United States: Is Arrowood The Next Kemper? The Insurance Insolvency System Is Broken

The Kemper/Lumbermens saga

To refresh everyone's recollection, this is a report from Business Insurance from March 14, 2010:

• The Long Grove, Ill.-based insurer [Kemper], which has been in voluntary runoff since 2004, earlier this month revealed a steep decline in its surplus, which several observers say indicates that liquidation is near.
• But that may be preferred by some policyholders who have been wary of settling liabilities with Kemper without full knowledge of its settlement strategy, which they say has been veiled by the confidential nature of the runoff, some observers note.
• In financial statements filed March 1, Kemper reported that its lead insurance unit, Lumbermens Mutual Casualty Co., had a surplus of $8.1 million as of Dec. 31, 2009, a drop from about $113.2 million a year earlier.
• Kemper's American Manufacturers Mutual Insurance Co. unit reported surplus of $11.2 million at the end of 2009, relatively unchanged from a year earlier. Lumbermens reinsures American Manufacturers, sources said.
• The Illinois Department of Insurance approved Kemper's runoff in 2004. Details of the runoff operations under the department's supervision have been kept confidential.
• But with Kemper's operating expenses running at about $5 million a month and its surplus nearing depletion, a liquidation order is expected this year, several sources said.

It took another three years for the Kemper/Lumbermens companies to be ordered into liquidation proceedings in Illinois, over a decade after its alarming financial condition burst into public view at the end of 2002. Another ten years later, that liquidation continues, as noted in the Office of Special Deputy Receiver's 2022 Annual report (see pages 6-7).

The Arrowood/Royal story

Arrowood Indemnity Company, the successor to Royal Sun Alliance USA, including Royal Insurance and Royal Indemnity, has been publishing grim financial statements for several years, yet the Delaware Insurance Department has taken little visible action. The predictable end of the story of Arrowood was written in 2007 when insurance regulators in Delaware permitted its formation, unmooring those legacy US liabilities from the much larger and better funded global company. Other insurance companies that were segregated to run-off legacy liabilities have faced similar fates, like Bedivere which ran off historic One Beacon/Commercial Union liabilities and entered liquidation in Pennsylvania in 2021.

Unsurprisingly, the smaller Arrowood entity has run into serious headwinds. As of Arrowood's last financial statements, issued in August for the second quarter of 2023, its statutory surplus (a regulatory equivalent of equity) was only $6.7 million. The "going concern" note tells a dismaying story:

"Based on the Company's evaluation, the Company has sufficient liquidity for the Company to continue as a going concern as defined in SSAP No. 1, Disclosures of Accounting Policies, Risks & Uncertainties, and Other Disclosures. However, the Company's Risk Based Capital (RBC) Ratio, which is the ratio of the Company's adjusted capital to Authorized Control Level Capital, as of December 31, 2022, has fallen below its RBC Mandatory Control Level. At the Mandatory Control Level, the Delaware Department of Insurance (DOI) is mandated to place a company under its control, except where, as is the case with the Company, such company is a property and casualty company that is no longer writing new business and is running off its existing liabilities. Under these circumstances the Commissioner has discretion to allow the continued run-off of the Company under the supervision of the Commissioner. The Company is operating under a formal Supervision Order issued by the Commissioner. Nevertheless, the DOI could seek to place the Company in formal proceedings (i.e., rehabilitation or liquidation) at any time based on the Company's financial condition. As a result, substantial doubt exists about the Company's ability to continue as a going concern. This risk of a proceeding would be further increased if 1) the Company fails to execute successfully on its RBC Plan which the Company continues to operate under, 2) the Company fails to have sufficient liquid assets to meet its current obligations, or 3) the Company's reported statutory liabilities would exceed its reported statutory admitted assets.

The Company continues to operate under the RBC plan filed in 2022. The plan includes the Company's continued execution of its operating strategy with a focus on ongoing cost reductions, expense management, reinsurance collections and loss settlements. Details of the RBC Plan are confidential pursuant to the state's RBC statute. The Company's operations are under increased monitoring and supervision by the DOI as noted above and discussions are ongoing with the DOI."

Quarterly Financial Statement as of June 30, 2023, of Arrowood Indemnity Company, Notes to Financial Statements 1.D. "Going Concern".

Arrowood is required to post adequate reserves for the liabilities it faces; however, despite lengthy disclosures concerning its exposure to the risks of abuse and opioid claims, there is little evidence that they are adequately reserved.

What's next?

Policyholders are concerned. One policyholder, the Roman Catholic Diocese of Brooklyn filed an action against Arrowood management alleging malfeasance in Arrowood's home state of North Carolina, which was turned back in favor of Delaware. In the Roman Catholic Diocese of Rockville Centre bankruptcy, the bankruptcy court recently permitted discovery concerning Arrowood's solvency. The financial statements reveal that Arrowood issued primary and excess coverage to both dioceses for two decades, from 1957 to 1977.

In the face of these obvious problems, most alarming is the statement that: "At the Mandatory Control Level, the Delaware Department of Insurance (DOI) is mandated to place a company under its control, except where, as is the case with the Company, such company is a property and casualty company that is no longer writing new business and is running off its existing liabilities. Under these circumstances the Commissioner has discretion to allow the continued run-off of the Company under the supervision of the Commissioner." This is an absurd situation. No insurance company in this financial condition could ever write new business, yet the fact that Arrowood cannot do so (and was never intended to do so) is being used as an excuse for the insurance commissioner to dodge placing Arrowood into liquidation.

Thus, we are facing another Kemper scenario. Arrowood will spend most of its funds to fight claims, delaying the inevitable for as long as possible, while policyholders and claimants will be denied access to an important safety net accessible only when its insurance company is in liquidation – state insurance guaranty funds. Do policyholders and claimants have to wait another five or ten years before they can access the system designed for exactly this scenario? Why? There is no doubt how this story ends.