this hour has 22 minutes

This Hour has 22 Minutes

CONFERENCE

PRESENTS

This Hour has 22 Minutes

1- Madoff Fraud

2- Payments in Recessionary Times

3- Bankruptcy and Risk Mgmt

4- Fiduciary Claims

4 Business Insurance Claims Consulting (“BICC”) © Deloitte & Touche LLP and affiliated entities.

News Anchors

Madoff Fraud

Madoff trial

Episode Contents – Madoff Fraud

• Background - Hedge funds• What happened? - Madoff Story & Hedge

fund frauds• How could it happen? Who can I blame?• What is the Recourse?• What is the Impact of Madoff Fraud on

Insurance?• What are the Lessons to be Learned?

Simplified explanation of the Madoff Scandal

The Madoff Story - Background

• Bernard Madoff founded Bernard L. Madoff Investment Securities LLC in 1960

• Was one of the top market maker businesses on Wall Street

• His firm developed innovative computer information technology to disseminate stock quotes – later this technology became the NASDAQ

• Madoff was a former Chairman of the NASDAQ

The Madoff Story – The Fall Out

– $65B Loss or $20B?– 8,800 claimants– $1.2B recovered to date– $120M in compensation paid by SIPC– Hundreds of litigation cases

Anatomy of a hedge fund fraud

– A simple example:

MASTER FUND

Domestic Feeder Offshore Feeder

Domestic Investors

Offshore Investors

You and me

Trading activities

Intermediaries – invest in the master fund

Anatomy of a hedge fund fraud: The players

Party RoleInvestment Manager Develops the investment strategy;

responsible for hiring service providers

AdministratorTo provide financial reporting; communication with shareholders/partners

Custodian Hold the assets

Auditor Verify the financial results

The Madoff Story – The Ponzi Scheme

• According to former CFO, Frank Dipascali, for at least 20 years, the results of the Madoff Fund were entirely fictional

• Clients were sorted into categories, each with its own pattern of fictional but plausible trading

• They created account statements and trading slips for trades that never took place

• Finally, on December 11, 2008, amidst the economic crisis, Madoff could not fund $7B of redemptions out of his fund

• He was sentenced to 150 years in prison on June 29, 2009. With good behaviour, he is set to be released in 2139

Other famous hedge fund frauds

• The Madoff Fraud is not unique. There have been other famous hedge fund frauds/failures including:– Manhattan Capital (2001) $400 Million– Stanford Financial Group (2009) $8,000 Million– Westgate Capital Management (2009) $900 Million– WG Trading Co (2009) $554 Million

How Could it happen? Who can I blame?

• Where was the failure?• Were there abundant warning signs?• Process of due diligence

Investor recourse

• Investors have limited recourse. Some options include:– Litigation against Feeder fund for negligence, mismanagement and

fiduciary duty– Litigation against Regulators– Claims under the Securities Investor Protection Corp. (“SIPC”)

– Claims limited to $500,000– Canada has a similar program called the Canadian Investor Protection

Fund (“CIPF”) with limits of $1,000,000 investor

– Make a claim under homeowner insurance– Limited coverage for securities losses due to theft– AIG is being sued by two homeowners alleging the insurer is refusing to

honour the fraud-protection provision in their homeowners insurance– Likely limited coverage (<$100,000)

Impact of Madoff fraud on Insurance

• Still too early to gauge exactly how much insurance coverage will come into play

• Many of the Feeder funds are being sued by investors– D&O and E&O coverage – Legal defense cost coverage (eg. Tremont Group)– Crime insurance and fidelity bonds

• Impact of Madoff fraud will be felt for years to come in the form of increased prices and restricted coverage.

Lessons learned - How do we prevent the next Madoff?

• It is unclear whether more regulation could have prevented this fraud– SEC investigated Madoff, but did not uncover

• Introduce reforms to demand that custodians, brokers, administrators all be independent

• Use the IRS model– Advisors and custodians would be required to report assets – Asset data would be cross referenced, and any disparities would

be investigated.

Lessons learned – What should investors do?

• Review all insurance policies– D&O and E&O policies– Ensure coverage is sufficient

• Exercise greater due diligence– Inquire/demand that your investment manager is exercising due

care– Some large investor’s are buying “Madoff Insurance” – hiring

private investigators to research the social aspects of their money managers

– Deloitte Financial Advisory

Top 10 Messages left on Bernie Madoff’s vmail

Questions

Expectations on Payments in Recessionary Times

Episode Contents

• State of the Industry– Trump Question

• What is “reasonable” payment timing?• Unreasonable payment timing• Cut-through clauses• How can we get interim payments?• Steps to take to get cash

State of the Industry

• Insurance industry hit hard. – AIG Bailout– Lehman bankruptcy, Merrill Lynch takeover & bailout– Increased M&A activity

• Insurers note an increase in competitive pressures.• Canadian life insurers facing falling stocks.• Insurance companies need to make money to exist.

Trump Question

What is “reasonable” payment timing

• What do you know of your Insurance company regarding payments on claims?

• Has this changed in light of the economic downturn?• Industry benchmark on large commercial claims• Lloyd’s audits their syndicates on timing of payments.

