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CONFERENCE PRESENTS This Hour has 22 Minutes
This Hour has 22 Minutes1- Madoff Fraud2- Payments in Recessionary Times3- Bankruptcy and Risk Mgmt4- Fiduciary Claims
Madoff trial • “You only find out who is swimming naked when the tide goes out” • Warren Buffett
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?
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 Trading activities Domestic Feeder Offshore Feeder Intermediaries – invest in the master fund Domestic Investors Offshore Investors You and me
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
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 • Does a severe downturn in the economy constitute an event of force majeure? • Can no longer get financing from banks • Trump is arguing this for the Trump Hotel in Chicago • Claim relating to “a once-in-a-century credit tsunami” • Requirements: • 1) An event in the FM clause has occurred • 2) FM event was beyond control and was unexpected • 3) FM event prevented party from performing its contractual obligations • 4) No reasonable steps to avoid or mitigate the event
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
Steps to take to get cash • Don’t try to do everything in-house
Steps to take to get cash • Develop an insurance loss team comprised (as appropriate) of the following skills: • Retain experts • Presentation is everything Engineers and Accountants Insurance Broker Risk Manager
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
Steps to take to get cash • Communicate with appropriate internalmanagement • 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
Bankruptcy/Reorganization RIMS Conference 2009 September 15, 2009
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
Fiduciary Claims:The Pension Crisis RIMS Conference 2009 September 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)