policies, become irrecoverable. Whilst there is no substitute for consulting a specialist insurance team we know that
for a number of reasons this does not always happen. The attached checklist should help you to avoid some of the major pitfalls.
For more information contact Ralph Fearnhead, an associate within Addleshaw Goddard's Insurance and Reinsurance Litigation team.
Considerations for policyholders facing a potential loss
Identifying which policy responds
Are you insured?
• Who has knowledge of and responsibility for your organisation's insurance?
• What policies are there? What do they cover?
• Who placed the policy? The broker who may have useful information about how to position any claim.
• If your organisation does not fall within the definition of the "Insured", it may not be too late: it may be possible to widen the definition of the "Insured" following discussions with your insurer, or to look to other types of insurance, for example, legal expenses insurance, which can be obtained after the event.
Which policy applies?
It is usual to have a number of different policies covering different types of losses applying over different periods of time.
• Read the policies carefully to assess whether the claim falls within one or more of the insurance policies which your organisation has arranged.
• The scope of cover of a policy will be limited by the type and amount of the claim in issue. Different policies may apply depending on the amount of the claim, for example, primary and excess insurance policies may both respond to the same loss.
• Consider the date of any claim and consider which policy period it falls under. This is not always obvious and can vary depending on the type of policy. Is it:
• A "claims made" policy, covering claims reported during the relevant policy period regardless of when they occurred?
• A "claims occurring" policy, covering claims occurring during the policy period regardless of when they are reported?
Notification
It sounds simple but this is one of the most commonly overlooked areas. Most insurance policies require written notice to be given "as soon as practicable" or within a specified time limit, not just of actual claims but more commonly of "circumstances" which may give rise to claims or legal proceedings.
where the insurer has not suffered any obvious disadvantage and where the claim is, in principle, covered by the insurance. We advise that you should:
• Promptly notify your insurer (and broker, if required by the policy) in writing, of all potential claims (or circumstances, depending on the terms of your cover, which may in the future give rise to claims). Check your policy wording to ensure that you follow any specific requirements as to the form or content of notice.
• Notify your insurer of potential as well as actual claims: it is not safe to assume that a problem is too trivial to report. If in doubt, you should discuss this with your Risk Manager.
• Confirm that your insurer actually receives notice of the claim (or circumstance).
• Notify all relevant insurers of claims or potential claims (under all possible policies) in circumstances where more than one policy could respond.
Managing the claim
It is important to be aware of what the policy does and does not cover to ensure that your management of a claim does not inadvertently make it irrecoverable.
Exclusions
Most corporate policies include extensive exclusions. Fraud and dishonesty will generally not be covered. Fines are not usually covered.
Loss
• Consider how loss is calculated under the policy and when it is said to have arisen. Has it already been crystallised, or is it contingent on the outcome of the legal proceedings or some other event?
• Look out for time limits for the submission of a proof of loss, and note that this may need to be sworn or verified under oath.
Communicating with insurers
• Try to establish good relations with the insurer from the outset. Securing insurer "buy in" for the actions taken at every step of the proceedings may not be a pre-requisite to cover, but is always helpful.
• Seek written confirmation from the insurer that you have complied with the necessary notification provisions, as well as written confirmation of policy coverage for the claim.
• Ensure compliance with any policy provisions relating to communications or notices.
• Check what reporting obligations are contained in the policy, in terms of what documentation the insurers want to see, and what information should be provided with what level of frequency. Keep
• Check the policy to see whether the insurer's written and/or prior consent is required in advance of taking a particular step (for example, in relation to admissions of liability or settlements, policies often stipulate that the insurer must provide written consent before any admissions are made or settlements are entered into).
• The policy may contain a "claims co-operation" or a "claims control" clause giving the insurer differing rights in connection with the handling and conduct of the claim. You may have a duty to co-operate by providing reasonable assistance with securing evidence, obtaining witnesses, keeping the insurer informed and other procedural matters, or the insurer may have the right to take over the conduct of the claim and control it.
• Check that common interest privilege operates to protect privilege in documents disclosed to insurers.
Costs
Many policies provide cover for the cost of defending legal proceedings brought against the insured and, if the insured loses, the costs of the successful claimant.
• Check whether the insurer's prior written consent is required before any costs are incurred, and whether there are any other policy requirements.
• Do not assume continued consent; you should reaffirm consent at each significant stage of the proceedings.
Note that you will be responsible for costs in the first instance. It is for you to seek to recover the costs from the insurer.
Disputes over Cover
• Do not rely on the representation of an insurance agent who tells you that the policy does not cover a loss — get the opinion of an insurance lawyer.
• Do not accept at face value your insurer's claim that there is no coverage for your loss — get the opinion of an insurance lawyer. In the current climate, it is not unusual for insurers to deny cover in the first instance.
• Your insurer may be required to defend you even if the claim made against you is not covered. Many US policies contain a duty to defend clause which is much wider than the actual policy cover.
• Insurer conduct may require it to cover a loss even if the loss is not a covered loss.
• If your insurer sends you a "reservation of rights" letter you may need to take steps to protect your interest.
• An insurer cannot necessarily settle a case against you that you do not want to settle – it will depend on the terms of cover.
• If you want a case against you settled, remain informed of settlement negotiations and insist that your insurer accepts a reasonable offer made within your policy coverage limits.
• Your interests and those of your insurer may be aligned at times but they are not identical. If the claim against you is of any significance you should consider hiring your own lawyers to protect your interests.
Settlement
• Take care not to make any admissions of liability or abandon any causes of action without the insurer's consent.
• Insurer consent will almost certainly be required in respect of any settlement of legal proceedings.
• To recover under certain policies, it may be necessary to show that a legal liability has arisen in respect of the claim, as determined by agreement, award or judgment. Reaching a settlement before this has been established may mean jeopardise your recovery.
For further information, please contact the Insurance Team
