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Lancaster waste authority's mysterious
offshore Cayman Islands account

Funds from offshore account
used to pay previous bond issue

LCSWMA's unusual practices seem to be a
'creative-finance fund,' rather than the prudent
insurance used by most Pennsylvania public entities


The proposed purchaser of the trouble-prone Harrisburg incinerator, the Lancaster County Solid Waste Management Authority (LCSWMA), has an unusual insurance problem.

At least some of its risk is not covered by insurers regulated and guaranteed by the Commonwealth of Pennsylvania.



Downloads:

Moody's credit analysis of LCSWMA 2-23-13

A glossary of insurance terms and laws:

Admitted insurance - Admitted carriers are licensed and governed by the laws of the state they are in, and their rates and forms (coverages) are reviewed and approved by that state. Admitted carriers are protected by their state guarantee fund.

Non-admitted insurance - Non-admitted carriers are not licensed and governed by the laws of the state, nor are they guaranteed by that state's insurance fund.

Non-admitted paper - Insurance written from a carrier not licensed by the state.

Captive insurance - Policies underwritten by companies established specifically to insure risk for a particular group or groups.

Surplus line insurance - Insurance from a 'surplus line producer,' providing coverage not licensed by the state.

Third Class City Code of Pennsylvania - mandates that Third Class cities like Harrisburg and Lancaster buy insurance from companies 'duly authorized by law to transact insurance business in the Commonwealth of Pennsylvania.'

The Pennsyvania Code - authorizes, under certain circumstances, the purchase of non-admitted insurance, if admitted insurance is unavailable, or prohibitively expensive.

Instead, the Lancaster waste authority has been attempting to cover risk by unconventional means for a public agency: self-regulated and self-assessed offshore "pools."

At least one such account is based in the Cayman Islands.

LCSWMA also used some of the money supposedly set aside for insurance risk to pay off bond debt.

The unusual methods used by the Lancaster Authority to insure its own incinerator in Lancaster County represents an ongoing controversy that has pitted LCSWMA and its operator, Covanta, against the Harrisburg Authority.

In recent years the Harrisburg Authority was not convinced that LCSWMA or Covanta were carrying adequate insurance, and did not elect to insure the Harrisburg incinerator in the same fashion.


The importance of good insurance at the Harrisburg incinerator was underscored by a recent severe and unexpected mechanical breakdown at the facility.

A small crack was discovered in a single high-tech incinerator turbine fan blade.

The cracked turbine fan blade left the incinerator hobbled for months, unable to burn enough garbage, or to make enough electricity, to generate revenue to pay for itself.

After investigation the cracked fan blade was determined to be a manufacturer's defect.

Following a protracted squabble between the Harrisburg Authority, its insurers and the turbine blade manufacturer, the manufacturer agreed to repair the fan blade under warranty. But the huge turbine fan had to be transported at great expense back to the manufacturer in Texas, and the incinerator was shut down while repairs were made.

The minutes of the Harrisburg Authority, the current owner of the incinerator, reflect the expensive nature of the breakdown, and the importance of proper insurance when things go wrong.

"Approximately $700,000 of the turbine repairs were covered by insurance proceeds," the authority's January 23, 2013, minutes reflect.

The incinerator, fortunately, was covered by a business interruption insurance policy, underwritten by a known Pennsylvania insurance broker.

Next time, under its proposed new owner, the incinerator, its owner, and its bottom line, might not be so lucky.

A '747 fueled by garbage':
Questions about financial strength of Lancaster waste authority

The issue of the Lancaster Waste Authority's insurance coverage goes to the heart of whether the authority has the financial strength to manage the incinerator properly, and meet its obligations, experts says.

LCSWMA is currently in negotiations with a state-appointed receiver to purchase the Harrisburg incinerator from The Harrisburg Authority.

'The issue of the Lancaster authority's insurance coverage goes to the heart of whether the authority has the financial strength to manage the incinerator properly'

But the complexity of the deal, coupled with a history of mechanical problems at the incinerator, has caused Moody's investment service to threaten a double-notch downgrade of LCSWMA's credit rating, to just above non-investment grade.

The months of downtime for the turbine fan repair illustrates the problem.