Unreasonable payment timing

• Duty of insurance company to conduct an insurance claim investigation.

• Unreasonable delays may be due to:– Documentation– Order of Payment– Coverage– Communication

Cut-through clauses – A Growing Trend?

• If Insurer goes belly up, the Reinsurer is still on the hook and payment is made directly to the Insured, not to the Insurer.

• Provides security from an Insured’s perspective.• Avoids the risks associated with insurance.• Allows the Insured to have more control over the real Insurer

in cases where the administration and claims handling is provided by the Reinsurer.

• Most frequently sought when an Insurer receives a downgrade in its ratings.

How can we get interim payments?

• Credit crunch pain• Lack of interim financing• Most Insurers will accept interim claims• Reasonable percentage (50% or 75%) of what is likely to be

the overall compensation figure. • Must justify and document proof • Benefits are: cash flow, establish communication, address

issues sooner, avoids surprises, minimizes the outstanding amount

Steps to take to get cash

• Review insurance policy• Maintain documents

– Claims are fact intensive– Complete record is vital for claim

• Don’t try to do everything in-house

• Develop an insurance loss team comprised (as appropriate) of the following skills:

• Retain experts• Presentation is everything

Engineers and AccountantsRisk ManagerInsurance Broker

Steps to take to get cash• Communicate with the adjuster

– Get buy in on major decisions to minimize “Monday-morning quarterbacking”

• Try to avoid surprises• However, do what you need to keep

your business operating

• Communicate with appropriate internal management – Explain the claim process and

timing– Manage claim settlement

expectations– Business interruption is not

“black and white”– Be cautious if booking

receivables for business interruption

Commercial Break

Questions?

Bankruptcy/Reorganization

RIMS Conference 2009September 15, 2009

How not to declare Bankruptcy…

Agenda – Bankruptcy/Reorganization

• State of the Economy – Auto, Real Estate, Retail• Risks in a bankrupt company – still covered?• Issues – BI Values

– Contingent BI – key customers/suppliers

State of the Economy

• September 18, 2008• Falling interest rates• Steep increase in filings

Risks in a Bankrupt Company – still covered?

• Cancellation - Insurers cannot cancel a policy• Most policies have change of control policies• If Insurer goes bankrupt, then Insured must go elsewhere• But could get bumped up with Clawback payments• Claims – OSFI possibility but limited. Very few clear answers

Issues – BI values

• Declared values may not be the same• Contracts not the same• May not be a true BI loss• Contingent BI – no coverage for yourself if others have gone

down. Best practice is good ERM & supply chain management

Commercial Break

Questions

Fiduciary Claims:The Pension Crisis

RIMS Conference 2009September 15, 2009

Agenda – Fiduciary Claims

• Pensions at a glance• Issues• What this means to risk management

Pensions at a glance…

• Pension funds consist of assets and liabilities• Defined Benefit vs. Defined Contribution• An underfunded plan is defined as a plan whose liabilities

exceed the assets– Only a defined benefit plan can have an unfunded liability– Many assumptions are required to quantify the plan liabilities

including: discount rate, actuarial assumptions, etc.

• In the US, the Employment Retirement Income and Security Act (“ERISA”) governs pensions nationally

• In Canada, each province has its own pension standards legislation

Pensions at a glance….

• A plan can be underfunded temporarily, but must adopt a schedule to address the shortfall within a defined period (eg. ERISA defines a period of 7 years)

Pensions at a glance: Timeline

1974 ERISA Enacted

1963 Studebanker Pension failure

Pension Chronology

1960's 1970's 1980's 1990's 2000's

2006 FAS 158 Accounting rules for Defined Benefit Pensions

2006 Pension Protectection Act,

2008/2009 Pension crisis – More to Come

Pension Issues: Underfunded pension crisis

• Financial crisis is sapping the assets of defined benefit pension plans

Pension Issue: Underfunded pension crisis

• According to the 2008 Milliman Pension Funding Study, the top 100 pension funds are 80% funded at the end of 2008, compared to 106% in the prior year

• Almost half of top unions have underfunded pension plans

Pension Issue: Notable underfunded pensions

$1 Billion

$20 Billion$20 Billion $3 Billion

Pension issue – What happens in Bankruptcy?

Pension Issues: Litigation

• Until recently, large fiduciary liability claims were rare

• Pension litigation is on the rise, and projected to be the most heavily litigated issue in the U.S.– According to

pensionlitigationdata.com, 100% of ERISA litigation in the U.S. involves fiduciary breach allegation

Pension Issues: Litigation

• Areas of dispute– Fees litigation– Stock drop cases– Conversion claims– Surplus entitlement

• Even Defined Contribution plans are not immune to lawsuits– Claims related to the selection and monitoring of investment

advisors – Negligent or inappropriate investment decisions

What this means to risk management

• Fiduciaries may be held personally liable for breach of responsibilities in the handling of pension plans

• Some D&O policies exclude fiduciary liability exposure as well as those exposures pertaining to employee benefits– In some cases, fiduciaries may need to purchase fiduciary liability

insurance

Questions

THANK YOU FOR ATTENDING THE

CONFERENCE

ENJOY THE REST OF YOUR CONFERENCE!

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