The independent review of the supervision of CBL Insurance is a particularly pitiful tale.
It shows that the Reserve Bank of New Zealand, our insurance regulator, was asleep at the wheel while a regulator in a small European country, with a population of only 35,000, was decisive and knew more about CBL than we did.
The big losers from this debacle are the Reserve Bank's reputation and NZX-listed CBL Corporation, which owned 100 per cent of CBL Insurance.
The only apparent winners are the CBL directors and senior staff who sold $100.5 million worth of shares before the listed company collapsed.
The story begins almost a decade ago with the passing of the Insurance (Prudential Supervision) Act 2010. The objective of the legislation was to promote and encourage the sound operation of licensed insurers and protect the interests of those dealing with insurance companies.
The Reserve Bank of New Zealand (RBNZ) was given the role of insurance regulator as it was already responsible for banks and financial institutions.
The National Government wanted a "light-handed approach", with the legislation sponsor, Finance Minister Bill English, noting that the new Act "is comparatively light-handed in its application, and it is intended to deliver regulation that does not mire the industry in a compliance mentality".
This light-handed approach was questionable given the disastrous consequences of the 1987 sharemarket crash, the bailout of Bank of New Zealand in the early 1990s and the collapse of the finance company sector just prior to the introduction of the new insurance regulations.
According to English at the time of its implementation, the new legislation "contains a strong emphasis on director and senior officer obligations and accountability, which are intended to be reasonably self-administering for compliance insurers once implementation is completed".
English conveniently failed to mention that directors and senior officers were primarily responsible for the three financial disasters outlined above.
An analysis of the legislation indicated that the RBNZ's main role was to license insurance entities and after that, these companies would be effectively self-regulating. However, the legislation obliged the central bank to supervise this self-compliance. The independent review stated that "in the event of non-compliance, the RBNZ is enabled to escalate supervision (but not obliged to do so)".
A provisional licence was issued to CBL Insurance in February 2012. This was followed by the granting of a full licence in September 2013, even though a KPMG review raised several issues regarding the company's affairs.
The licence was granted on the condition that CBL addressed the matters raised by KPMG and the insurer sent a monthly report to the regulator outlying the progress on these issues.
Graeme Wheeler was Reserve Bank governor when the CBL licence was granted, Toby Fiennes was head of prudential supervision, Arthur Grimes was chairman and Sue Sheldon was deputy chair.
In the two-year period between September 2013 and September 2015, when CBL Corporation launched its IPO, the NZ regulator had further concerns about the insurance company's solvency. An internal RBNZ actuary report referred to "a serious solvency issue for CBL at 31 December 2013 and going forward".
The CBL IPO in September 2015 was a big success, with chairman Sir John Wells writing in the offer document: "A listing on the NZX Main Board and ASX provides additional capital for future growth, should strengthen regulatory capital and will allow employees and public market investors the opportunity to share in CBL's success."
The final IPO price was $1.55, compared with the indicative range between $1.45 and $1.85 a share, and $125.3m worth of shares were sold to the public.
This $125.3m was distributed as follows:
• $35.3m went to existing shareholders, mainly chief executive Peter Harris and director Alistair Hutchison
• $20.0m was allocated as additional capital to CBL Insurance, the entity regulated by the RBNZ
• The remaining $70.0m remained with CBL Corporation, the listed company.
The $20m allocation to CBL Insurance, which represented only 16 per cent of the value of shares sold, was extremely small given the insurance company's solvency issues.
In June 2016, just nine months after the IPO, the insurance group's solvency issues were raised again by an internal RBNZ review. A letter was sent to the insurance group stating: "As discussed, it is still the Reserve Bank's view that reserving risk remains the most significant risk to CBL Insurance."
In October 2016, the Gibraltar Financial Services Commission raised concerns about CBL Insurance with the RBNZ. Gibraltar is a small country in southern Europe with a population of only 35,000 and the commission supervises a broad range of companies that do business in or from the country.
The Gibraltar regulator had concerns about CBL Insurance because over 50 per cent of its gross written premiums were transacted through Elite Insurance which operated in Gibraltar. The RBNZ communicated no major concerns to the Gibraltar Commission although they both agreed that claims reserving was the biggest risk factor for both CBL and Elite.
In April 2017, Harris, Hutchinson and senior management sold 20 million shares at $3.26 each, realising $65.2m.
The accompanying NZX release contained the following statement from Wells: "Advice from our advisers suggests this transaction will provide additional liquidity in the market for CBL shares which we believe will benefit all shareholders."
CBL needed more equity to strengthen its ailing insurance operations, not the sale of $65.2m worth of existing shares by directors and senior management to "provide additional liquidity in the market for CBL shares".
This brought the total amount of money realised by directors and senior management through the sale of CBL shares to $100.5m.
Just two months later, the Gibraltar Commission raised further concerns about Elite and CBL after a review by the UK-based PricewaterhouseCoopers. The review showed that Elite was materially under-reserved and CBL was probably in a similar situation.
Regulators in Denmark and Ireland also expressed concerns about CBL's strength as a reinsurer.
Finally, in July and August 2017 the RBNZ began to take decisive action against CBL.
CBL was instructed to refrain from undertaking a range of expansionary transactions without the prior written permission of the regulator and its minimum solvency requirement should be raised from 100 per cent to 170 per cent.
RBNZ also appointed McGrathNicol as investigator and two actuary firms, Finity and Milliman, to examine the claims reserves of CBL Insurance's French construction business, which represented a substantial proportion of its business.
None of these solvency issues were reported to the stock exchange and more than 47 million shares were traded on the NZX and ASX between the end of August 2017 and February 2, 2018, the day before the company's shares were suspended.
The independent review released this week concluded that the RBNZ could have been more forceful with CBL in the run-up to the September 2015 IPO, when it gave the insurer the benefit of the doubt even though it had concerns about its solvency.
If the regulator had acted on the findings of its external and internal actuaries "that in turn would have obliged the CBL board to take urgent and immediate remedial action on its financial position and financial management" in the first half of 2015.
The report had this to say about the IPO: "When CBL had indicated to the RBNZ that the IPO would not proceed unless the regulator's solvency concerns with CBL were satisfied, we believe that the RBNZ should have considered using its position as prudential regulator of CBL in 2015 to deter CBL Corporation from issuing a Product Disclosure Statement and listing on the NZX before the RBNZ had been fully satisfied on its reserving and solvency concerns."
RBNZ didn't insist that these reserving and solvency concerns were addressed and less than 28 months after CBL's IPO, its shares were worthless.
CBL directors and staff had sold $100.5m worth of shares before the market value plunged from $747m in early February 2018 to zero.
- Brian Gaynor is a director of Milford Asset Management.