Fremont Averts Insolvency
Santa Monica-based insurance carrier Fremont General Corp., teetering dangerously close to insolvency and a state takeover, has signed a critical reinsurance deal that will allow it to keep operating, at least for awhile.
The deal, finalized Sept. 29 and still subject to state regulatory approval, calls for Bermuda-based XL Mid Ocean Reinsurance Ltd. to inject $400 million into Fremont’s depleted capital reserves, in exchange for a share of profits from future premium revenues.
“This is an extremely crucial deal,” said Nils Wright, editor of the Bay Area trade publication Workers’ Comp Executive. “Without it, they would be in real dire straits, if not completely insolvent.”
Just weeks earlier, Fremont had to boost its reserves by $450 million (using money earmarked for operating costs) to make sure it could pay out all the claims filed against its client companies. Around the same time, the company announced it was laying off 190 workers at its Glendale workers’ compensation operating facility.
The $450-million reserve boost prompted downgrades of Fremont’s creditworthiness from AM Best Co. and other insurance industry credit rating agencies. AM Best, which previously downgraded Fremont from an “A-” to “B++”, downgraded Fremont in August to “B.”
“That $450 million is by far the largest reserve boost I’ve seen in all my years in the business,” Wright said.
It also led to trade press reports that Fremont was at the top of the list of workers’ compensation carriers with solvency problems severe enough to trigger a state takeover. Earlier this year, the state took over rival carrier Superior National of Calabasas; that carrier was formally liquidated by the state last month, forcing thousands of customers to scramble for workers’ compensation coverage.
State regulators said last week that the $400-million capital infusion would likely lessen the pressure for a state takeover of Fremont, one of the state’s largest underwriters of workers’ comp premiums for employers.
“Absent Fremont being able to complete this reinsurance transaction, there would probably be a strong possibility that further regulatory action would be necessary,” said Norris Clark, deputy commissioner of financial surveillance with the state Department of Insurance.
Despite this agreement, state regulators and outside observers say Fremont is hardly out of the woods.
Uncertain future
“This will stabilize operations in the short term,” said Joseph Roethel, managing senior financial analyst for AM Best, “but I don’t think the reinsurance arrangement is going to change our rating. We’re going to be looking closely to see how operations fare from here forward. We want to see some profitability return.”
Fremont’s stock price, which had plummeted nearly 90 percent over the last two years, jumped 21 percent to $3.38 a share in the two trading days after the agreement was announced.
Calls to Fremont last week were referred to President and Chief Operating Officer Louis Rampino, who did not return repeated calls seeking comment on the agreement or what it means for Fremont’s future.
Fremont’s troubles started more than a year ago as another reinsurance deal turned sour. That deal was designed to protect Fremont from very large claims, those of more than $50,000 apiece. But it didn’t cover the majority of claims, those under $50,000, and the costs of those started rising. By August 1999, Fremont had a reserve shortfall of $50 million, forcing it to pump $75 million into its reserves.
At that point, the credit rating agencies began downgrading Fremont, prompting its stock price to tumble more than 70 percent in two months.
Although Fremont executives clearly hoped the $75-million reserve boost would help right the ship, it turned out to be merely a dry run for the crisis that hit in the middle of this year. Claims payouts continued to rise as they have for the entire industry. Fremont and other carriers had for years been charging premiums below the actual cost of claims, and even a sharp rise in premiums at the beginning of this year hasn’t been able to close the gap.
As a result, by the end of the second quarter, Fremont found itself with that huge hole that had to be plugged by putting $450 million into reserve accounts to handle claims payouts.
The reserve boost left Fremont with a huge operating loss for the second quarter, which translated into a $268-million loss on its income statement.
White knight arrives
Faced with this huge loss and no immediately available means to offset it, Fremont was forced to seek a reinsurance investment. A preliminary deal with XL Mid Ocean Reinsurance was struck in August, but it took several more weeks to hammer out the details, including the profit-sharing arrangement. State regulators must still approve the deal, a process expected to take four to six weeks.
Nevertheless, Roethel and other analysts are awaiting the release of an annual audit of Fremont’s operations, something required of all insurance carriers. The audit was begun in June by Ernst & Young LLP; results are expected in the next few weeks.
“This should give us a clearer picture of what’s going on with premium revenues and claims payouts,” Roethel said.
Ultimately, though, state insurance regulators will be looking for much more than just new data.
“Look, Fremont is going to be a downsized operation because there is no way they can continue to write as much premium as they have in the past and be profitable,” said the Department of Insurance’s Clark. “This reinsurance deal leaves Fremont with considerably less surplus. With a lower surplus base, you just can’t write as much premium.”
As a rule of thumb, Clark said, for every $100 million in surplus (the amount by which assets exceed liabilities), a workers’ comp carrier can underwrite between $200 million and $300 million in premiums. If the carrier writes much more than that, it might not have enough funds on hand to pay off claims.
While he did not have exact figures, Clark estimated the deal could result in Fremont’s surplus dropping by about $200 million, meaning the company would have to reduce the total amount of outstanding premiums by $400 million to $600 million.
“Writing less premium dollars is the start of the plan to rebuild the company,” Clark said.
