talking about… - wsia the sting - dan brown...mar 16, 2010 · stamping offices in 14 states...

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2016 Marcus Payne Advanced E&S

November 6 - 9, 2016

Recognizing Scams in the Non-admitted Market

Dan BrownPartner, Dentons US, LLP

Avoiding “The Sting”

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What we are not talking about…Arraignment Set for Former Los Angeles Broker Charged in Decade-Long Auto Insurance Scheme (09/15/16)

After an investigation by the California Department of Insurance, Rosie Villegas of North Hills was charged with one misdemeanor count for transacting insurance without a license. She allegedly misrepresented client information on insurance applications and continued to sell auto insurance to consumers for more than a decade after her broker license expired in 2002. The department is requesting that anyone who purchased insurance from Villegas to contact the department's Investigation Division. Villegas will be arraigned on October 27, 2016.

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From the Press…• March 2015: Collapse of Southport Lane's Insurance Empire (Alexander

Chatfield Burns / 2 insurers, 2 reinsurers, brokerage & hedge fund, approximately $180 million at issue, DE and LA)

– Formed hedge fund at age 23

– Bought an insurance company without paying anything (but promised to invest $50M)

– Created a trust (with unknown assets) days before purchasing the insurer to use as the investment

– Used $25M of the insurer's actual assets to then buy another insurer

– Moved assets to questionable or unidentifiable investments (e.g., artwork of disputed validity, untraceable telecom investment)

– Initial insurance company declared insolvent last year

– Four former state insurance commissioners on the Board

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From the Press…

• September 2016: Elaborate $2.25 Million Bogus Insurance and Annuity Scheme Uncovered (S. Branstetter / LifeCo, CA Department)

• March 2014: Former Fugitive Admits Selling Bogus Insurance Policies (Thomas Grubb / Aconorate Insurance Agency, $1 million, US DOJ, NJ)

• December 2012: Central Jersey Couple That Ran Insurance Brokerage Company Charged with Stealing Nearly $1.8 Million from Eight Insurance Companies (Brian Mohen & Lisa Stanko – Mohen, NJ AG)

• November 2012: Former North Jersey Insurance Brokerage Company Employee Pleads Guilty to Using Her Position to Steal Millions of Dollars (Kelly Roetto / John A. Rocco Co., $3.8 million, NJ AG)

• August 2012: “Insurer” of the Ethan Allen Heads to Federal Prison (Christopher Purser / Global Property Owners Association, 20 deaths, US DOJ, TX)

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Some [Very] BasicsDon't take (or "borrow" or "use") your client's money

Communicate regularly/promptly with your clients

Don't transact business unless you are properly licensed in the relevant jurisdiction(s)

Don't sleep with your clients

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Occupational Fraud• Fraud schemes tend to be extremely costly (median loss for

insurance = $107,000 [up from prior years]).

• Schemes frequently continue for years before detection.

• Frauds far more likely to be detected by tip (usually employees) especially if you have a hotline, than by audits, controls, or other means.

• Implementation of anti-fraud controls appears to have measurable impact on an organization’s exposure to fraud (both duration and quantity).

Source: 2016 Report to the Nation on Occupational Fraud & Abuse; Association of Certified Fraud Examiners

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Occupational Fraud

• Small businesses (<100) especially vulnerable, suffering higher incidence of fraud but same median loss.

• Lack of adequate internal controls is most commonly cited factor allowing fraud to occur, followed by overriding controls.

• Fraud committed by owners/executives cause the greatest damage (median loss: $703,000).

• Vast majority of fraudsters are first-time offenders (no prior convictions or firings).


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Nonadmitted Scams

Target• Markets with availability/affordability problems (e.g., hard markets)

• Markets outside “routine” regulation

• “Surplus Lines” – rely on "gullible, ignorant, or greedy retail agents"

• Direct procurement

• RRGs and PGs

• Mandated coverages

• Specialty programs

• Surety/promissory notes

• Health care plans

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Why Accuse Surplus Lines?

