CLICO Unplugged: An Insider’s Perspective By the Business GURU {Devil’s Advocate #5}

by DevilsAdvocate / March 30th, 2010

There are more questions than answers
Pictures in my mind that will not show
There are more questions than answers
And the more I find out the less I know
Yeah, the more I find out the less I know

– Johnny Nash

This episode of Devil's Advocate is on a matter near to everyone who invested with this firm - CLICO

It is with some reluctance but also a keen sense of duty that I enter the debate over CLICO in Barbados and the Caribbean. I’ve listened very carefully to the issues on all sides and to the rhetoric by other business leaders, politicians and most regretfully from CLICO itself. I have decided to pen this essay to place the issues into perspective.

At the outset let me declare that many of my friends are CLICO agents and many more friends and relatives have invested various sums of money with CLICO. In my professional life, I am directly involved in the management of a company in the financial services industry. In a sense I therefore have both a personal interest and a professional interest in the way in which regulated entities conduct themselves in Caribbean Markets.

First let me commend CGI and Barbados Public Workers Cooperative Credit Union for their brave efforts at purchasing two of the CLICO Holdings Subsidiaries. Barbadians may never fully understand nor appreciate the selfless position these two entities took by intervening in the market and effectively providing a lifeline to the rest of the CLICO Group. While I do not have any specifics in hand, based on previous experiences, I would imagine that those entities would find it difficult to extract CLICO General and CMFC from the CLICO Holdings Group.

An explanation may be required. Within a group such as this it is usual for such things as IT, HR, Compliance, Internal Audit, General Administration, Property Management even Cleaning to be outsourced to some other related company. That would allow the Group as a whole to benefit from economies of scale which smaller companies would never achieve. This would however make disentangling these entities difficult because each company focuses on its core business and does not have the other key life-support systems necessary to live.

A somewhat bizarre analogy would be to see CLICO as a Siamese triplet. As a whole the body functions fine, but when separating, each of the triplets may be missing an arm, or a leg or some other more vital organ. Upon separation it may then be necessary to add a prosthesis or maybe perform an organ transplant.

If you make use of an internet search facility that is made available by the local Corporate Affairs Dept., you will see the following list of companies that are locally registered and which presumably would be part of the CLICO Group. This list does not capture any associated or related company that does not carry “CLICO” as part of its name.

CLICO ADMINISTRATIVE SERVICES INC.

CLICO AGRICULTURAL DEVELOPMENTS INC.
CLICO BALANCED FUND INC.
CLICO CORPORATE SERVICES INC.
CLICO FINANCIAL COMPLEX INCORPORATED
CLICO FINANCIAL HOLDINGS INC.
CLICO HOLDINGS (BARBADOS) LIMITED
CLICO HOTELS INC.
CLICO INTERNATIONAL GENERAL INSURANCE LIMITED
CLICO INTERNATIONAL LIFE INSURANCE LIMITED
CLICO INVESTMENT BANK LIMITED
CLICO MORTGAGE & FINANCE CORPORATION
CLICO PROPERTY DEVELOPMENT INC.
CLICO TELEMEDIA (B’DOS) LIMITED

Just the names of these companies would give you a sense of the scope and reach of the CLICO Holdings group within the local context.

How CLICO worked

CLICO not unlike other insurance companies around the globe had a very simple business proposition. They developed a team of exceptional Sales Associates, who were skilled in the art and science of closing sales. Each year this sales force was set targets and every year over the past several decades they made these targets and were well-rewarded for their efforts.

The company took this premium income and after paying these commissions, they invested the balance.

However, we all know that in the Caribbean it is difficult to find appropriate investments so after buying all the bonds, equities and unlisted securities it could, CLICO turned to actually buying other companies in an attempt to legitimately invest the funds it had taken from its policy-holders.

That in itself was no problem. However, CLICO could be called an institutional investor and prudent institutional investors have an appreciation for the role that Governance can play in influencing the success or otherwise of the investor. The prudent investor fully understands the investments he makes and has appropriate corporate governance and risk management practices.

Risk Management

CLICO’s risk management framework ought to have embraced the idea that if any asset they invested in was held in another currency there was a risk that currency movements alone could affect the value. This is referred to as “currency risk.”

Many forms of investment may not be readily saleable on the open market (commercial property for example). It is also possible that the market may have small capacity and it may therefore take a long time to sell. Assets that are easily sold are termed liquid; therefore this type of risk is termed “liquidity risk.”

The risk that there may be a disruption in the internal financial affairs of the investment, thereby causing a loss of value, is called “financial risk.” A prime example of that form of risk was experienced by the investors in Enron, or one of the “dot-com” stocks that really never did have a profitable financial footing.

