Insurance and the promise of the future

What’s the difference between a football club, a financial holding company and an insurance provider? The activity. The business models. But, above all, the way regulation applies to managers, in particular when it comes to assessing the future. A recent story dramatically illustrates this difference: we could consider the unfinished saga of the Everton football club takeover either from a purely footballing perspective – an example of the problems of deregulated finance – or as a touchstone for insurance regulation. We’re taking the latter point of view because it ultimately sheds light on this murky affair. So, let’s have a look at 777 Re‘s misfortunes before putting them into perspective. Fasten your seatbelts.

 

1. The forced landing of 777 Re

On 16 February 2024, a press release from AM Best, the US rating agency specialised in insurance, announced that 777 Re had been downgraded from B (good) to C- (weak). On 8 November 2023, AM Best had already lowered 777 Re’s rating from A- (excellent) to B (good). For a borrowing company, such a sequence of events would be disastrous, implying a considerable increase in the cost of its debt, but for a reinsurer, it’s a death sentence: the service that a reinsurer provides to its insurer clients is solvency. According to the Josimar football website, the Bermudian regulator placed 777 Re under administrative control in mid-January. What could justify such decisive action from the regulator and a hard-hitting communication from the rating agency?

On 2 November 2023, that is, less than a week before AM Best’s downgrading of 777 Re, the reinsurer published its consolidated financial statements and audit report. The following table provides an overview of the business’s balance sheet assets since its creation.

History of 777 Re‘s assets

The table doesn’t present income statement data as they aren’t useful. We can see that, out of 777 Re’s $3 billion in assets as at 31 December 2022, 70% were classified as level 3. That means their valuation depended on ‘unobservable data that reflect the assumptions of the reporting entity’. This is sometimes referred to as a mark-to-myself valuation, by analogy with mark-to-market valuations (level 1) or mark-to-model valuations (level 2). The auditor simply took note. However, the regulator and the rating agency were all the more concerned that 50% of the assets were made up of equities and structured securities issued by entities within the scope of 777 Partners (see complete survey in the financial statements).

In the first year of operation, 2019, there was certainly a loan and purchases of structured assets granted to the parent company totalling 8% of the balance sheet, but this trend accelerated considerably in the course of 2022: in that year alone, 777 Re repurchased $1 billion in assets from group companies, presumably at a high price, since there was no independent valuation. All of this occurred without signing a single reinsurance treaty, meaning the company didn’t really engage in the business of reinsurance.

2. A squadron flight plan

The independent press (mainly on social media) and a high-profile lawsuit[1] from a supposed victim of 777 Partners shed light on the circumstances that led to its reinsurance subsidiary getting lost in the Bermuda Triangle. 777 Re was conceived as a way of growing the money earned by its parent company from simple, if not particularly glorious, arbitrage activities – advancing future income to annuitants – through a very technical business: life reinsurance. When the company offered victims upfront payments for their rights to future damages, a federal judge annulled 777 Partners‘ contracts with former footballers who had suffered concussions and, due to poverty, were forced to accept unfair conditions. This court ruling undermined the business model of the financial conglomerate grouping insurance companies around 777 Partners.

The fragility of the 777 group was further accentuated by the failure of a last-ditch effort investment strategy: the purchase of historic football clubs considered ‘distressed assets’, with a view to reselling them at a profit. The method was to replicate that of the stock market raiders of the 1980s: hive off the debt into a bad bank and resell the promising assets (stadiums and players). So, 777 Partners bought Cricket & Football Club di Genova, the oldest club in Italy’s Serie A, Red Star de Saint-Ouen, Standard de Liège, and so on. But this strategy turned out to be a triple loser: first, in Genoa in particular, the courts blocked the mistreatment of creditors; second, football’s regulatory bodies, particularly in Belgium, imposed sporting sanctions to penalise the cavalier approach to payroll; and finally, the would-be financial wizards learnt the hard way about the business model of European sports. Whereas in the United States the closed leagues are cartels that produce entertainment profitably, leagues in Europe, with promotion and relegation, force teams to choose between profitability and sporting success.[2] By failing to understand this quickly enough, the directors of 777 Partners found themselves having to advance large sums of money to the clubs they bought – $106 million to Genoa, more than $200 million to Everton before the sale was even completed – without having understood that what drives asset value – namely success – is expensive. Weighed down by its illiquid sports assets, the 777 group drained all the cash it could to keep them afloat until a much hoped-for resale. Unfortunately for all concerned, the operation failed.

3. What lessons can we learn from this unfortunate affair?

This fable teaches us two simple lessons. The first is that the accurate assessment of future values requires the consistent enforcement of a firm regulatory framework. The companies in the 777 Partners group operated in a region akin to the Wild West, where anything goes. They thought their methods would work in European football, but the courts and football authorities proved to be more diligent than the American justice system (which can sometimes act swiftly) in this area. Finally, it only took a week for AM Best to react to the publication of 777 Re‘s accounts, and scarcely more for the regulator to place the company under administrative control based on a mere presumption of account manipulation, because valuing 70% of assets at mark-to-myself simply isn’t done in the insurance industry.

However, if the Bermudian reinsurer had not provided its parent company with a billion dollars in liquidity, 777 would not have flown that far nor caused so much damage. This raises a legitimate question about whether Bermuda offers all the desirable guarantees in terms of reinsurance: it has the words of regulation (the same as in our European directives), the authorities of regulation (Bermuda Monetary Authority), the gestures of regulation (placing under trusteeship), but it is not really regulation… In his novel Schiste noir, Arnaud Chneiweiss described the instrumentalisation of a Bermudian reinsurer in a murky geopolitical affair on a completely different scale to the unpleasant adventure we have been discussing… One of those that European regulation has so far protected us from – precisely because the European regulator enforces the accurate assessment of future values and prohibits European insurers from reinsuring in Bermuda. So, let’s leave the others to sink there.

1https://www.courtlistener.com/docket/68501286/leadenhall-capital-partners-llp-v-wander/
2Andreff W., ed. 2015, Disequilibrium Sports Economics. Competitive imbalance and budget constraints, Cheltenham: Edward Elgar.

 

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Pierre-Charles Pradier – Economist 
Accuracy Talks Straight #11 – The Academic Insight