Ease of market entry

Lax regulation

[Former] Reliance on “broker responsibility”

Untrained agents

Inability to monitor market conduct & activity

Continuing perception of unregulated market dominated by thinly capitalized offshore insurers & scam artists

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The Current Reality

Evolution of US surplus lines industry (now 75% of the market)

Federal law [almost] controls insurer eligibility (NRRA)

Regulatory focus on surplus lines licensee

Stamping offices in 14 states (soon to be 15)

NAPSLO & AAMGA

Technical, unintended violation of complex state surplus lines laws is not fraud

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Offshore InsurersTurks & Caicos

Cayman Islands

Netherland Antilles

Isle of Man Antigua

BelgiumIreland

Dominion of Melchizedek

Aruba

St. Vincent

Panama

Vanuatu

AnguillaCosta Rica

Dominica

Rotuma

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Offshore Insurers Examples of Known Fraud

Tri-Continental Exchange / Combined Services, Ltd., multiple insurers (St. Vincent / Matthew Schachter, aka Robert L. Brown)

Regency Insurance of the West Indies, Ltd. (Capistrano Beach, California)

Alpine Assurance, Ltd. (Turks & Caicos)

West Point Insurance Company (Antigua)

American Trust Insurance Company, Ltd. (Turks & Caicos / Alan Teale)

International Casualty and Surety Company, Ltd (New Zealand)

Universal Pacific Insurance Company, Ltd. (Rotuma, Fiji Islands)

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Offshore Insurers Examples of Known Fraud

International Fidelity & Surety, Ltd. (Vanuatu)

Westwood Insurance Company, Ltd. (Antigua)

Global Insurance Company, S.A. (Uruguay)

North American Marine and General Insurance Company, Ltd. (Panama)

New England International Surety, Inc. (Panama / Belgium)

Provident Capital Indemnity, Ltd. (Dominica / Costa Rica)

California Pacific Bankers & Insurance, Ltd. (Melchizedek)

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Domiciles of Convenience

Superficial regulation

• Domiciliary secrecy laws / no public disclosure / no records

• Permissive laws on holding companies & affiliates

• Jurisdictional issues (“judgment proof”)

• Intentional use of names similar to reputable insurers

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The Importance of Insurer Identity

Nationwide Insurance CompanyTri-Continental ExchangeNationwide GroupBest-rated A+ XV

• California Indemnity Insurance CompanyAdmitted company in FloridaCalifornia Indemnity Insurance CorporationUnauthorized ineligible insurance issuing crop insurance in Florida in 1995

• Alpine Insurance CompanyIllinois InsurerAlpine Assurance, Ltd.Turks & Caicos Insurer

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The Importance of Insurer Identity• Associated International Insurance Company

California insurer Associated International Insurance Ltd.Bermuda insurer

• Voyager Indemnity Insurance CompanyA- rated insurer, part of American Bankers GroupVoyager Insurance Company Ltd. Insurer de-licensed by Bermuda

• Phoenix Assurance Public Limited CompanyPart of prestigious Royal SunAlliance GroupPhoenix Insurance CompanyFronting company for St. Eustatius Insurance Co., Netherland Antilles (capitalized with a fraudulent gold mine in the mountains of Columbia)

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Problems Obscure ownership

• Weak local management

• Bogus financial statements

• Fraudulent / overvalued assets

• Understated liabilities

• Insider deals

• Transfer of assets

• Sham transactions

• Unauthorized changes in ownership, possibly to fictitious persons, to facilitate flow of premium to unknown persons

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Problems

Inadequate reinsurers

• High-risk liability business

• Use of purchasing groups to circumvent state regulation

• Common ownership of management, underwriting agencies, reinsurance brokers reinsurers, and purchasing group administrators

• Premium skimming

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Primary Causes of InsolvenciesSurplus Lines vs. Admitted Insurers (1977-2014)