Perhaps the most familiar but often least understood form of investment risk is “market risk.” In a highly liquid market like the collective stock exchanges in the United States and across the developed world, the price of securities is set by the forces of supply and demand. If there is a high demand for a given issue of stock, or a given bond, the price will rise as each purchaser is willing to pay more for the security than the last one. The reverse of that occurs when the sellers want to rid themselves of an issue more than the buyers want to buy it. Each seller is willing to receive less than the last one and the market price, or valuation, declines.

These same forms of risks apply to a house, an issue of stock, a mutual fund, or a bond. Some forms of investment risk can be insured against. For example, the risk that an investment rental property might burn down, or the custodian of your stock and bond investments might go out of business.

When you look at CLICO’s overall investment portfolio, it becomes obvious that the risks were complex, interconnected and indeed created a special form of risk called contagion risk – the risk that an event in one company could negatively affect another company within the group.

Given all that has happened, if there was an effective risk management framework, surely CLICO would feel compelled to share it with the public at least to assure the public that it was managing prudently.

Governance

Another key aspect of the CLICO matter is Governance. For our purposes I would simply use the Wikipedia definition: “the set of processes, customs, policies, laws, and institutions affecting the way a corporation is directed, administered or controlled. Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. The principal stakeholders are the shareholders, management, and the board of directors. Other stakeholders include employees, customers, creditors, suppliers, regulators, and the community at large.”

In the case of CLICO, I would also add the policy-holders as a key part of the Governance framework.

As we have established, the Management, Shareholders and the Board are key to the Governance process. The Shareholders elect or select the Directors who constitute the Board. The Board in turn selects a competent management team to conduct the day to day operations of the company. In the case of CLICO, it would appear that there was significant interlocking within Boards within he Group. It also would appear that in the case of Barbados, the Chairman was effectively Executive Chairman and functioned as a maximum leader. It is reasonable to conclude that both in terms of Board and Management there was little or no consideration for professional advice or appropriate discussion on issues that were central to the company.

Furthermore, both the management and the Board had a fiduciary responsibility. A fiduciary is expected to be extremely loyal to the person to whom he owes the duty and should not put his personal interests before the duty. In the case of CLICO I would make a distinction between any deposit-taking, investment or life-insurance arms and the other administrative and holding companies which could arguably be held to a somewhat lower standard.

Readers would appreciate however, how difficult it would be to put on one hat as a fiduciary in the insurance arm, where there is also a duty of care to the institution and try to make decisions that are strictly in the best interest of that specific institution and then to put on another hat and make decisions in the best interest of another company within the group—especialy in situations where there was likely conflict.

For example a life insurance company could made an investment in a hotel management company on the basis of a propectus and with a particular projected return. If the expected return did not materialise, prudent Directors of the life insurance entity would do all that they could to recover the original investment even to the detriment of the hotel management company.

If we use a similar scenario and apply it to CLICO, it could be argued that a conflict of duty could exist between the Directors of say the insurance arm and the hotel arm because the Directors of the Insurance arm might be constrained or minded to act in the best interest of the Group as opposed to the best interest of the insurance entity. This would be even more true if the boards were largely the same individuals. In this case it could be argued that there was a breach of fiduciary duty to the policy-holders.

A key part of Governance is also the environment within which decisions are made. Directors must be free to ask questions and fully ventilate relevant points. Mr. Parris would have to confirm that he in fact created such an environment in the CLICO Board-room.

Another issue is the interaction between Board and Management and the extent to which there is separation of duties. What were the specific reports that were required of management? Were such reports forthcoming? What actions did the Board take for example when it discovered that the Statutory Fund was deficient? Prudent Directors in an Insurance company surely would get reports on statutory requirements to ensure that the company was being run according to the Laws of Barbados.

As Chairman of the Board of Directors, Mr. Leroy Parris has a duty to inform the public when the Directors became aware of the issue, what was being done by the Company to right that wrong and what timeline they had agreed with management to achieve that objective. Surely in a responsible insurance company following the appropriate legislation is important.

Regulatory Environment

Illustration Courtesy Barbados Free Press - This Representation is BFP's and not necessarily endorsed by TBR

While CLICO has to take full responsibility for what appears to be a catastrophic failure of its Corporate Governance and Risk Management frameworks, it is difficult to understand where the regulators were in all this. In Barbados for example it could be argued that the Central Bank of Barbados had some limited jurisdiction over even the insurance company because within the group was one entity which was regulated by the Central bank. The Bank under the Financial Institutions Act had the right to inspect other companies within the CLICO Group.

