XL Insurance (Bermuda) Ltd. bought Winterthur International from Credit Suisse Group in 2001. The agreement was subject to a "three-year reserve-seasoning exposure," meaning a review of the appropriateness of the Winterthur reserves.
Following separately conducted reviews, Credit Suisse's "extensive analysis of recently provided data ... utilizing third-party specialists to assist in estimating the reserves required for such liabilities" suggested it owed XL about $541 million. XL's estimate, on the other hand, "developed with the support of various leading third-party actuarial and claims advisors," was about $1.45 billion.
The agreement called for arbitration should the two parties not agree on an appropriate payment. The arbitration is "baseball-style." The arbiter (never arbitrator) will make his or her calculations, and whichever of the two estimates is closer to the arbiter's number will be the amount of the settlement later this year, winner take all. This technique, which Congress has been trying to impose in labor-management disputes, is better than "split-the-difference" arbitration, according to XL's Chairman Brian O'Hara.
What I don't get is:
1. Are reserves that difficult to value?
2. Isn't this gambling? Sure, all financial behavior is gambling, but betting half the difference between the actual number and your number is somehow more nakedly gambling. If I were a shareholder in either company, how would I feel about the executives rolling d'em bones, if d'em bones were my bones?
3. Credit Suisse duly booked as a liability its estimate of the loss. Presumably a footnote in one of its financial reports addresses the contingent loss. XL appears to have recorded its estimate as an asset. How do XL's auditors feel about that? I haven't audited since taking inventory on the Ark, but prudence, the accountant's guiding principle, would suggest booking the lower amount.
By the bye, O'Hara confirmed booking the full amount in a question-and-answer session during the earnings call. It was pointed out that the deal falls into the company's Bermuda books. If XL loses, the difference between the arbiter's valuation and XL's higher number will be dollar-for-dollar. How much of the $909 million write-down that XL would take, should it lose the bet, has been reinsured? If the answer is all of it, then booking the full amount is the correct course of action.
4. If XL wins, will baseball players, who once talked of earning "Canseco dollars," start referring to "O'Hara dollars" and insisting on "insurance-style arbitration" in their contracts?
5. Finally, the mandatory question whenever an insurance issue is discussed today is this: Although it's none of his beeswax, how is New York State Attorney General Eliot Spitzer going to react to this?
Both XL Insurance Ltd. and Credit Suisse Group feel so strongly about their estimates that they made the larger bet. Even at this distance from the action, the smell of machismo is unavoidable.
Either way, Credit Suisse has made the larger bet. It wants to launch an initial public offering and spin off Winterthur. It can't do so until the ninth inning is over and the fat lady sings--or howls in pain, depending on who wins.
ROGER CROMBIE, a writer, editor and former accountant, is a regular columnist for Risk & Insurance®.
August 1, 2005
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