Primary Cause Surplus Lines Admitted

% of Total % of Total

Deficient loss reserves (inadequate pricing) 36% 47%

Affiliate problems 20% 8%

Alleged fraud 14% 7%

Investment problems (overstated assets) 10% 6%

Catastrophe losses 6% 7%

Reinsurance failure 6% 7%

Miscellaneous 4% 7%

Rapid growth 2% 12%

Significant change in business 2% 4%

Total 100% 100%

Source: Best’s Special Report – U.S. Surplus Lines, Segment Review , August 27, 2015

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The problem with the villain theory – mismanagement and fraud as the causes of insolvency – is that it ignores the economics of a mature, overcrowded and price-driven business. A company with high costs and no advantages will either go out of business or be absorbed by a competitor. A management that cannot figure out how to survive such a situation is not necessarily incompetent or dishonest, even if in terminal desperation it takes foolish chances or fudges some numbers. And it is a short step from blaming the management for causing an insolvency to blaming the regulator for letting it happen.”

Managing Insurer Insolvency 2003Stewart Economics

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Producer Liability for Insurer Insolvency“… an insurance agent or broker is not a guarantor of the financial condition or solvency of the company from which he obtains the insurance. He is required, however, to use reasonable skill and judgment with a view to the security or indemnity for which the insurance is sought, and a failure in that respect may render him liable to the insured for resulting losses." [Cite.] As such, "where the company was solvent when the policy was procured, its subsequent insolvency generally does not impose liability on the agent or broker." [Cite.] There is one exception to this rule. A broker is not liable for an insurer's subsequent insolvency where the insurer was solvent at the time the policy was placed, "unless at that time or at a later time when the insured could be protected, the agent knows or by the exercise of reasonable diligence should know, of facts or circumstances which would put a reasonable agent on notice that the insurance presents an unreasonable risk.”

AYH Holdings, Inc., v. Avreco, Inc., Illinois Appellate Court

March 2005

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Texas Insurance Code§ 981.211. FINANCIAL CONDITION OF SURPLUS LINES INSURERS

(a) A surplus lines agent must make a reasonable effort to determine the financial condition of an eligible surplus lines insurer before placing insurance with that insurer.

(b) A surplus lines agent may not knowingly place surplus lines insurance with a financially unsound insurer.

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Agent Liability for Insurer Insolvency“…deficiencies in the filings were not “technical” or “minor” as characterized by Genatt.

…the Court finds that the broker’s failure to comply with the strict provisions of the Insurance Law is evidence that they did not act with reasonable care. … the Court also finds that the defendant breached its contract with the plaintiff in failing to procure proper insurance for it.

…The Court finds that the admitted failure to strictly comply with the provisions of Insurance Law § 2118, constitutes a breach of Genatt’s fiduciary duty to the plaintiff.

…An insurance broker who breaches his duty to an insured by not obtaining proper insurance becomes liable to the extent that the carrier would have been.”

East Coast Management Ltd. v Genatt AssociatesSupreme Court, Nassau County, New York

June 2005

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Financial Statement Fraud

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Paper transactions - not backed by anything of value

• Art

• Industrial development bonds

• T-bills (Sovereign Cherokee National Tejas)

• Debentures

• Futures Contracts

• Gold certificates & other precious metals contracts

• Mineral / timber interest (gold tailings under parking lot in Colorado; kaolin mine in Brazil)

• CDs issued by non-existent financial institutions

Overstated / Fraudulent Assets

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Pink Sheet Stocks

Companies not highly traded

Market quotes non-existent

Not accepted on major stock exchanges

Trade at value less than $5 per share (often investments in affiliates)

Questions of value and liquidity


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Real EstateQuestionable appraisals


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Real EstateQuestionable appraisals


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Liabilities

• Poor accounting controls

• Failure to record claims

• Inadequate reserving practices

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Surplus Notes

Typically long-term highly subordinated debt instrument used to directly enhance surplus (“debt treated as equity”)

Standards for Evaluation

• % of note to total surplus (conservative - <15%)