But what of the Supervisor of Insurance? Was that functionary asleep at the wheel? While there is no excuse for the Directors of CLICO not maintaining the Fund in accordance with The Insurance Act, the Supervisor ought to have intervened. Indeed a key issue is also whether or not the Company was declaring dividends during the years while its Statutory Fund was deficient. Section 26-6 of the Insurance Act suggests that no such dividend ought to be declared until the Statutory Fund is in tact. My question to Mr. Parris is therefore can he assure his policy-holders that during the period, no dividends were declared in respect of the Insurance companies of which he is Chairman?

Corporate Structure

A few comments with regard to the complexity, and I daresay, sheer genius of the CLICO structure.

I have often heard it bandied around that CLICO was an outstanding corporate citizen which contributed to Government’s coffers through its corporate and other taxes. While I am not privy to any financial information other than that which is required to be made public by Statute, it is common with complex structures like CLICO’s for such companies to pay no taxes to Government. What the group does is to run certain of the companies at losses to offset the taxes they would otherwise pay through the regulated entities. Central bank and the Supervisor of Insurance would frown on unprofitable financial and insurance institutions but would not be as concerned if some other entity like a Real Estate Holding Company were to make a massive loss and effectively wipe out the tax liability of the Group as a whole.

Someone has to therefore clear the air as to whether or not CLICO was making its contribution as a corporate citizen. All of us Barbadians pay our taxes and try our best to so manage our affairs as to limit our own personal tax exposure. But we do actually pay taxes. The Executive Chairman and his accounting advisors must assure Barbadians that the CLICO companies were actually making a contribution to this country’s tax intake.

Conclusion

There are many persons in Barbados who owe, not so much the public, but more importantly the Policy-holders of CLICO, a complete candid set of answers, free of rhetoric and put in the simplest form.

It is being re-iterated Parris is still Chairman, so he owes the first set of explanations. It is his s responsibility even if he chooses to delegate it. If you are in charge, you have to face the music at crunch time. The Board of Directors must also show that they are in charge and hold the policy-holders’ best interests at heart. The Board should have a full investigation and someone has to be held responsible. If no-one is responsible, the members of the Board will have to answer other questions.

Mr. Thornhill and the other members of CLICO’s management team should be more candid and direct in their statements, and should acknowledge responsibility for this state of events. Since the possibility of a CL Financial failure must have been one of the contingencies they were planning against.

CLICO B’dos’ Chairman most importantly has to speak out on the issue of Pensions. As I understand it these funds ought to be segregated and managed separately. I am yet to hear a definitive set of assurances that these various pension funds are fully intact. If they are not intact, CLICO also has to come under closer scrutiny with a view to whether or not there was any breaking of statutes on the part of the company.

The Government of Barbados also needs to provide the public a full explanation of what appears to be a systemic failing of institutions that were created to protect the public interest. Furthermore, the former Prime Minister ought for the record to explain what was happening under his watch or that of any other Minister who might have had responsibility for the Office of the Supervisor of insurance.

There is no doubt that we have come through and may still be experiencing one of the toughest and greatest of all recessions. It is therefore anticipated that there will be some business failures and some distress within the private sector. What is outrageous in this CLICO situation is that it continues to be business as usual. No investigations to determine responsibility. No-one is taking responsibility.

In the absence of such information, Government is creating a moral hazard in which some actors with more information than others can exploit the situation. Equal access to the information surrounding CLICO is extremely important if Barbados is to recover from this challenge.

Moral hazard can also occur when upper management is shielded from the consequences of poor decision making. This situation can occur in a variety of situations, such as the following:

• When a manager has a secure position from which he or she cannot be readily removed.
• When a manager is protected by someone higher in the corporate structure, such as in cases of nepotism or pet projects.
• When funding and/or managerial status for a project is independent of the project’s success.
• When the failure of the project is of minimal overall consequence to the firm, regardless of the local impact on the managed division.
• When there is no clear means of determining who is accountable for a given project.
• When senior management has its own remuneration as its primary motivation for decision making (example:. hitting short term quarterly earnings targets or creating high medium term earnings, without due regard for the medium term effects on, or risks for the business, so that large bonuses can be justified in the current periods).

Now, a few comments for the policy-holders who seem to be forced into a situation where they are taking the full responsibility for what happened with CLICO. They are the ones who seem destined to receive a few cents on the dollar for their hard-earned investments.

They should be seeking legal advice and seeking out each other with the idea of planning class action law-suits against the Boards, against CL Financial, against any entity or individual who may have erred in law or failed in their duty to them as fiduciaries. Their fiduciaries within the CLICO Group appear to have failed them, Government too appears to have failed them. It is left to the policy-holders to act swiftly to protect their own interests.