The incinerator, or the Harrisburg Resource Recovery Facility, as it is known, is a tremendously complicated, high-tech, and temperamental facility.

With turbine fan blades spinning at thousands of RPM to churn out electricity from garbage-heated steam, the plant, at the heart of Harrisburg's financial meltdown, is essentially a "747 fueled by garbage," one long-time observer tells me.

With a history of trouble and mechanical breakdowns, good insurance is a must.

The unseen component: insurance

The incident of the broken fan blade and the months of unexpected down time from 2012 into 2013 reflect not only the complexity of the machine, but also the complexity of the financial deal that requires the plant to be operational, and generating electricity, to make its promised bond payments.

It also explains the importance of proper insurance to cover problems when things go awry.

The authority owning the incinerator must not only be financially able to make repairs and deal with problems such as mechanical breakdown and environmental damage.

Proper insurance also covers business interruption when things go bad, so that the authority can make its promised bond payments and obligations.

By its own admission, the Lancaster Authority may not have the wherewithal to do all this.

The Lancaster waste authority, it turns out, does not rely on state-regulated or -guaranteed insurance for all of its risks, as does the Harrisburg Authority.

Nor may the Lancaster Authority, by its own admission, be able to afford adequate, state-guaranteed insurance for its risks.

So it has to go overseas.

Without the proper insurance, LCSWMA may not have enough money to make its bond payments should the unexpected catastrophe occur.

And since the usual state insurance pool does not guarantee some of the Lancaster Authority's offshore "insurance," there may be no money from the Commonwealth of Pennsylvania to backstop a financial crisis, should one arise.

In which case, should a series of bad events unfold, LCSWMA could default on its bonds.

Bone of contention: offshore 'insurance' accounts

LCSWMA financial reports shed only a little light on the issue.

In LCSWMA's 2012 Full Audited Financial Statement, as in earlier years, LCSWMA reports:

"The Authority self insures certain risks, for which commercial insurance is not economically available including pollution occurrence, through the Government Self Insurance Fund, an entity which is separate from the Authority. Each participant in the fund contributes to this entity on a self-assessed basis. Contributions are placed into a trust and managed pursuant to a trustee agreement. The available self insurance coverage was $3,923,307 and $3,934,326 at December 31, 2012 and 2011, respectively. The agreement for formation of the fund provides that the fund will be self- sustaining through member premiums."

Among other problems, LCSWMA isn't being totally forthcoming in this and other financial statements.

It turns out, there is no insurance company called "Government Self Insurance Fund," as described by the authority's financial reports.

Neither is there a "Government Self Insurance Fund" listed with Pennsylvania Insurance Department, says Melissa Fox, a spokesperson for the department.


'It turns out, there is no insurance company called Government Self Insurance Fund, as described by the Lancaster authority's financial report'

Nor would such a fund, not registered with the state, be overseen or guaranteed by the state in the event of financial collapse, says Fox.

So there is no public "backstop" should this fund be found to be insolvent, or without enough resources to cover a serious problem.

Elsewhere, LCSWMA provides other clues as to what this mysterious "Government Self Insurance Fund" may actually be.

In its 2009 financial statement, LCSWMA reports, "The Authority has also issued a letter of credit to Raffles Insurance, Ltd. to guaranty payment of additional captive insurance premiums."

Raffles Insurance, Ltd., is a private, offshore concern based in the Cayman Islands.

In its September 7, 2010 Board of Director minutes, LCSWMA further states, "Workers' Compensation, Automobile, and General Liability are covered through Raffles Insurance, Ltd."

Raffles is not registered, overseen, or backed by the Pennsylvania Insurance Department, according to a state website listing companies "admitted" and licensed to underwrite insurance policies in Pennsylvania.

Causing further concern, LCSWMA revealed in its 2009 financial statement, "During the year ended December 31, 2009, the Authority received $3 million from the fund as a return of prior period contributions. This amount is included in miscellaneous non-operating revenues in the accompanying statements of revenues, expenses, and changes in net assets, and was used by the Authority to effect the redemption of the Series A of 1998 bonds."

So the mysterious fund is not only self-assessed.

Funds supposedly needed for insurance risks were taken in and out of the account to pay off bonds from the previous decade. This would certainly not be the case for traditional insurance policies or coverage, experts say.

