Actuary Law

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Even flawed actuarial work can be a defense to a securities fraud claim

Flawed actuarial work provided a defense for the individual officers and directors who relied on it in a recent decision by the federal district court for the Southern District of New York.    In re CRM Holdings, Ltd. Securities Litig. (S.D.N.Y., May 10, 2012).  This decision on a motion to dismiss a securities class action by the public shareholders of CRM Holdings, Ltd. (CRM) offers some useful language for defense of misrepresentation claims against actuaries and insurance company management.

CRM provided administration services to run various group workers compensation self insurance trusts in New York and California.   After an initial public offering in December 2005,  at least one large trust in New York administer by CRMH, the Health Insurance Trust of New York (HITNY), came under scrutiny for apparent under-reserving.   The court decision describes various criticisms raised the following year of the reserves set by the independent actuaries hired by HITNY.  Although CRM’s financials were not directly impacted by those reserves, the ability of CRM to continue to generate fees from HITNY and other trusts depended on the continued viability of those trusts.

In early 2008, the majority of the trusts which made up the business of CRM in New York had terminated, and the company’s stock price had dropped dramatically, leading to this securities fraud class action lawsuit against individual officers and directors.   This decision ruled on the defendants’ motion to dismiss the complaint on the basis that it had not alleged the requisite “scienter” — a knowing intent to deceive the investing public.   

Despite the fact that there were numerous alleged criticisms being heaped on the original independent actuary of HITNY for under-estimating reserves during the class period, the Court found that just alleging that an actuarial reserve estimate is wrong is not sufficient to show an intent to deceive:

Plaintiffs allege that “[t]he magnitude of the reserve  insufficiencies  here  supports  a  strong inference  of  scienter.”  (Id. at  39.)  However,  as discussed  supra, while  CRM  established  initial loss  reserve  amounts  for  the  trusts,  it  was  the responsibility  of  an  independent  actuary  and accountant     to     ensure     that     the     claims liability/expense   amounts   reported   by   CRM were  accurate.  See,  supra  p.  9-10.  Insurance reserves   “are,    by   their    nature,    ’extremely conjectural,  and  may  need  adjustment  as  time passes  and  their  accuracy  can  be  tested  in retrospect.’”  Zirkin  v.  Quanta  Capital  Holdings Ltd., No. 07 Civ. 851 (RPP), 2009 WL 185940, at   *11   (S.D.N.Y.   Jan.   23,   2009)   (quoting Stephens  v.  National  Distillers  &  Chem.  Corp., 6  F.3d  63,  65  (2d  Cir.  1993)).  Reserves  are opinions,  and  the  Complaint  must  allege  facts showing  ”that  defendants  did  not  truly  hold those  opinions  [either  knowingly  or  recklessly] at  the  time  they  were  made  public.”  Fait  v. Regions Fin. Corp., 712 F. Supp. 2d 117, 124-25 (S.D.N.Y.  2010).  Plaintiffs  have  not  made  any such  allegations  in  the  [Consolidated Amended Complaint]. 

This discussion of reserves now goes into my folder of cases to cite when someone argues that an actuarial estimate which misses the mark by a wide range must have meant that the actuary was guilty of fraud. As the decision says, loss reserve estimates are opinions, and while an erroneous opinion might vary widely from what actually develops, it creates no inference of fraudulent intent. In this case, the existence of an independent actuary issuing a reserve opinion, even an opinion that was alleged to be flawed and wide of the mark, was sufficient to provide protection to individual officers of CRM from being forced to defend themselves in a securities fraud case.