• Length of note’s maturity (>10 years)

• Interest rate (low)

• Supports prudent business plan

• Permission of regulator for repayment of principal & interest

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Accountants/Auditors/Actuaries

• Forged reports

• Co-conspirators

• Professional negligence

Reinsurers

• Fraudulent reinsurance

• Overstated credit for reinsurance

Related Parties

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Insurance Fraud Protection Act

• Creates criminal liabilities & penalties for insurance professionals

• Targets management fraud

• Applies to insurance &

reinsurance transactions

• Covers company executives,

directors, agents brokers,

MGAs, & employees

• Enforced by the Department of Justice & US Attorneys, with support from the FBI

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The IFPA Prohibits:

✖ Presenting materially false financial reports about an insurer to either regulators or business associates

✖ Misappropriating premiums and other funds belonging to an insurer

✖ Attempting to influence or obstruct the administration of the law in an insurance matter pending before a regulatory official

✖ Anyone ever convicted of a criminal felony involving dishonesty or breach of trust from engaging in the business of insurance without the prior written consent of the state insurance regulator

✖ Permitting a person convicted of a felony involving dishonesty to participate in interstate insurance transactions

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Agent Fraud

• Bid-rigging / price-fixing

• Theft / conversion

• Premium finance scams

• Forgery / alteration

of documents

• Bogus claims

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Agent Abuses

• Failure to monitor financial condition of insurers

• No resident / non-resident surplus lines agent

• Unfair competition (no diligent effort / fictitious affidavits)

• Binding authority (misuse /

wrongful delegation

• Taxes

• Coverages

www.napslo.org

2016 Regulatory UpdateNonadmitted Insurance and Reinsurance Reform Act ("NRRA")

Foreign Account Tax Compliance Act ("FATCA")

Terrorism Risk and Reinsurance Act ("TRIA")

National Association of Registered Agents & Brokers ("NARAB")

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NRRA• In effect for 5 years now (July 21, 2011)

• Regulation of placement solely by insured’s home state (principal place of business/principal residence)

• Only the home state can require a surplus lines broker to be licensed

• Only the home state can require premium tax payment

• States may enter into a compact to allocate among the states taxes paid to home state

www.napslo.org

NRRA• Exempt Commercial Purchasers – broker exempt

from state diligent search requirements

• [Somewhat] uniform standards for surplus lines insurer eligibility– US insurers: licensed in state of domicile and maintain

minimum capital & surplus

– Non-US insurers: on IID Quarterly Listing of Alien Insurers

• All states have now adopted NRRA-specific legislation

www.napslo.org

FATCA• Current version effective July 1, 2014

• IRS reporting requirements directed at foreign financial institutions and intermediaries to prevent tax evasion by US citizens (targets tax non-compliance by US taxpayers with foreign accounts)

• US broker required to confirm FATCA status of non-US insurer (IRS Form W-88EN-E) and non-US broker (Form W-8IMY)

• If unable to determine non-US entity status, US broker required to withhold 30% of premium for payment to IRS

• Unlikely US brokers will place business with non-US entity not qualified as exempt from FATCA

• W-8 forms are valid for 3 years

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Terrorism Risk Insurance Program Reauthorization Act of 2015

• Enacted January 12, 2015

– Passed July 17

– Reauthorizes for 6 years (ending 12/31/2020)

– Increases insurers’ co-pay from 15% to 20% over 5 years

– Program trigger increases from $100M to $200M over 5 years

– Industry aggregate retention increases from current $27.5B to $37.5B (by $2B per year

– Treasury’s recoupment rate increases from 133% to 140%

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NARAB

• National licensing clearinghouse

• Enacted as part of Terrorism Risk and Reinsurance Authorization Act in January 2015

• One set of producer licensing and CE standards for the entire US

• States maintain authority over consumer protection, market conduct and unfair trade practices

• President, with advice and consent of Senate will appoint 13 members (8 regulatory / 5 industry) – [90 days?] from enactment.

