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.