These unusual practices seem to more reflect a "creative finance fund," rather than a prudent standard insurance pool used by most public entities, including cities and counties.

Admitted vs. Non-admitted insurance:
Mandated by Pennsylvania's Third Class City Code, and the Pennsylvania Code

Because they are not "admitted," or not licensed, to underwrite insurance in Pennsylvania, Raffles, Ltd., and similar offshore concerns are known in the trade as "non-admitted" insurers.

These firms issue what is called in the insurance trade "non-admitted paper."

The use of admitted vs. non-admitted insurance in turn is governed by various state laws, including the Third Class City Code, and the Pennsylvania Code, says Bob Anspach, an insurance expert with the Pennsylvania Municipal League.

Third class cities like Harrisburg and Lancaster are supposed to first attempt to purchase "admitted-paper insurance," says Anspach.

Pennsylvania's Third Class City Code (Section 2403 - Specific powers) for example, enables a city council to, "make contracts of insurance with any mutual or other fire insurance company, association or exchange, duly authorized by law to transact insurance business in the Commonwealth of Pennsylvania, on any building or property owned by the city."

The code further mandates (Article XIX - Contracts) that this restriction applies to contracts made between a city like Harrisburg:

"involving any policies of insurance or surety company bonds; those made for public utility service under tariffs on file with the Pennsylvania Public Utility Commission; those made with another political subdivision or a county, the Commonwealth of Pennsylvania, the Federal government, any agency of the Commonwealth or the Federal government, or any municipal authority," such as LCSWMA.

There are exemptions in law allowing for non-admitted paper insurance, Anspach points out.

If insurance is non-attainable through a licensed carrier, or is too expensive, a public entity may have to insure itself through an offshore carrier of non-admitted insurance paper.

For example, in the Harrisburg Receiver's financial recovery plan, former Harrisburg Receiver David Unkovic noted, "In interviews (with Harrisburg's insurance team), it was indicated that Travelers, who had been providing the City with its insurance needs for several years, chose not to renew their program due primarily to the City's financial condition. (The city) was successful in having Brit Insurance, a London insurer, agree to provide a renewal offering."

In this case, Travelers insurance (an admitted company) no longer wanted to insure the financially risky City of Harrisburg. So Harrisburg, in a financial bind, had no choice but to turn to insurance from Brit Insurance, a carrier not licensed in Pennsylvania, but a member of the Lloyd's of London syndicate.

The Pennsylvania Code and surplus line insurance

Insurance not admitted or licensed by the Commonwealth of Pennsylvania is called "surplus line insurance," Anspach explains.

The rules governing when a third class city such as Harrisburg or Lancaster, or its authorities, can turn to surplus lines are found in the Surplus Lines Law of the Pennsylvania Code (Article 16 of the Insurance Company Law of 1921, May 17, P.L. 682, as amended and supplemented).

Section 1604 of the Pennsylvania Code states:

"Insurance may be procured through a surplus lines licensee from nonadmitted insurers if the following requirements are met:

(i) The full amount or kind of insurance cannot be obtained from admitted insurers.

(ii) The full amount or kind of insurance cannot be obtained from any admitted insurers because coverage comparable to the coverage being sought generally is not available in the authorized market.

(iii) The kind of insurance sought to be obtained from admitted insurers requires a unique form of coverage not available in the admitted market.

In other words, by law, the surplus line insurance can only be used by public entities such as the Harrisburg or Lancaster waste authorities if admitted and licensed insurers will not write the coverage, or if the entity can't afford the coverage offered by licensed insurers.

And all this is supposed to be documented by the authority purchasing the insurance.

All of which raises some interesting questions.

If the Harrisburg Authority is able to purchase admitted insurance from companies licensed in Pennsylvania to insure its incinerator, why can't the Lancaster Authority also insure its plants using the same lawful methods?

Is the Lancaster Authority unable to afford proper insurance?

If so, this tends to underline and reinforce Moody's concerns about LCSWMA and its financial strength.

Lastly, just what exactly are the unusual offshore accounts used by the Lancaster County Solid Waste Management Authority, and why did LCSWMA turn to them?

 

-- Bill Keisling
posted April 16, 2013

 

 

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