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Stamping Offices

Contribute to a stable, efficient, reputable, financially strong surplus lines market

• Monitor financial status of eligible insurers

• Encourage / obtain compliance

• Improve quality of policies issues

• Provide technical assistance / distribute information

• Education to agents and insurers

• Accumulate statistics on surplus lines market

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US Stamping Offices

(NC to be added in 2017.)




Dan Brown

https://www.surveymonkey.com/r/Dan-Brown





Appendix

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Why Accuse Surplus Lines?A little history…

Dangers of “Surplus Line” Insurance

“Many business men cannot obtain sufficient insurance in companies licensed in theState where the property to be insured is located, and are compelled to place the“surplus line’ with unadmitted companies or associations. Here great care isnecessary. The “surplus line” concerns as a class are inferior in financialresponsibility and general caliber to the companies regularly licensed. Many of themare wholly unworthy of confidence.

These considerations apply with especial force to unadmitted foreign companies, ofwhich a number are transacting business in the United States.

Many brokers making a specialty of placing “surplus lines” are incompetent,dishonest, or both. They collect premiums which they fail to pay to the companies,and, as they act as agents for the insured, the premiums must be paid again, or thepolicy will be cancelled.”

A.M. Best - May 1917

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Kenilworth Insurance CompanyA Case Study Presented to the NAIC Annual Meeting - December 1982

“… over ten years ago the author determined that most of the fraudulent activity which had occurred in the sixties in the insurance industry was related to the excess and surplus lines and reinsurance business.

(Surplus lines) is a book of business that is essentially not subject to any regulation other than surplus lines brokers who generally have to file certain reports with the state insurance departments, primarily for tax reasons.

It is attractive for the high premiums per risk, both in terms of cash flow and the fewer number of individuals exposed to claims.

… if a company wants to write in a particular state, but cannot be admitted in that state by the Insurance Department, it can go to the London market and write the risk through a London broker. … risks such as these are treated in the convention blank as reinsurance and rarely, if ever, broken down by state.”

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1970’s Sasse syndicate (Bronx slum property business - $15 million)

Jack Goepfert

Den-Har (Dennis Harrison)

1980’s Kenilworth Insurance Company – Jack Goepfert

Carlos Miro (Transit Casualty Company)

Alan Teale (Victoria Insurance Company & many others)

1990’s California Inner-city small commercial & substandard auto

markets (LA riots, offshore insurers)

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Overstated/Fraudulent Assets

Rented Assets

• Have occurred with federal GSE securities in the past

• Insurer leases rights to bonds for fee paid to “broker”

• Insurer can only produce lease agreements & fraudulent trust receipts, not bonds themselves

• “Brokers” not own securities either – no authority to assign interest and actual ownership often impossible to determine

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Occupational Fraud – Initial Detection

All Cases Fraud by Owners/ Executives

Tip 42% 53%

Management Review 16% 15%

Internal Audit 19% 12%

By Accident 7% 17%

External Audit 3% 16%

IT Controls 1% NR

Source: 2014 and 2008 Report to the Nation on Occupational Fraud & Abuse; Association of Certified Fraud Examiners

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Occupational Fraud – Insurance Industry

Frequency of specific types of schemes:

1. Corruption (33.9%)

2. Skimming (22.6%)

3. Billing (17.7%)


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Associate in Surplus Lines Insurance• Nationally recognized insurance designation

• Developed by Derek Hughes / NAPSLO Educational Foundation and The Institutes

• Highest level of professional education available in the surplus lines market

• Courses:– 2 dealing specifically with surplus lines

– 2 electives approved by The Institutes

• ASLI exemplifies a commitment to professionalism, dedication to the pursuit of excellence, and investment in the future of the surplus lines industry

ASLI




Dan Brown

https://www.surveymonkey.com/r/Dan-Brown


talking about… - wsia the sting - dan brown...mar 16, 2010 · stamping offices in 14 states...

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