The circumstances surrounding the liquidation of a small Oklahoma insurer highlight the concern over how effectively state insurance regulators are able assess potential buyers of insurance companies, according to a recent report in the Wall Street Journal. But Oklahoma’s insurance commissioner says he disagrees with that assertion.
Tying the collapse of Red Rock Insurance Co. indirectly to the failed insurance holdings of a young Wall Street financier, the authors of “Bogus Stamps, Phony Bonds Backed Failed Insurer,” published on April 20, state: “The unusual circumstances behind the Red Rock liquidation, together with the Burns case, reinforce concerns about the ability of state regulators to screen out unsuitable buyers of insurance companies.”
Oklahoma Insurance Commissioner John D. Doak said, however, that the Oklahoma Insurance Department’s policies and procedures worked as they were supposed to in the Red Rock case.
“State based regulation of insurance provides an orderly and effective procedure, consistent with due process, to screen out unsuitable buyers of insurance companies,” he said.
In the WSJ article, authors Mark Maremont and Leslie Scism acknowledge that Alexander Chatfield Burns and his failed private equity firm/insurance empire, Southport Lane Management LLC, had no direct involvement with Red Rock Insurance, which is in liquidation in Oklahoma.
But Maremont and Scism wrote that two executives — Andrew B. Scherr and Scott W. Hartman — who through their financial services holding company, Foster Jennings Inc., bought the entity that became Red Rock did have business ties to Burns.
Scherr “now runs the remnants of Mr. Burns’s former firm, in which he was an executive and minority partner,” and Hartman “was involved in a financing arrangement that Foster Jennings had with Mr. Burns’s company, which ended in 2012,” the WSJ article stated.
Scherr and Hartman’s purchase in 2013 of the bankrupt Oklahoma insurer, BancInsure, which was later re-named Red Rock Insurance, was based on the representation that they would invest some $30 million in capital into the company.
BancInsure, which insured community banks, was already in serious trouble when Foster Jennings bought it. Due to the collapse of so many small banks during the economic downturn, the company suffered big losses that depleted its surplus and was in danger of being taken over by regulators at the time of the acquisition.
“An Application for Receivership had already been filed in state court against BancInsure/Red Rock at the time Foster Jennings made an offer to purchase it,” Commissioner Doak wrote in an email to Insurance Journal. “The Department viewed the proposed acquisition as an opportunity to avoid placing the company in receivership. The Department followed the statutory procedure for approval of insurance company acquisitions in compliance with NAIC and Oklahoma standards.
“Following a public hearing, the acquisition was conditionally approved based on submitted documents and testimony under oath. A key condition to approval was the infusion of approximately $30 million dollars in liquid assets by Foster Jennings,” he said.
Foster Jennings paid $1 for BancInsure, renamed the company Red Rock Insurance Co. and changed the insurer’s focus into more general property/casualty lines.
The company reported in an October 2013 announcement that its “new strategy will involve writing business in the program distribution segment of the industry, where managing general agents and program administrators focus on insurance for specific types or classes of businesses, from commercial auto fleets and real estate agents to marinas and wind turbines.”
It didn’t exactly turn out that way. “Subsequent to the conditional approval, the Department continued to use its regulatory authority to ensure that the conditions were satisfied and the company’s assets were not depleted. On several occasions, Foster Jennings delivered evidence of ‘capital infusion,’ which the Department deemed unacceptable,” according to Commissioner Doak.
Scherr and Hartman, as Foster Jennings, “represented that they were bringing $30 million in marketable assets,” said Nestor Romero, assistant receiver for the Red Rock liquidation.
Foster Jennings said the assets were marketable securities, but because the insurance department wasn’t sure how to value them it brought in the Securities Valuation Office of the NAIC for a valuation, Romero said. The SVO couldn’t determine a value either.
Then the buyers said they had invested in another fund, which was made up of treasuries. That investment turned out to be something other than U.S. treasuries and was unsuitable from the department’s point of view, Romero said.
