Tower's CFO resigns; Ratings agency red flags concerns over the company's 'financial profile deteriorating' as its reinsurance for the Feb 2011 Canterbury quake runs dry and it's left to fend for itself

Tower's CFO resigns; Ratings agency red flags concerns over the company's 'financial profile deteriorating' as its reinsurance for the Feb 2011 Canterbury quake runs dry and it's left to fend for itself

Tower Insurance Limited (TIL) is skating on thin ice in the wake of the Canterbury earthquakes.

It has announced the resignation of its Chief Financial Officer of two years, Brett Wilson, the day after ratings agency, A.M. Best, has sounded the alarm bells over the insurer's finances. 

Affirming Tower's outlook as ‘negative’, A.M. Best red flags the fact the company has run out of reinsurance to cover claims related to the February 2011 quakes, so is digging into its own coffers to cover outstanding claims.

It is concerned about the company’s “financial profile deteriorating”, and says the quake hangover could have a “material impact on its prospective financial strength”.

“The negative outlook for TIL’s ratings reflects A.M. Best’s concern about the company’s financial profile deteriorating in the event of further loss development from the Canterbury earthquake claims,” A.M. Best says.

“Based on the company’s interim financial statements through March 31, 2016, the estimated gross ultimate incurred claims for the February 2011 event have exceeded the catastrophe reinsurance and adverse development cover limits.

“Hence any further significant loss development on the unsettled claims in relation to this event will be fully retained by the company and may have a material impact on its prospective financial strength.”

Tower left with $74.5m bill

Tower, in its 2016 interim results, said it expected the total cost of the February 2011 event to be $449.8m. Yet its reinsurance has only covered $375.4m, which leaves it with a shortfall of $74.5m.

It accordingly expensed $2.9m before tax ($2.1 million after tax) for provisions for the February 2011 quake in the 2016 half year. This came off the back of it increasing its provisions for the event by $45.5m before tax in the 2015 Financial Year.

As at March 31, Tower still had 641 outstanding claims from all of the 2010/2011 quakes. At this stage it had spent over $705m settling 15,260 claims. The outstanding claims are likely to be the complex and expensive ones.

Tower is in the same position, in regard to its reinsurance levels, as New Zealand’s other main general insurers.

A.M. Best has stressed the importance of the company having enough capital to settle its remaining quake claims.

In keeping the outlook of Tower’s parent, ‘Tower Limited’ (TL) - a non-operating insurance holding company - at ‘negative’, it says:

“Factors that may lead to negative rating action include continued adverse loss development or a reduction in capital that could cause the company’s risk-adjusted capitalization to decline. Furthermore, TIL’s ratings may experience downward pressure if TL’s financial flexibility deteriorates significantly on a consolidated basis.”

Devon ditches Tower shares

Following Tower announcing A.M. Best's ratings to the NZX, it has announced Devon Asset Management has halved its shareholding in the company from 5.54% to 2.39%.

Devon has been cutting back its involvement with Tower since March 3, when its shareholding sat at 13%. 

The company has been under the leadership of Chief Executive Richard Harding since August last year, before which David Hancock was CEO for two years. Wilson will remain in his role until a new CFO is appointed.

Tower's share price inched up immediately after its ratings affirmation, but has since dropped back to $1.38. It's fallen by around 30% over the past year.

A- financial strength rating affirmed

A.M. Best has also affirmed TIL’s financial strength rating as A- (Excellent), and its issuer credit rating as a-.  

Meanwhile it’s affirmed the issuer credit rating of Tower’s parent as bbb-.

“The ratings reflect TIL’s adequate risk-adjusted capitalization, which results from the company’s moderate underwriting leverage, prudent reinsurance arrangement and conservative investments. In addition, over the past four accident years, the company continues to report favourable underwriting results, with combined ratios consistently below 95%,” A.M. Best says.

“A major offsetting factor in TIL’s rating assessment is the volatility in its historical earnings, stemming largely from prior-year reserve adjustments for unsettled Canterbury earthquake claims. Another offsetting factor is the high dividend payout ratio, which has constrained growth in its absolute and risk-adjusted capitalization.”

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Who is buying? ACC?

ACC increased its stake in Tower from 6.9% to 8.3% on May 30. Since writing this story, Salt Funds Management has also increased its stake from 11.9% to 13.3%.

Other than that, Tower hasn't reported any other major share purchases to the NZX. It is possible more minor shareholders have bought shares, which haven't had to be reported to the NZX. It is also possible Tower has bought some of its shares back. However on May 24 it announced to the market it would discontinue its share buy-back programme. 

