Update: After publication, it was announced that Brookfield Reinsurance completed the acquisition of Argo Group on November 16th.

Readers of Risky Business will know how vociferous my opposition to insurance company reorganizations has been in general, and to the OneBeacon and Arrowood transactions in particular. Both are now insolvent as was easily predicted from the first mention of their intended reorganizations.

Time and again, insurance regulators have failed in their primary responsibility to protect the insurance-buying public. Time and again regulators have been duped or bullied, drunk the Kool-Aid of the actuarial science justifications, or hidden behind the letter of the law to protect their cronies.

One of the lessons that I think we all have learned from the transactions is that policyholders wait until it’s too late in the reorganization process to raise objections. When the writing is on the wall, it is time to read it and act before being left seeking cents on the dollar from the liquidating estate of an insolvent insurer or a State Guaranty Fund. That brings me to the point of this blog post. The writing is on the wall for Argonaut Insurance Company; it is time to read it.

Parentage: The Importance of the Ultimate Owner

The ultimate owner of an insurance company is an important consideration in determining its risks. An insurance holding company with many insurance companies among its subsidiaries will tend to be much more committed to each individual insurance company than, say, a private equity owner, who will be less concerned with reputational risk and likely more opportunistic in its philosophy.

The ultimate parent of Argonaut remains Argo Group International Holdings Ltd., a Bermuda company exclusively comprising a group of insurance companies. However, on February 8, 2023, it was announced that Argo Group would be acquired by Brookfield Reinsurance Ltd.  According to their third quarter 2023 statutory filings, the anticipated closing date is now February 2024. Both sides remain committed to the transaction, and all that is lacking are some regulatory sign offs.

Brookfield Reinsurance was incorporated in Bermuda in 2020, operating a financial services business described as “providing capital-based solutions to the insurance industry”. Brookfield’s parent was Brookfield Asset Management. A series of complicated reorganizational moves followed, described in a court filing as the “Brookfield Arrangement”.

While Brookfield Reinsurance is technically in the insurance business, it has no track record, has a close relationship with private equity, and has a stated goal of “providing capital-based solutions to the insurance industry”. That statement alone should terrify any policyholder with legacy liabilities relying on their Argonaut coverage. The writing on the wall tells me that sooner rather than later, the deployers of these so-called capital-based solutions will be tempted to seek to split Argonaut into two companies, with all of the legacy liabilities in one, and any ongoing business in the other.  The new owners likely have little interest in legacy liabilities associated with lines of business that are discontinued but see value in the insurance and underwriting footprint that Argonaut has established.

Capital Adequacy: Troubling Developments

Argonaut’s risk-based capital (RBC) ratio — which compares risk-based capital to statutory surplus — has declined steadily over the last 10 years, from 597% in 2013 to 439% in 2018 to 252% in 2022. That compares unfavorably with its peer group and was, no doubt, a factor in the AM Best downgrade to A- in 2019. While 252% is above the trigger point for regulatory intervention, there is little room for maneuver. The A- credit rating is likely at risk which may explain the $65.4 million capital contribution during the third quarter.

As a result of poor profitability in 2022 (Combined Ratio > 120%), the company was required to submit a plan to the Illinois Insurance Departed to increase the RBC ratio about 300%. Given these troubling developments and weakening capital, it is extremely surprising that Argonaut was permitted to declare two surplus reducing dividends of $50mm in 2019 and 2020.

Legacy Liabilities: Lack of Reserves

Although Argonaut has positioned itself as a specialty insurer in recent years, it was formed in 1948 and wrote significant amounts of corporate general liability coverage during its history. Every insurer that wrote CGL coverage during that period has had to deal with shocks to profitability to adequately reserve for legacy liabilities such as asbestos and environmental claims. Emerging classes of liability that trigger those same occurrence-based policies include opioids, talc, PFAS, and sex abuse.

Argonaut financials are silent about their exposure to these emerging classes of loss. Their mandatory disclosed liabilities for asbestos and environmental claims (note 33) were $56mm in December 2022, net of reinsurance. The amount of ceded reinsurance, which protects the bottom line from reserve increases, was just 14% for these claims— low by industry standards.  A review of 10 years of losses incurred, paid and reserved for asbestos and environmental losses indicated that Argonaut has been adopting a reserve-as-you-pay approach. December 2022 reserves are half the amount paid for those losses over the last 10 years.

Overall, I do not have confidence that the company is adequately reserved for legacy liabilities — not for established ones such as for asbestos and environmental, and not for emerging ones either.

Core Business: A Change in Commitment

Argonaut has been through a period of significant instability in the leadership of its core business. Investors have made accusations of inappropriate corporate expenses, false and misleading public statements, and inadequate underwriting standards.

Chief Executive, Mark Watson, was pushed out in November 2019, and his successor stepped down in March 2022. Argonaut later settled a pending SEC investigation concerning perks paid to Watson. In August 2022, the company announced a Loss Portfolio Transfer (using retroactive reinsurance) with an Enstar subsidiary, covering accident years 2011 to 2019. While there is nothing inherently fishy about a retroactive reinsurance transaction, it is a surprising move in these circumstances and communicates weakness in the core business strategy.

Retroactive reinsurance is almost always used for legacy liabilities or discontinued books of business. In this case, it is for recent accident years, 2011-2019. The “subject business” is redacted in the publicly available version of the agreement, but given the size of the transaction, it includes the majority of lines of business. Argonaut will, at least in the first instance, retain claims handling responsibility. But I find it mystifying that the company would risk its renewal rights by signaling weakness to existing policyholders in this way. The counter party, Enstar, a reputable counterparty, also has the right to retain a third-party administrator. Argonaut is signaling a change in its commitment to existing lines of business, including in the claim-handling experience, which is a key way in which insurers compete with one another.

Policyholders have paid a painful price for the reorganization of insurance companies, as those of OneBeacon, Home and Royal insurance companies can attest. While Argonaut representation in the insurance programs of corporations may not be as significant as that of OneBeacon, Home or Royal, it nevertheless wrote a significant amount of general liability insurance.

Conclusion

• The current Argonaut business model is quite different to the one that underwrote CGL coverage in earlier decades.
• The ultimate ownership is now set to be private equity.
• The LPT with Enstar raises further questions about their commitment to the current business model.
• Argonaut’s financial strength is deteriorating, and 10 years of reserving history indicates that it is unprepared for emerging risks.

The time has arrived for policyholders to take proactive steps, in unison, to ensure that the new owners do not reorganize away whatever security remains for legacy liability policyholders. The Illinois Department of Insurance is the place to begin that process.