The WSJ article stated that some of the assets Foster Jennings tried to present to regulators involved “bonds linked to an admitted counterfeiter and a supposed $40 million stamp collection that couldn’t be authenticated.”
Red Rock ultimately realized only $5 million out of the projected $30 million.
“There was a continuing pattern of them placing assets before the department and [those assets being found] not to be representative of $30 million,” Romero said.
After several failed attempts to satisfy the insurance department’s capital requirements, a formal determination was made that the company was in hazardous financial condition. The department “imposed supervision and ultimately filed for and obtained an order of receivership and liquidation,” Doak wrote.
In December 2013, the department selected Red Rock to provide liability coverage — an Oklahoma Temporary Motorist Liability Policy — for Oklahoma drivers whose license plates were seized for failure to carry state-mandated auto insurance.
There were some policies sold under that program and a few inland marine policies sold, but otherwise “there was very, very little business” transacted at Red Rock, Romero said.
“I would have to look at the exact figures but it was very little money,” he said.
The company admitted it was insolvent in its amended first quarter 2014 financial statement and the OID moved to take Red Rock into conservatorship, saying it fit the definitions of “impairment” and “insolvency.”
Red Rock was ordered into liquidation in August 2014.
The claims being paid today through state guaranty funds involve losses stemming from BancInsure, Romero said. “I could look at all the loss reserves but I could imagine that at the very least, probably 99.9 percent of the losses relate back to BancInsure business, not Red Rock,” he said.
The WSJ article quoted Patricia McCoy, who teaches insurance law at Boston College, as advising that capital provided by new owners of insurance companies should be placed in escrow and examined before an acquisition is completed.
Romero said the suggestion is probably a good one. Moving forward, a best practice would be to put these assets in escrow, get them valued completely and then close off the transaction, he said.
“You do have to have that valuation, not just representation but valuation, prior to the consummation of the transaction,” he said.
Commissioner Doak indicated that the department doesn’t intend to change its current policies and procedures. “No policyholders were adversely affected by the conditional approval,” he said.
Whether or not Scherr and Hartman will be subject to any penalties due to the misrepresentation of assets is “under review by the receivership,” Doak said.
Dallas National, Imperial Fire & Casualty
The WSJ has run several articles recently that question state regulators’ ability to monitor insurance company transactions funded by hedge funds and private equity.
A March 20 article, “Young Financier’s Insurance Empire Collapses,” detailed the collapse of the Burns/Southport Lane insurance empire, which included two failed insurance companies — Texas-based Dallas National and Louisiana-headquartered Imperial Fire & Casualty.
Burns had no previous insurance experience when he was approved to acquire Dallas National, a workers’ compensation insurer, and Imperial Fire & Casualty, which wrote personal lines.
Dallas National (which Southport transferred to Delaware and renamed Freestone) is now in liquidation in Delaware; Imperial was seized and sold by Louisiana regulators.
A Texas Department of Insurance spokesman told Insurance Journal that “Dallas National reported satisfactory financial results prior to 2011 and maintained adequate policyholder surplus. In 2011, Dallas National reported material reserve development which resulted in a net loss for the year. However, TDI did not have any major solvency concerns at the time of re-domestication.”
TDI also said of the Southport Lane/ Dallas National transaction that “TDI followed its normal processes for the review and approval of acquisitions of control.”
The WSJ quoted Louisiana Insurance Commissioner Jim Donelon as saying his agency “let its guard down” in 2013 in approving Southport’s purchase of Imperial.
- Southport Lane Acquires Dallas National Insurance Co.
- Southport Lane Acquires Louisiana’s Imperial Fire & Casualty
- Regulators Missed Chance to Block Bad Deals
- Wall Street Journal: Collapse of Southport Lane’s Insurance Empire
- Bogus Stamps, Phony Bonds Backed Failed Insurer
- Red Rock Insurance to Provide Temporary Coverage for Oklahoma Uninsured Drivers
- Oklahoma City-based Insurer Reenters Marketplace with New Capital Backing
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