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III. Insurance-Linked Securities
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3. Update on Mariah Re
Although the litigation risk profile of Cat Bonds has historically been low, disputes do arise from time to time as in any risk transfer market. To our knowledge, only two transactions have been subject to litigation or arbitration, and in neither case did investors make a claim of securities fraud. Rather, the disputes involved idiosyncratic questions of coverage under the underlying risk transfer contract rather than claims of inadequate disclosure. We believe the relative absence of ILS transaction-related litigation results from several factors, including well-developed documentation and disclosure standards, transfer restrictions limiting the offering and secondary re-sales to sophisticated investors and the remote nature of the underlying risk (typically modeled at 1-in-50 to 1-in-100 year return period), which has resulted in a limited number of triggering events.
One transaction that is subject to litigation was American Family’s Mariah Re transaction, which utilized an industry loss index to cover severe U.S. thunderstorm risk. The dispute involved a coverage question of whether index-provider Property Claim Services (“PCS”) was permitted to supplement a catastrophe bulletin, thereby resulting in a total loss of the bond and a recovery by American Family. In particular, the complaint by Mariah Re alleged: (i) breach of contract against PCS, modeling firm AIR Worldwide Corporation, and American Family; (ii) unjust enrichment against American Family; (iii) conversion against American Family; and (iv) tortious interference with contract against American Family. It sought a declaratory judgment against all defendants and specific performance against all defendants.
The U.S. District Court for the Southern District of New York dismissed the investor claim in late 2014. In June 2015, the U.S. Court of Appeals for the Second Circuit upheld the lower court’s dismissal of the claim, thereby bringing to a close the investor challenge. In dismissing the complaint with prejudice, the District Court cited the unambiguous documentation standards and the underlying bargain of risk transfer:
At bottom, the Reinsurance Scheme formulated by the parties was a highly sophisticated and integrated set of agreements whereby investors and insurers gambled
on the likelihood and severity of catastrophic weather events. If storms were infrequent and mild, investors in Mariah stood to realize significant earnings on their investment at the expense of the ceding insurer, American Family. If, on the other hand, the weather turned fierce, as was the case with Catastrophe 42, American Family gained a hedge on its policyholders’ claims by accessing the funds in the special purpose vehicle, Mariah. PCS, AIR, and the Banks were engaged solely to facilitate the arrangements between the risk- taking parties and had no skin in the game. Having gambled and lost on the weather—and there appears to be no dispute that Catastrophe 42 was a “severe” weather event that “ranks as one of the top [weather] outbreaks of all time”—Mariah now attempts to convert its unsuccessful risk venture into a game of “gotcha” on the contracts. Unfortunately for Mariah, the documents themselves are unambiguous and provide no basis for the relief sought in the Amended Complaint.
Willkie had no involvement in the Mariah Re transaction or the subsequent litigation.
K. ExcessReserveFinancings
The year 2015 continued the previous year’s trend of a decrease in the number of new excess reserve financing transactions. As in the prior year, the likely cause was caution from both regulators and life insurance companies as a result of activities by the NAIC’s7 Captive’s and Special Purpose Vehicle Use (E) Subgroup, and in particular the adoption by the NAIC in late 2014 of Actuarial Guideline 48 (“AG 48”). AG 48 applies to all policies issued after December 31, 2014 that fall under regulation XXX or AXXX. Even with the continued slowdown, however, a few life insurance companies restructured existing transactions to take advantage of lower lending rates and the continued interest by reinsurance companies to act as credit providers, and another cautious few closed new transactions in 2015. In addition, there was an interest in financing XXX and
7 If not otherwise defined in the text, references and acronyms are defined in the glossary attached as Annex A to this Year in Review.
Developments and Trends in Insurance Transactions and Regulation 2015 Year in Review