IAN’S ALERT: The McKinsey Opioid Settlement

We haven’t done an IANS ALERT in a long time. If you’re unfamiliar, IANS stands for “incurred and never spoken“, i.e. the future reserve charges management knows about but the actuaries aren’t made aware of yet.

When Stephen Catlin talks about $200B reserve holes, he is sounding the alarm on IANS losses. You can call them shadow reserves if you prefer.

So why write about them now? Because we had a significant new class of IANS reserves created last week that may have significant repercussions for the insurance industry.

Guilt By Association

McKinsey, the consulting firm, was sued by the government for essentially aiding and abetting Purdue Pharma in selling opioids. They agreed to a $573M settlement to end the case.

What did McKinsey do wrong? They were hired by Purdue to advise them on how to increase their growth. In other words, they did what they do for every other client who hires them.

It’s not like their was some nefarious plot (that I’m aware of anyway) where McKinsey called Purdue and told them “we have a plan to addict more people to painkillers. Pay us a ransom and we’ll let you see it.”

I’m obviously not making light of the very serious issue of opioid addiction and that some parties who profited from it did immoral things to sell more pills.

However, I’m having an awfully hard time seeing how any company that helped Purdue conduct its business is guilty by association.

If consultants are now liable for the conduct of their clients, what about the manufacturers who sold them the machinery to make the pills? Or the trucking companies who transported the pills to the pharmacy? Or the bankers who raised capital for them?

Actually, I should probably stop speculating in case a lawyer reads this and gets ideas! But where does this end? Even in asbestos, the chain of liability stopped well before it got to service providers of the producer.

Deep Pockets

The obvious reason the states went after McKinsey is the same reason asbestos lawyers tried direct actions versus insurers…they have deep pockets. Purdue is bankrupt, so let’s sue everyone who did business with Purdue.

The problem is this won’t be an isolated incident. Next time there is a controversial mass tort target, consultants will be targeted again (and maybe the bankers and vendors too?).

I don’t know what McKinsey’s insurance coverage is for this loss, but I would assume they have a large GL cover and this would presumably apply (unless the settlement barred use of insurance proceeds?).

I would bet that McKinsey was also considered a blue chip account with a really low ROL because of the firm’s prestige. That won’t be the case anymore.

I don’t know how you can write it now. Anytime a client does something bad, they could be found liable.

Since it’s difficult for a consultant to judge whether their client is upstanding or not (and thus turn down an engagement), this will inevitably produce future suits…and future insurance claims.

Who’s Next?

Obviously, these future claims won’t be limited to McKinsey. All consulting firms are now at risk. And they will likely clash.

If there are three manufacturers of a harmful product, they likely use three different consultants (to avoid conflict). So as an insurer, you now have to pick which consultants you’re willing to write to avoid the clash.

We shouldn’t overlook that Marsh and Aon also have significant consulting businesses. In the next financial crisis, will Wyman be sued for any excess risk their banking clients took (if Wyman endorsed the strategy)?

As suggested above, this legal theory can be extended to any type of advisory business. If you hire a marketing firm to sell your product, they’re exposed. If you have outside legal counsel and their advice helped you grow your business, they’re in the line of fire. If bankers raised debt so you could grow faster, they’re guilty.

What do bankers and ad agencies and large law firms all have in common? Deep pockets. So this isn’t going to stop at McKinsey.

How Do Insurers Respond?

This is where the IANS aspect fits in. Odds that anyone raises their GL IBNR for this new exposure? Low. Odds that companies will talk about this as a reason to raise GL prices further. High!

It’s another “free lunch“. Raise pricing for exposure you know you have, but don’t recognize the increased exposure in your loss reserves.

Better to punt and hope by the time the loss actually emerges, something else will break your way to let you avoid showing a big charge.
Aside: Yes, it appears this is also happening with Covid losses as we speak.

So when Catlin advises of giant loss deficiencies, he may be wrong about the magnitude, but he is right about his theme.

The good thing for the industry is, if the trial bar ever finds a way to sue actuaries for underbooking loss reserves (unlikely but crazier things have happened), the management teams won’t be charged with aiding and betting, because there is no proof.

After all, they never speak to the actuaries of the shadow reserves they book in their heads!

In Other News…

When I wrote recently about GameStop, I suggested they needed to raise equity ASAP to take advantage of the higher stock price. They didn’t. Why? They believed they were restricted by their pending year end earnings release.

Which is pretty much the dumbest excuse ever. There’s an easy solution to that…pre-release the earnings. GameStop claims they didn’t have enough time to do that, but when you’re stock is up >10X, you pull 24 hr shifts to get the pre-release out.

So when GameStop eventually does go back to $10 or lower, they will be facing a D&O suit…for not issuing shares at the peak and thus inflicting long term harm on their shareholders that could have been avoided.