AMP Capital Investors has this morning also decreased its shareholding from 5.4% to 4.7%.

In May 2015 Tower boasted it had settled 94% of its earthquake claims, well ahead of the rest of the insurance industry. That means most of the remaining 6% would by that stage have been reasonably advanced and claim reserves pretty stable. Why then are they continuing to burn cash at such a high rate, including all of the adverse development cover (ADC) they purchased? Tower is unlikely to have been offered an ADC top up if reinsurers had not been given claim data by Tower that showed they had a chance of making a buck out of the deal. Insurers always knew they were going to get more late over cap claims from EQC and reserved for that (or ought to have) long ago. These new claims will also generally be lower value due to having been through at least some form of assessment by EQC. What then is the explanation for the apparent mismatch between Towers rhetoric about being nearly there over a year ago and the ongoing increase in claim reserves?

Thats a really good question/comment - I asked the NZX to investigate Tower's disclosures around settlement rates last year after they made those disclosures to the NZX (because they were obviously wrong). The NZX passed my complaint onto the FMA, who wrote back to me and said "the FMA has limited resources and can't investigate, however we have asked Tower and they have assured us they were telling the truth"

I find interesting that the CFO has just resigned, and as you say the ADC has run out. If I was the provider of ADC to Tower I would be asking some hard questions, if I was their shareholders I would be asking even more questions, and if I was a provider of ADC to any NZ General insurer at the moment I would be putting my pen back in my pocket.

Be interesting to see whether IAG will be successful in hiding their losses this year by disguising them under the AMI, Lumley License and entity integration!...Cam Preston

IAG would have no need to ‘disguise’ their Lumley and AMI EQ claim reserve escalations as they would be separately accounted for by Westfarmers/ NZ Govt, given both sets of claims were ring fenced when IAG acquired those brands. IAG's reported EQ results will be net of these brands claims - or ought to be.

Tower is stating 641 EQ claims outstanding. That does not include claims that Tower may have written off their books but in fact are still in dispute. Nor does it include those yet to come From EQC. But if you take the 641 claims at say $500K average at the very very least, where is the $320 million going to come from. Perhaps the late CFO can do arithmetic too!

Cancelling a claim reserve when you know there is a likelihood or possibility a disputed claim will proceed, is dodgy. I’d be surprised if a listed company would engage in such risky behavior. What reserve to set for an EQ claim however is a highly subjective exercise given the multiple permutations of circumstances that can apply. I’ve watched insurers reserves for claims I’m involved with fluctuate wildly. Sometimes for good reason as new information becomes available but if you were minded it would be easy to deliberately understate the amount, confident that few people have the expertise to successfully challenge your numbers. Even then you could claim it was a matter of opinion/judgement. Your average of an extra $500K per claim net to Tower is far too high. Tower will already have created and booked to their account some reserves for the 641. So the net impact will be only a fraction of your $320m – unless they have been ‘conservative’ in their case reserving. But we have no way of knowing that. New claims from EQC will generally be lower cost ones.

Yes it is a dodgy act to write off a claim that is under dispute but that is exactly what Tower did with ours & we have that in writing! Appreciate there will be contingency already allocated for these outstanding claims and you have to allow for the EQC contribution,but at the end of the day the cash has to be stumped up for the true and final cost and that has to come out of current assets.Could identify off the cuff 15 claims Tower had assessed at about $300k but are actual rebuilds most of which well over 1mill.

Agree with most of that, however companies do undertake 'risky behaviour' for the purposes of survival. $500k is not 'far too high' (even after EQC contribution). Tower provided full replacement to 'When new' standard. It was sloppy underwriting and its really expensive to keep to that promise. Your assumption that new claims from EQC will generally be lower cost ones seems reasonable, but in fact the oppose is true - claimants going 'overcap' now, 5+ years later, are far more educated about their contractual rights and as a consequence these new overcap claims are costing a lot more to settle than the early ones. It is a most interesting situation whereby the insurers have to delay (for necessity/survival) and those delays saved them many billions early on, but now it is backfiring and costing them hundreds of millions more now. The main point being the quest for survival makes companies do 'risky things'. CFO's by nature don't like risk, which is why, I suspect, this one is off.

Woodbury & Stapleton: The issues are:

(1) has Tower reserved enough for the 641?

answer – you can speculate but we don’t have any way of knowing for sure as we can’t distinguish the part that new over cap claims coming in contributes to the overall event cost escalation, vs under reserving of claims that Tower had on its books at May 2015 when they made their ‘almost across the line’ announcement to the market.

and (2) how much will each new over cap claim cost and has Tower allowed enough contingency?

