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- Orange County Case
- WorldCom Accounting Scandal: The Wrong Call (Part 1)
- WorldCom Accounting Scandal: The Wrong Call (Part 2)
- China Aviation Oil - Derivative Losses
- Case Study: Taisei Marine and Fire Insurance
- Northern Rock: A Case in Low Frequency High Impact Event
- Bankgesellschaft Berlin Case Study – Credit Risk and Operational Risk
- Bankers Trust Case Study
- Case Study: Equity Derivative Losses at UBS
Case Study: Taisei Marine and Fire Insurance
The Taisei Marine and Fire Insurance (TMFI)company along with Nissan Fire & Marine and Chiyoda Fire & Marine Insurance was part of the Fortress Re pool. Fortress Re was responsible for inward reinsurance business. TMFI had large property and casualty business in Japan.
TMFI was Japan’s 15th in the list of top non-life insurers. TMFI’s solvency margin (assets over liabilities) was 815%. The norm set by Japanese authorities being 200%. This margin was calculated to assess financial strength. TMFI had large volumes of domestic Japanese property and casualty business. It also had a large volume of inward reinsurance (reinsurance business accepted by the insurer or reinsurer, but not given up to another insurer) through its US reinsurance pool managed by Fortress Re, a North Carolina based reinsurance managing agency.
Fortress Re used traditional methods and products to offset risk. Later on though, it started implementing finite insurance, and by 2000 was using only this method to offset its risk. Typically insurers set aside a percentage of the payouts in the event the cause of insurance occurs. If the amount does not cover the insurer will pay for the rest. This means lower costs and it also lowers the level of potential risk an insurer can face. Fotress served as the pool’s reinsurance manager. The Fortress Re pool included aviation, marine and many other reinsurance products with aviation comprising 70% of the portfolio. Fortress ceded 25% of its business to Carolina Re, a Bermuda-based reinsurer, which was owned by the principals and close family of Fortress executives.
The pool made large profits. Then there were a number of aviation related accidents which triggered claims. These included TWA off Long Island, New York (1996), Swissair off the coast of Nova Scotia (1998), EgyptAir of the East Coast of the US (1999), Alaska Airlines off the West Coast of the US (2000) and Concorde in Paris (2000).
Then 9/11 happened and the strain of all the previous claims meant TMFI went bankrupt as it could not provide sufficient reinsurance protection against this major event. The players other than Fotress Re in the pool were not fully cognizant of the risks inherent in the portfolio. Fotress Re was granted liberty by other members of the pool to conduct business on their behalf and to arrange reinsurance protection. A trust that was misguided and ultimately fatal.
The finite reinsurance model allowed Fortress Re to claim reinsurance claims payments from the finite reinsurers and it paid premiums to cover these deals over a 5-year period. As the risks were spread over time, the future premiums were not accounted for as current liabilities on the books of the pool members, giving a false impression of profitability.
The aviation insurance regulators state that airline companies must buy insurance from local insurers (fronting insurance companies). Then, these local insurance companies are allowed to transfer all risks to in this case the Fortress Re pool which in turn reinsured but with a limit on coverage (finite reinsurance).
Through its reinsurance pool, Fortress Re assumed inward insurance from other fronting insurance companies. Then other companies such as Taisei would participate in the pool and assume risk. For further cover, a finite risk program was implemented to spread the risk over a long time period.
The actual risks were masked by accounting risk transfer procedures. If TMFI had strictly adhered to accounting risk transfer procedures, it would have treated the premiums as deposits, since it was a financial agreement not a risk transference. In this event the company should have to make an adjustment to take all the losses into the income statement and consider the effect on its solvency margin. This procedure might have made it difficult for TFMI to determine if the risk had actually been transferred and if there was sufficient catastrophe cover. So despite having a 850% solvency margin, TMFI could not cover the claims, as their risk assessment was inadequate. Finite insurance while lowering cost in the books did not provide for real cover when the impossible happened.
TMFI went bankrupt thanks to not being aware what it had signed up for and how badly their liabilities might be in the event of a worst case scenario. Nissan and Chiyoda the other members of the pool managed to miss bankruptcy thanks mostly due to their size.
TMFI is a case wherein there was Insurance Risk. Their uninsured exposure being a part of the Fortress Re pool was low even for low-frequency high-impact events. The low chance of an event like 9/11 needs to be factored, managed, and potentially hedged.
TMFI as a member of the pool should have clearly understood terms of its contracts, the liabilities thereof and therefore had in place risk mitigating strategies. It should have along with other members calibrated risk as close as possible and undertaken measures to limit it.