A reasonable crack at the first bit is that to have an average of $500K net of EQC contribution (say $650K gross allowing for 1.3 events), you’d need plenty approaching $1m. Are owners owners of substantial houses as badly damaged as that going to have sat back and accepted EQCs undercap verdict without getting their insurer out to survey? Unlikely. A small number might if they were oblivious but most would be proactive, especially given the now high community awareness. You challenge my belief that $500K is too high, in an authoritative manner. What data do you have to support your assertion? My industry contacts tell me the number and average value of new over cap claims is so far relatively modest and EQC says it is well through the process of reviewing this group. But obviously there is room for an element of doubt as who knows the quality of these EQC reviews. On the second part, if you went by Towers record of reserving quality so far, as judged by ongoing reserve escalation, you’d have to have some concerns. But is it really any worse than the other insurers? Until they also get to the same ‘94% a year ago’ mark, you won’t know.

Open ended cover was not ‘sloppy underwriting’. South British (later NZI) introduced the concept and the rest of the market including Tower was forced to follow or die. You are making a retrospective judgment using hindsight vision. None of the modelling predicted the repeat series nature of this EQ event. Easy to be clever after the event.

Do believe the author of the article is bang on in that the remaining claims are likely to be the complex & expensive ones. That is largely because these are resilient people with the resources to fight with lawyers & employ expensive independent experts. They are not going to cave in. Those sort of people with those sort of resources can logically be expected to be able to afford expensive larger houses. As you say 94% supposedly was settled by Tower some time ago yet why are they now still leaking bucket loads Perhaps that is precisely because this remaining 6% are a heck of a more expensive than those already settled.

Actually I think you have missed the much bigger issue here, and that is the thousands of EQC repaired and cash settled properties currently undercap that will end up overcap. 641 is a red herring, The interesting thing is that EQC never made anyone sign full and final discharges on their 'settlements'. So I think the whole industry might be facing profitability and litigation issues for many years to come I'm afraid, certainly is a bed of their own making, and not a great prospect for any investor. It's knowing the story of what is actually happening rather then the story reported in the balance sheet that makes a good investor these days, and this is a classic case of it (which is the main downfall of every rating agency ever BTW). As for the 'market' forcing them to follow - that is why they have this dirty word called 'regulation', it stops people jumping off the harbour bridge like leemings...

You have formed a belief there are many more properties that will go over cap and be more costly than the average so far but you (and I) have insufficient evidence to conclusively assert this, one way or the other. We don’t know, and won’t until we get hard data on exactly how many new claims have come in and what the average cost is. And even then we won’t be able to tell how accurately Tower has reserved for them. Anecdote is not evidence. I suggest your conclusions are suffering from confirmation bias.

It’s fantasy to suggest regulators would have foreseen the unique circumstances of the CHCH EQ, determined that open ended policies exposed insurers in the way they have and then have intervened to limit a corporates ability to offer the insurance products they wished to. No one in the industry saw it coming and neither would have Govt officials.

Certainly time is the only thing that will tell, unfortunately like money, time is scarce - especially for the homeowners that have already have their lives on hold for more than 5 one saw it coming, it was an earthquake, but the if the insurers are selling the promise of covering their customer for it (which they still are) - and making the profits from that promise - then the other side of the good faith bargain means they should keep that promise when it does occur and claims are made, and not delay while trying to recapitalise because they decided to take all the profits in dividends and alike and not take a conservative approach to the risks they were writing. Unfortunately its been almost 6 year now, and the excuses have worn thin.

" These new claims will also generally be lower value due to having been through at least some form of assessment by EQC. "
You are assuming that this is a rational world. EQC inhabit a different one.
I am familiar with a claim (not mine) that is still stuck with EQC. A 2 story house, with multiple cracks in the floor slab, floor levels all over the place, with GPR showing voids and/or bulging under the slab, and significant other issues,. The homeowner is still battling EQC to get over-cap, and yet to reach their insurer, Tower. There may be hundreds of claims like this.

This is obviously a relatively modern house. Allowable floor level variation and extent of cracking before replacement is necessary, are well litigated issues with established precedents. Voids are common and usually relatively straightforward to address. The homeowner could well be justified in their distress but it could also equally be the case that EQC is justified in their position. It’s just not possible to say from the information provided that this is an over cap claim.